If you’ve been reading MBW closely this year, you’ll definitely know two things about Hipgnosis Songs Fund in 2021: (i) It’s been buying major league copyrights at a rate of knots; and (ii) It’s been under some pressure to disclose more about the prices it pays for catalogs – and the calculations it uses to decide on those prices.
A dose of that pressure came from investment bank Stifel earlier this year.
Amongst other criticisms, Stifel questioned Hipgnosis’ practice of reporting estimated accrued revenue – i.e. the money the company believes it has coming down the pipe, but which isn’t yet in its bank account.
For a music publisher who could be waiting over a year for money collected abroad to arrive from PROs, suggested Stifel, this practice could cause investor concern over cash-flow.
Today (March 16), Hipgnosis has made significant upgrades to its investor disclosure going forward, including two moves clearly designed to allay any chatter over the way it reports accrued income.
For the music industry, there’s an interesting story revealed by the first of these moves: a commitment from Hipgnosis to report “Variance Against Forecast (VAF)” to investors in the future.
VAF, explains Hipgnosis, will show the difference between the total of the royalty statements received from each catalog Hipgnosis has bought, versus what the company predicted these catalogs would generate in turnover at the time of purchase.
In layman’s terms, VAF will show the difference between what UK-listed Hipgnosis thought its songs would be earning, and what they’re actually earning.
“The VAF for all catalogs owned as at the 30th September 2020 was +0.4%, meaning that royalty statement revenue is, in aggregate, higher than forecast at the time of acquisition.”
Hipgnosis investor update
In its note to investors, Hipgnosis explained: “The VAF is expressed as a percentage point deviation from zero, where a positive number means that the actual performance of the portfolio is tracking ahead of the cumulative forecast. A negative number indicates that the portfolio is falling behind forecast.
It added: “The VAF for all [Hipgnosis] catalogs owned as at the 30th September 2020 was +0.4%, meaning that royalty statement revenue is, in aggregate, higher than forecast at the time of acquisition.”
So whatever Hipgnosis spent on its song portfolio (a debate that’s no doubt continuing to rage through the music industry as we type), the songs the company owned as of September 2020 had earned very slightly more (+0.4%) than what the firm originally predicted they would.
Which begs the obvious question: How does Hipgnosis (or, more accurately, its investment adviser) actually calculate what its acquisitions will earn in the future?
The company revealed that today, too.
Within a detailed explanation of VAF to investors, Hipgnosis wrote: “As part of its due diligence prior to acquiring every catalog [our] investment adviser constructs a financial model which analyzes the past performance of a catalog, removes revenues that it deems to be non-recurring to establish its baseline earnings, and forecasts its future earnings.
“The key assumptions in [this] financial model are (1) expected market growth or decay from peak earnings (in the case of catalogs with a weighted average vintage of less than 10 years); (2) expected uplifts in revenue from bringing efficiencies to the collection of royalty payments; and (3) uplifts from active Song Management.”
Hipgnosis further explained that its estimates for administration efficiencies and Song Management potential are analyzed individually for each catalog based on their individual characteristics.
However, Hipgnosis also revealed that its market growth and decay assumptions (i.e. how much a song’s earnings will grow or decline) are based on a set model, which we dig into below.
Hipgnosis Songs Fund: How it calculates asset prices
For catalogs with weighted average earnings greater than ten years, Hipgnosis (via its investment adviser) applies the following growth assumptions.
As you can see, the company bases its valuations here on the idea that performance income will continue to rise by 6% YoY every year from 2021-2025, but that other income (namely downloads and mechanical) will decline by double-digits in each of these years.
The company is also assuming that streaming revenues for these established ten-year-plus songs will grow by 21% in 2021, then another 18% in 2022, then another 17% in 2023.
Hipgnosis also revealed today the growth/decay assumptions it makes about songs that it acquires which have less than ten years of annual earnings to their name.
As you can see below, this forecast is based on what a song will earn versus the year of its release (which one would presume to be its peak year of popularity).
The company predicts, for example, that streaming earnings will decline by 19% in both the first and second year after a modern hit’s release, but that this drop-off will plateau to single-digit declines, and then single-digit growth, in the years that follow.
In addition to Variance Against Forecast (VAF), Hipgnosis also committed today to publish Pro-Forma Annual Revenue (PFAR) figures for investors in future. This is seemingly a direct answer to Stifel and others who’ve questioned how the company treats accrued income in its finances.
Hipgnosis explained: “Due to the process of royalty collection, Hipgnosis is required under IFRS to accrue for a proportion of its revenue where revenue has been earned but where cash has not yet been received. These accruals are highly accurate due to the reliable and predictable nature of song income.
“Whilst we are working on providing new detailed analysis of our portfolio of songs and their performance, the additional performance disclosures announced today will offer rich analysis as we present like-for-like data points over time.”
Merck Mercuriadis, Hipgnosis Songs fund
“To support investors’ understanding of the underlying annual revenues of its current portfolio of songs, without the impact of timing of the addition of newly-acquired portfolios, estimated IFRS revenue accruals and non-recurring contractual ‘Rights To Income’ (RTI) in relation to periods prior to acquisition, [Hipgnosis will now also] provide a Pro-Forma Annual Revenue (PFAR) which comprises revenue as per royalty statements received.”
Thus, investors will now be able to see clearly both Hipgnosis’ total revenues (including accrued income), as well as pro-forma revenues (i.e. the money that’s actually landed in its bank account).
Said Hipgnosis: “The PFAR of the portfolio owned as at 31st December 2020 for the 2019 calendar year was USD 111.7m equal to 11.04 cents per ordinary share in issue as at that date.”
Merck Mercuriadis the Founder and CEO of Hipgnosis Songs Fund Limited said: “As we approach our third annual report since launch in 2018, we are committed to providing additional disclosure to our shareholders which seeks to look through our rapid growth, and give a consistent basis to evaluate our performance and prospects.
“Whilst we are working on providing new detailed analysis of our portfolio of songs and their performance, the additional performance disclosures announced today will offer rich analysis as we present like-for-like data points over time.
“This work, led by our Chief Financial Officer, Chris Helm, Chief Operating Officer, Björn Lindvall and Commercial Finance Director, Samantha Garcia, represents an important step in our commitment to improving and delivering best in class market disclosures. This will be enhanced further in the future with the contribution of our new Executive Vice President Richard Rowe.”Music Business Worldwide