Merck Mercuriadis seems willing – currently – to trade in his ‘call option’ at Hipgnosis Songs Fund. So why is the company’s board offering to ‘bribe’ potential bidders with a £20 million bung in an attempt to offset it?

Continue to article...

What’s happened?

If you’re interested enough to read this article, I’m going to go ahead and assume that you have a rough handle on what’s been going on at Hipgnosis Songs Fund.

In short: shareholders are very unhappy with the UK-listed firm’s current valuation on the London Stock Exchange (around USD $1bn), and have ushered in a new board.

That board, led by Chairman Rob Naylor, seems to be continually aiming its arrows, publicly, at the firm’s investment adviser: Blackstone-backed Hipgnosis Song Management (HSM) and its leader, Merck Mercuriadis.

Said arrows are ultimately being slung at Mercuriadis because of one reason more than any other: Mercuriadis (and HSM) has a ‘call option’ protection to acquire HSF in certain circumstances – particularly if HSM is ever sacked by the HSF board (or a new private owner) as the firm’s investment adviser.

Needless to say, the new HSF board does not like this one bit.

Tied in with that, Mercuriadis (and HSM) also has access to big pots of cash – via Blackstone. So, if that ‘call option’ ever came into play, putting money where Mercuriadis’ mouth is… likely wouldn’t present a problem.

Yesterday (January 18), things took a frankly bizarre turn.

In the morning, the Hipgnosis Songs Fund board issued a proposal to shareholders that, if accepted, would mean HSF paying any third-party bidder who comes forward with a “recommendable” acquisition offer for HSF (and its portfolio) a fee of up to GBP £20 million.

This proposed £20 million bung, according to the HSF board, would ensure that these third-party bidders would “not [be] deterred from seeking to engage with [HSF] regarding a recommendable offer for the company’s assets as a result of the terms of [HSM’s] call option“.

The Times has since described this bung as “bidder bribery”.

Here’s the weird bit.

On Tuesday (January 16)– two days before HSF’s £20 million “bidder bribery” announcement yesterday – Merck Mercuriadis informed the HSF board in writing that he was willing to trade his ‘call option’ away.

The Financial Times reports that, in exchange for giving up this ‘call option’, Mercuriadis wants a guaranteed multi-year agreement for HSM to continue as HSF’s investment adviser.

The Times followed up on the matter in its City column today, reporting: “[Rob] Naylor is not being entirely straight with the market. This week he received a strings-attached proposal from Mercuriadis’ management firm offering to drop the call option.”

(HSM has since confirmed that Mercuriadis’ ‘call option’ offer was “verbally communicated to the [HSF] board in December 2023” and that “this was formalised in a written proposal that was delivered to the Board on 16 January 2024”.)

So. The 35% of Hipgnosis Songs Fund shareholders who, according to Naylor, have backed the £20 million bung plan, are now probably left asking: “But if there’s no ‘call option’… why are we offering to give away £20 million of HSF’s money to third-party bidders… under the logic that it’s required because of the ‘call option’?”

Why would Merck Mercuriadis trade in his call option?

The most obvious answer to the question in red above: To re-establish some confidence amongst HSF shareholders that HSM isn’t going to stand in the way of HSF getting the best possible sale price.

While the call option has been Mercuriadis’ trump card for some time – essentially protecting him from ‘losing’ the HSF portfolio he personally amassed – it’s also become a bête noire for HSF investors, who overwhelmingly expressed their displeasure via a ‘Discontinuation Vote’ in October last year.

In a statement, HSM confirmed today that Mercuriadis’ willingness to trade in his HSF ‘call option’ “reflects Hipgnosis Songs Management’s desire to remain the Investment Adviser to the Company and work constructively and collaboratively with the Board to maximise shareholder value”. 

Another obvious answer to the red question above?

Because HSM remains confident that, with or without the ‘call option’, it will eventually become the primary acquirer of HSF’s rights.

(Sorry to repeat this from other analyses, but just for those catching up: HSM, which is itself majority-owned by Blackstone, has access to Blackstone’s capital via the private Hipgnosis Songs Capital vehicle, for which HSM is also an exclusive investment adviser.)

A third good reason why Mercuriadis might be willing to trade his valuable ‘call option’ for a multi-year deal?

His confidence in the ‘Taylor Swift factor’.

The music industry and its investors have seen via Taylor Swift what can happen when a songwriter/artist sees their life’s work suddenly managed by someone of whom they don’t approve.

Mercuriadis may be banking on his close relationship with the songwriters whose catalogs he has acquired for HSF over the years.

He may also be banking on the fact the ‘Taylor Swift factor’ is a risk that, deep down, HSF’s board and investors won’t want to take.

In a previous article, MBW said it expected the most likely scenario was Blackstone/HSM buying the HSF rights. Is that still the case?

Well, it’s become less guaranteed – if Mercuriadis’ ‘call option’ is dissolved, then third-party bidders can rival any intention from HSM/Blackstone to acquire HSM with the ‘shackles off’.

It’s therefore possible that one of these third-parties may indeed eventually take ownership of HSF and its rights.

However, on balance, HSM/Blackstone’s takeover still seems to be the most likely outcome. Here’s why.

Following the interest rate surge that has affected macroeconomics across the world in the past 18 months – and the correlated drying-up of $100 million-plus, let alone $1 billion-plus music rights acquisitions – music copyrights aren’t quite the hot commodity they once seemed on Wall Street.

You only need look to KKR for evidence. The investment giant acquired over 60,000 copyrights in October 2021 via a $1.1 billion acquisition move conducted in collaboration with Dundee Partners.

Yet now, just over two years later, KKR is reportedly looking to get out of the music rights game. It’s apparently hired Raine Group to find a buyer for assets that, due to current market conditions, could struggle to attain a significant improvement on the valuation they achieved in 2021.

Furthermore, Blackstone has already shown itself as willing to make a pricey bid for HSF’s portfolio.

In September last year, Blackstone’s own fund – Hipgnosis Songs Capital – launched an offer to acquire 19% of the HSF catalog by ‘fair value’ (as of March 31, 2023) for a total price of USD $440 million.

Depending on which HSF company release you read (from different dates), that $440 million bid either came in at a 17.5% discount of HSF’s ‘fair value’ or – when only the ‘net consideration’ for HSF is considered, with fees removed – a 24.3% discount.

“Blackstone has already shown itself as willing to make a pricey bid for HSF’s portfolio.”

But here’s the kicker: In Hipgnosis Songs Fund’s latest results, the UK-listed fund’s ‘fair value’ (as of September 31, 2023), as assessed by Citrin Cooperman, was priced at USD $2.62 billion.

Many have suggested that the ‘discount rate’ applied by Citrin Cooperman to HSF’s assets – of 8.5% – is too low following the interest rate rises of 2022 and 2023, and should be adjusted upwards. Such an adjustment would instantly reduce the ‘fair value’ of HSF considerably.

How considerably?

From HSF’s own latest results, published last month: “A 0.5% increase in the discount rate to 9.0% would result in a decrease to the Fair Value of the Catalogue of 7.8% ($203.5 million).”

In fact, if that discount rate was raised by a full percentage point (from 8.5% to 9.5%), according to HSF’s financial report, the decline in HSF’s ‘fair value’ would be even more drastic – down by $378 million from $2.62 billion to $2.24 billion (see below).

Remember: Last year, Blackstone made a bid for 19% of Hipgnosis Songs Fund’s catalog by ‘fair value’.

So… if Hipgnosis Songs Fund today (as per its latest results) was ‘fairly valued’ with a 9.5% discount rate, rather than an oft-questioned 8.5% discount rate, 19% of its catalog by value would be worth around… $426 million.

That’s less than the $440 million that Blackstone bid last year.

“if Hipgnosis Songs Fund today (as per its latest results) was ‘fairly valued’ with a 9.5% discount rate, rather than an oft-questioned 8.5% discount rate, 19% of its catalog by value would be worth around $426 million.”

Purring away in the background of all of this drama: A Strategic Review of Hipgnosis Songs Fund is underway, headed up by the respected minds of Shot Tower Capital.

That review may conclude that Citrin Cooperman should be replaced as HSF’s independent valuer. A new independent valuer may then come in… and ramp up the discount rate, bringing down the ‘fair value’ of HSF.

Which is all to say: The new Hipgosis Songs Fund board has been attacking Merck Mercuriadis and HSM for some weeks now. On the surface, this seems all to have to do with the ‘call option’.

But does it, in fact, go deeper than that?

Are Rob Naylor and co actually trying to goad HSM/Blackstone into making an improved bid for HSF’s portfolio – this time, all of the portfolio?

A final thought…

Let’s say over the next few months, HSM/Blackstone – and/or another bidder – ends up acquiring the entire HSF portfolio for somewhere between its current public valuation (USD $1.08 billion), and its most recently-declared ‘fair value’ ($2.62 billion).

Depending on the price, HSF’s current public shareholders may breathe a sigh of relief.

An unproven asset class, one whose public value has been sunk during this period of skyrocketing interest rates, is finally off their back, and out of their hands.

But will they live to regret such a move?

You may have noticed a barrage of negative coverage regarding Hipgnosis Songs Fund’s value from a shareholder perspective in the UK business pages over the past six months.

Time and time again, HSF’s assets have been painted as vulnerable to the harsh realities of the ‘big boy’ financial markets.

If so, those of you in the music industry who believe in the long-term value of premium assets may enjoy the words of Sir Robin Millar CBE, Grammy-winning producer and co-founder of Blue Raincoat Music.

Millar was part of a consortium that acquired the Chrysalis Records catalog from Warner Music Group in 2016, before selling it – along with Blue Raincoat’s still-operational publishing business – to US-based Reservoir in 2019.

Earlier today (January 19), a barnstorming editorial from Millar – obsensibly reacting to sustained negative financial coverage of HSF – was published in UK-based trade publication, Record Of The Day.

“When my company bought Chrysalis Records in 2016, the perceived wisdom of city analysts was that we were paying ‘far too much’,” wrote Millar, adding: “If we had been made to sell by our shareholders two years after acquisition, as we are now seeing from Hipgnosis Songs Fund investors, we would have lost our shirts and more.”

“If we had been made to sell by our shareholders two years after acquisition, as we are now seeing from Hipgnosis Songs Fund investors, we would have lost our shirts and more.”

Sir Robin Millar CBE

Millar, who says it will take at least five years for the true value of the HSF catalog to be fully realized, adds: “I don’t know whether to laugh or cry when I read the apparent wisdom from the financial press, urging shareholders to cut and run [from HSF] and the appointment of what are little more than administrators looking for a fire sale of some of the most enduring classic songs of the last fifty years.”

He continues: “[Mercuriadis] saw the opportunity to disrupt the market place and it was no surprise to me that a year or so after the Goldrush, major music companies started to bid against and, in some cases outbid Hipgnosis. There was a febrile ‘let’s cut this guy down’ attitude towards him.”

Millar advises today’s HSF shareholders to “ignore the naysayers and make sure the fund is diligently managed by a lean but driven team”.

Three or four years from now, he says, “the real gold in them thar hills will start to emerge”.