Whilst it’s incredibly hard to look beyond the spiralling human crisis in Ukraine, as custodians of client capital it’s also important that we remain alert to potential opportunities thrown up by markets, which at times like this have a tendency to be even less rational than normal. As Ben Conway surmised last week, our assessment of potential opportunity is founded on changes in valuation and margin of safety as opposed to trying to forecast how a hard to predict geopolitical event might play out. It’s in this context that we revisit an investment we have covered in this blog before – Hipgnosis Songs.
Hipgnosis Songs is a London listed investment trust that since launch in 2018 has amassed a diversified portfolio of around 65,000 songs, a fair few of which are regarded by the good people at Rolling Stone Magazine as all-time greats. The royalty income earned from these catalogues support a targeted dividend of 5.25p pence per share which on the current share price equates to a not too shabby yield of 4.7%. Underpinned by streaming growth and active management, there is also scope for capital uplifts with the manager targeting a total annual return of 10% which looks attractive relative to the paltry returns available from large swathes of the fixed income market and also in the context of still expensive equity valuations which are likely to temper returns from that asset class going forward. The fact that the underlying cashflows should exhibit little economic sensitivity – people listen to music when they are happy and listen to music when they are sad – has further appeal in an environment in which it is arguably harder than ever to identify truly diversifying assets.
Despite these attributes, the Hipgnosis share price has swooned from a high of 130p in November 2021 to touch a low of 99p earlier this week. The net asset value (NAV) of the underlying portfolio has not changed over that period, but the shares have derated from a high single digit premium to, at its widest point, a 20% discount. The process of monitoring our existing holdings is a relentlessly ongoing process, but when responding to dramatic downward share price moves like this it is particularly important to reassess the original investment thesis in an objective manner and to apply ‘the clean sheet of paper test’ as we sometimes put it. Being cognisant of behavioural biases, particularly anchoring and overconfidence in the original investment case, are particularly important. On the other side of the ledger avoiding the pitfalls of herding behaviour and crowd following are also key. In short, focussing on the long-term fundamentals and how (if) they have changed is critical, as is maintaining the dexterity to exploit shorter term shifts in sentiment and technical situations.
There is no denying that Hipgnosis has had its own issues of late. Neil Young’s well publicised spat with Spotify led to some exaggerated claims regarding the resulting impact on Hipgnosis revenues but also raised question marks regarding the extent of actual control the manager exerts over acquired catalogues. The news last October that the investment advisor had entered a partnership to manage private funds on behalf of private equity behemoth Blackstone, also resulted in concerns over resource allocation and potential conflicts of interests when making new acquisitions. These ‘on the surface’ stock specific negatives together with the wider Ukraine inspired market turmoil, combined to create something of a perfect storm.
Time then to revisit the investment in depth; to ask has anything really changed; to try and discern the signal from the noise. The Neil Young story can be firmly put in the ‘storm in a teacup’ category given the small proportion of overall revenues that catalogue accounted for and more importantly the fact that the publicity afforded by the Spotify story actually resulted in more people listening to Harvest Moon et al than normal. Meanwhile the Blackstone deal has the benefits of adding significant resource and broadening the capability of the investment manager from which Hipgnosis Songs will benefit. We are also comforted by the clear conflicts policy the manager has in place and expect new acquisitions to be allocated on a pro-rata basis. More importantly, looking longer term the key drivers of future revenue growth look well set. Streaming growth forecasts remain buoyant and live performance earnings are set to recover post lockdown providing a lovely market tailwind for the trusts cash flows. Meanwhile the manager has invested heavily in both its royalty collection and song management resource (placing songs in adverts and fast-growing social media platforms) which will help maximise and drive revenues from the existing portfolio of songs going forward. With the asset class maturing and attracting significant capital we also think the NAV is materially undervalued. The 8.5% discount rate seems high to us in relation to that used in other alternative asset classes, whilst we also note that the independent valuer gives no credit to the portfolio effect that should accrue given the attractions of such a strong, diversified collection to a third-party buyer (private equity for arguments sake). Concerns around overpaying for new catalogues are valid but softened by the immediate pipeline where the manager would expect to transact at multiples in line with the existing portfolio. Such concerns are somewhat academic right now anyway, given the current double discount on which the shares trade. Tyres kicked. No major concerns.
Heightened volatility shifts in sentiment and large valuation moves can ultimately present opportunities for disciplined investors. An investment that has become significantly cheaper without any marked deterioration in fundamentals represents a more positively asymmetric return profile than before and, in the context of sensibly diversified portfolios, should become a higher conviction position as a result. As nimble, valuation led investors we are well placed to exploit these sorts of anomalies as they arise and remain poised to react to any further volatility these troublesome times might throw at us.
Ben Mackie – Fund Manager
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