Music Royalties: The Show Must Go On!

Author Robert May, CAIA

As far as ‘uncorrelated’ strategies go, there has always been one which has managed to consistently pique investors’ interest. Music Royalties. There is just something about the blend of personal and professional interest. Mostly everybody loves music; even the most fastidious and discerning investor will have been moved by a certain track or harbour an affinity for a certain artist. And who wouldn’t want to own some of their favourite catalogues, if they had a practically limitless war-chest?

At the same time, it is intuitive and easy to understand. This is a security created outside of finance and it is pretty simple: when a song gets played, somebody gets paid; and although once you lift the hood things get slightly more complicated, the basic premise of a royalty is fairly easy to understand. For that reason, it was not difficult to get meetings and ultimately raise money from some sophisticated and institutional investors.? I’m sure you can understand that from the perspective of a placement agent, that makes it a pretty good product!

That said, although we were among the first, we certainly were not the only ones with this idea, and since 2013, a great deal of capital has been raised in what is essentially a scarce asset class. Moreover, since that time, the low-rate environment which fostered such a rich dealmaking environment, and rendered the return profile so attractive, has demonstrably shifted.

In the second of a series of thought-pieces exploring alternative assets, we will look to explain the mechanics behind music royalties; explore why they grew so rapidly in popularity and the reasoning behind a potential decline in dealmaking cadence. Most importantly, we will cast our eyes to the future and discern whether there is a viable future for this asset class, because after all, nobody wants to be there when the music stops… especially if you paid for the party.?

?So what are music rights, exactly? ?

Every piece of music is made up of two copyrights: ?

• The song copyright, which is the words and music. ?Think about the lyrics, harmonies, and melodies of a song; they belong to the songwriter and/or the publisher.?
• Master recording copyright, which is a specific recording of that song. They belong to the recording artist, the record label and/or the recording studio.?

Each copyright is made-up of what we call derivative rights, which can be invested in independently from the other. The primary derivative rights relate to the right to collect different revenue streams:

• Streaming royalties are generated when consumers listen to either ad-based or subscription streaming services such as YouTube or Spotify
• Mechanical royalties are typically generated by the permanent sale of music in physical and digital formats like vinyl or CDs or digital downloads
• Synchronization licenses generate fees from marrying a piece of music with a film or television episode or a video game
• Performance royalties are generated by the broadcast of music on terrestrial radio or television?

As is clear from the above, there are many ways to both split the pie and generate value on offer here.

And why have they become so popular??

Put simply, music was a tremendous growth story, and everybody seemed to be singing from the same hymn sheet. Starting from about 2012/2013, just about every major investment bank began publishing positive reports on the growth in Global Music Industry Revenues. And they have not been wrong.

Most prominently, Goldman Sachs, who have produced some excellent and insightful coverage / research on the asset class. Their estimated 2020-2030 CAGR for Global Music Industry revenues was raised in 2022 to +7.3% from +7.1% the year prior and consists of a blended average of recorded music, live music, music publishing and of course streaming which, at +11% CAGR, was the strongest growth area. ?

Below are a few words from the International Federation of the Phonographic Industry:?

The global recorded music market grew by 9.0% in 2022, driven by growth in paid subscription streaming, according to IFPI, the organisation that represents the recorded music industry worldwide. Figures released today in IFPI’s Global Music Report show total trade revenues for 2022 were US$26.2 billion.?

?Subscription audio streaming revenues increased by 10.3% to US$12.7 billion and there were 589 million users of paid subscription accounts at the end of 2022.? Total streaming (including both paid subscription and advertising-supported) grew by 11.5% to reach US$17.5 billion, or 67.0% of total global recorded music revenues. There was growth in other areas too with physical revenues remaining resilient (+4.0%); performance rights revenue increasing by 8.6% and returning to pre-pandemic levels; and synchronisation income climbing by 22.3%. (https://www.ifpi.org/ifpi-global-music-report-global-recorded-music-revenues-grew-9-in-2022/)?

As you can see, this is an industry performing strongly with streaming hailed as the second coming for an industry which had found itself both plagued and assaulted by the relentless spread of piracy and illegal downloads. With the advent of streaming, Spotify, and the iPhone, the music industry has found itself a tech-enabled solution to implement a SaaS model on a growing user base. Users listening habits could be mapped and trends identified against the backdrop of monthly recurring revenue. In essence, you could now forecast cash flows, and it was that realisation which created the asset class. ?

Second, Music Royalties are an interesting example of a very new asset class with some very old assets. Many classic songs have been listened to for decades, and it is possible look back at the past performance metrics to justify future performance. In essence, they have a track-record.?

And now, for the final cherry on top; broadly speaking, it is fair to say that music is a non-correlated asset class. People have listened to music, whatever the weather, and will continue to do so for the foreseeable future. There is evidence to elicit this, but for the sake of brevity, let us allow ourselves to fall victim to an increasingly scarce commodity: common sense. Anecdotally, Spotify continues to play in the background, despite the devastation wrought by the obsessive and cursory glance at my portfolio. Sure, the genre may change, but a well-diversified portfolio of music catalogues, will be able to contend with this.

Now, imagine these qualities against the backdrop of a zero-to-negative interest rate environment. I think it is crucial to think about the growth of the asset class in these terms because, at its core, this was (and still is) a non-correlated fixed-income proxy. We should be aware of the below, but they do a good job of demonstrating the relative appeal of the cash flows derived from music catalogues.?

In 2020:?

• US 10-year treasury yield was 0.7%.?
• S&P 500 dividend yield was 1.8%.
• Vanguard High-yield Corporate Bond (VWEHX) yield was 3.9%.

Compare with listed music royalty vehicles in 2022:

• Royalty Exchange reports that the average annualized return on investment for catalogues sold on its platform was greater than 12%.?
• Hipgnosis Songs Fund’s (SONG) dividend yield is 4.3%.?
• Mills Music Trust’s (MMTRS) dividend yield is 9.6%.?

Moreover, the return profile targeted by most of the private vehicles we have seen to be somewhere in the region of an 8-12% coupon and a 12-20% IRR, culminating in a targeted 2x on invested capital.?

That is why it became so popular. Importantly, not just for LPs but also for GPs looking to be at the forefront of a new and exciting asset class. ?

So where are we now??

Alvine Capital has been following developments within this asset class for a decade, and in recent years, the proliferation of partnerships between mega-fund Private Equity houses and music investment specialists has been profound. Although it is hard to put a number on things, as these are (on the whole) private off-market transactions, our network advises us that estimates come in at $9.3bn in deal value since 2020.

We can see these catalogues absorbed by a variety of structures and entities, so we thought it might be useful to provide you with some information on the who’s who in the space. As the list has now become lengthy, we have decided to provide more details on the appendix, but suffice to say it includes all the big players: KKR, Blackstone, Carlyle, Apollo etc…

Clearly, these are some of the largest names in private equity, purchasing catalogues from some of the most iconic artists of all time, for eye-watering sums of money. That said, it is not the sum in of itself, which is ultimately relevant, rather it is the sum expressed as a multiple of the cash flow generated (by the catalogue) on an annual basis. Most readers will more than likely be familiar with private equity transactions expressed as a multiple of EBITDA, and this is no different.

When we first started raising capital within music royalties, purchasing a catalogue for 9-12x was considered a good deal. Nowadays, having followed the market closely, 19x can probably be considered the average, and realistically, some of the headline transactions listed in the appendix, are probably going for 30x. At these prices, you cannot blame the artists and songwriters for taking the money. These purchases are no longer income motivated, because the cash flow expressed as a percentage of the purchase price is simply too small to be attractive relative to other forms of credit.

Ultimately, you become reliant on multiple expansion to generate value. Again, most people reading this will understand intuitively, that the more you pay for something, the harder it is to actually do this. If we factor in the increased cost of leverage, which does play a part in many of these deals, the increased interest payments further reduce the return.?

The reason for the increase in average purchase price is hardly rocket science. Many of the names listed in the appendix have practically limitless cash reserves and hence the quantity of ‘dry powder’ chasing these catalogues has increased competition and therefore pricing.

Furthermore, we find ourselves in the relative quandary of increased interest rates whereby the targeted returns for these products have become unattractive relative to their better known, albeit boring cousin: Direct Lending. For this reason, much of our network of LPs have lost confidence in the ability of iconic, anglophone catalogues to deliver what was promised.

So where are we going??

To state simply that everyone paid too much money and the returns on a forward basis will be poor is overly simplistic and ultimately merits scrutiny. ?There are many years to augment cashflows through active management within portfolios, and most LPs who have met some of the groups listed above will be well aware of the below much vaunted strategies:

• Synchronisation. The act of combining visual and audio media, so that they ‘synchronise’ with one another to improve the audience experience. Essentially, getting a piece of music you own, to be used in a film or advert etc. Not only do you get paid a fee for this but if of course broadens the appeal of the song to an audience who otherwise may not have come across it. Most music funds will have a team focused on this.
• Collection. Oftentimes, a catalogue, when purchased from a non-institution, will have been managed in a ‘more relaxed’ fashion, for example by a non-specialist such as a family lawyer or an accountant. Sophisticated managers of music rights can employ experience and dedicated software to extract additional royalties from catalogues which may have been underpaid for many years.

The above, and in particular synchronisation, make for nice headlines and PR puff pieces, but whether they materialise the uplift in revenue required to negate the impact of an overly inflated payment price remains to be seen. That said, they can prove to be attractive carrot for artists looking for their life’s work to find a suitable home.

And so, for what it’s worth, Alvine Capital looks to prioritise the macro, rather than the micro, when assessing the future of this asset class.

All songs are equal, but some are more equal than others.

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I was recently sent a version of the Dire Strait’s classic: Sultans of Swing; except this time, instead of the dulcet tones of the Knopfler brothers, I was greeted by the strained croaking of Joe Biden ft. Donald Trump. Initially shocked at Donald’s dexterity or the fact that Biden could remember the words, I soon felt myself gripped by a sense of unease as I realised the propensity for fraud and misinformation that this Artificial Intelligent technology elicited.

Truly Orwellian in both subject and scope, recent deals have taken place, implementing changes designed to preserve both intellectual property and user experience – most of which should come to the benefit of owners of iconic music rights.

Two problems currently exist:

1. Equal treatment. To use Spotify as an example, subscribers pay $X per month which Spotify then pools into one pot and divides based upon the proportion of total monthly listens that a musician generated in that Geography. In effect, each stream is treated equally, as long as the user listens to 30 seconds (or more) of the song. Therefore, 31 seconds of rain noises, or 5mins of Bruce Springsteen, constitute an equal part of that pool. A bit annoying, if like Sony, you just spent $500m on his catalogue.
2. There are too many songs. Some staggering statistics from Goldman Sachs:

• Since 2018, the number of songs uploaded daily to Spotify has increased sixfold to 120,000 vs 20,000 in 2018. The onset of Generative AI can sensibly be assumed to propagate this trend.
• Major labels account for only 4% of new tracks uploaded on Spotify.
• People have been gaming the system to generate ‘listens’ on newly uploaded tracks. JP Morgan wrote a report claiming that you could generate as much of $1200 a month if you programmed software to listen to 31 seconds of your own song on repeat constantly (Spotify CEO, Daniel Ek, has since denied this).?

Due to this, major labels have been losing market share from 87% of total Spotify streams in 2017 to 75% in 2022. Yet according to consumer research from UMG, 80% of customer retention is predicated on availability of superstar/ iconic catalogues. This seems a bit unfair to the music fat cats, who, despite the fact that iconic/ superstar catalogues generate 95% of total royalty revenue, feel aggrieved by the loss of earnings resulting from ‘white noise’ or the ‘long tail of music’.

In response, there has been a recent spate of dealmaking designed to bring the music/ streaming industry into line with an ‘Artist-Centric Model.’ (See UMG’s recent deal with Deezer).? In brief, songs which are actively sought out by users, and generate ‘value’ for the platform, will be rewarded with a greater percentage of royalties over those which are ‘passively’ accessed. They are also keen to disincentivise the mass production of AI covers which they believe are set to proliferate should the existing model be maintained.

At present, the larger labels seem to be propositioning the smaller streaming services with novel payment models, in the hope that once concept is proven, the larger players (Spotify) will also adopt them.

In all fairness, the argument that artists should be compensated for the ‘value’ they bring seems fair, as long as it is possible to define ‘value’ in ubiquitous and commonly agreed terms. For owners of these ‘valuable’ music rights, a reproportioning of income away from the tail-end and back towards the classics can only be seen as a positive.

Nevertheless, for all the ‘white noise’ around fraudulent streaming and AI generated trash, a reassignment of the 5% of earnings currently captured by the long-tail of music, still only represents 5% of annual global streaming revenues, or about $900mn. Not exactly pocket-change, but it doesn’t make much difference if you spent too much at the jukebox.

Rather it seems that the smarter thing to do is focus not so much on reapportioning the existing pool of capital more towards your own rights, but rather to increase that pool of capital across the board. Music revenues have been growing year on year, driven predominantly by the growth in streaming, but also by a recovery in performance rights post-covid.

Recently, however, streaming revenue has begun to slow down: adjusted for inflation, it grew only 7% over 2021, the first time that growth has fallen into single-digit percentages for 15yrs. There are a few reasons for this, but essentially streaming in developed markets is becoming more mature, and despite the continued (albeit slowing) growth in userbase, the average revenue generated per user has fallen too far.

It is no surprise that such statistics begin to originate in tandem with the onset of family subscription bundles and a lack of pricing increases. Let’s compare music streaming to video on demand streaming; aka Spotify vs Netflix:

• Revenue per streaming hour for Spotify has decreased 14% between 2015 and 2021. In contrast, revenue per streaming hour for Netflix has increased b c. 60% between 2017 and 2020…. (!!!)
• On an aggregate basis the monthly subscription price for video on demand services has risen 10% every two years from 2014 to 2023. Netflix has gone from $8.99 to $13.99 in that period. In contrast, Spotify only begun to raise their prices last year…

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The straightforward reality is that these were very necessary, understandable, and most importantly, fairly minor and protracted pricing changes from Netflix in response to slowing subscription rates. People seemed to realise what was going on, but nobody seemed to mind. When Netflix increased prices and cracked down on shared accounts, I remember the flash of irritation swiftly counterbalanced by the pleasant realisation that my sisters would now have to pay for their own Netflix.

More importantly, the price increase was in effect fairly minor for what is an excellent, improving and consummate service. We can all understand that against the backdrop of a cost-of-living crisis, price increases will be unpopular, but many users are firmly embedded in the software and churn is very low across these platforms. Furthermore, although subjective, the pricing can be considered ‘fair’; especially when we consider spending on music (as a percentage of nominal spend) still stands 50% lower than it did in 1998… a time when you had to spend close to the monthly subscription price of Spotify on a singular CD from your favourite artist.

Which brings me onto the next point. When you bought that CD, you knew it was expensive, but you didn’t care because you liked the artist and wanted to listen to their music. This works across all forms of media. Just ask BT Sports who have worked out a way to con me out of ￡25 per month to watch Spurs get knocked out the Champions League. We didn’t even qualify this year, but I still forgot to cancel the subscription. I pay ￡25 for c. 2hrs of football per month yet listen to music for a couple of hours a day for nearly half the price.

So why does the same option not exist within the context of streaming? Recent efforts have included Tidal’s premium sound quality subscription for $19.99 vs the standard $9.99. Spotify have been reportedly planning something similar, introducing a premium package with respect to sound quality. Labels are currently in discussion about how to better monetise ‘superfans’ and although these discussions are in their relative infancy, the addressable market for this kind of offering could be huge, with our friends at Goldman estimating a $4.2bn market representing 26% of their 2024 paid streaming revenue estimate.

If handled with care, these changes could prolong the party and holders of iconic music rights stand to benefit from that.? That said, for new buyers, you can still have some fun but it’s more like 3am and the drinks are expensive. That’s if you can get your hands on one, cause that flash bloke in a suit over there has just bought the whole bar!

?So how should you play it?

For that reason, it is the Alvine Capital house view, that in order to generate exceptional returns in this asset class, it is now time to be seeking new venues; or rather: new geographies.

It may sound facetious, but there is a big wide world out there, filled to the brim with people who don’t necessarily speak English but still listen to music. They will have their own interpretation of ‘iconic’, influenced by their upbringing and culture.

With respect to ‘streaming’, they are currently listening to music via YouTube or some form of ad-based music platform.

Ad-Supported Streaming Music Revenue

% Total 2022 Streaming Revenue

However, as smartphone penetration increases, the migration towards paid-streaming services seems inevitable… and the numbers in consideration here are mind-boggling.

To provide you with some highlights, Boomplay, Africa’s leading streaming platform, has over 75m monthly users. There are two ways of looking at that. Firstly, 75m seems like quite a few users- however, if we take a step back and consider that figure in the context of Africa’s population, it is tiny, demonstrating the capacity for growth. Resso is the largest streaming platform in Brazil, Indonesia and India. It had over 250m installs as of May 2022. Tencent Music, China’s platform, is set to become the third largest player globally by 2030, with a 15.6% global market share. In India, there could be as many as 1.1bn listeners by 2025…

Now, let’s consider these numbers against the backdrop of paid-streaming penetration (as a percentage of smartphone population). Our friends at Goldman Sachs, who have been following this area since 2018 forecast EM paid-streaming penetration to double to 12% in 2030. This sort of growth is simply impossible in mature markets, and the absolute figure is still low!

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The only snag is that the Average revenue per users is still on the lower end. The reason for this is that companies are still looking to entice consumers with ‘bundles’ or incredibly low prices.

Market participants who are able to source catalogues in these regions, (Yes – they do exist) have been paying demonstrably lower prices (c. 7-9x) due to lack of competition and sophistication, immediately bolstering the return profile. There is also a complexity premium attached, but innovation is required in a market that has, at least with respect to iconic anglophone catalogues, become saturated. All the mechanics which drove the structural growth exhibited over the past decade in developed markets are playing out in a similar fashion, but at a startling scale.?

Like with any investing, emerging markets offer heightened opportunity, but are usually not the first port of call. For those with experience investing in this asset class, they should absolutely be considered as part of a growing allocation to the asset. For those looking to dip their foot, we hope this thought-piece has taught you a bit, and also demonstrated the incredible appeal of investing in music.

After all, there’s got to be a reason everybody wants to get into this party….??

APPENDIX:

Brookfield and Primary Wave

As of November 2022, Brookfield Asset management acquired the rights to?60 songs written by Shannon Rubican and George Merrill, the duo behind the two Houston’s smash hits for somewhere between $50-$100mn.???

This is part of a $2bn partnership with Music publisher Primary Wave to push into music royalties.??

As part of the deal Brookfield also took a stake in Primary Wave, which already owns the catalogues of Stevie Nicks, Bob Marley, James Brown, Ray Charles, Def Leppard, Olivia Newton-John and many other in what consists of over 800 top-10 singles and more than 400 #1 hits.??

Blackstone backed Hipgnosis??????????????????? ??????????????? ??

In October 2021, Blackstone announced a majority stake in Hipgnosis as part of a $1bn venture.??

In January 2023, Justin Bieber sold his music publishing rights and catalogue shares to Hipgnosis Song Capital for $200 million.???

Previously, Hipgnosis also acquired a large stake in Shakira’s work as well as Red Hot Chili Peppers, Neil Young’s.?

KKR venture with BMG??

In March 2021. KKR teamed up with one of the world’s largest music companies BMG to target large acquisitions of music labels and catalogues?ranging around the $1bn mark.??

In October 2021, KKR purchased a portfolio of song rights from Kobalt Capital for $1.1bn partnering up with Dundee Partners (Hendel Family Office) giving them access to more than 62,00 copyrights by artists across many genres.??

Universal Music Group??

In 2020?Bob Dylan sold over 600 copyrights to UMG valued at over $300mn.??

July 2023, UMG has recently acquired a 70% stake in the music catalogue owned by RS Thailand-based RS group for $45mn with over 10,000 songs.??

Sony Group??

Most notably, Bruce Springsteen’s master recordings and publishing rights were bought for $500m (!!!!!!!!)

Warner Music Group??

Warner Chappell Music, the global music publishing business of Warner has a vast collection representing works by over 80,000, including names such as Twenty-One Pilots, Green Day, Katy Perry, Stormzy, etc.?Warner also paid $250m for David Bowie’s entire music catalogue.??

WMG is publicly traded, with Fidelity Investments having the largest stake, followed by Vanguard and Sands Capital.?

Harbour View Equity Partners:???

Raised $1b from Investment firm Apollo Asset Management.??

Bought the catalogue of Luis Fonsi for as much as $100m as well as the publishing and recorded catalogue of Deryck Whibley, the chief songwriter of Sum 41.??

July 2023 Harbourview recently acquired 50% of Nelly’s entire catalogue for a reported $50m.

Pophouse Entertainment??

They hold the catalogue and master to Swedish house mafia as well as the 75% of Avicii’s catalogue.

Influence media

Financed with $750m in Partnership both BlackRock and Warner Music Group with the idea of pursuing smaller more diverse artist such as a $25m deal for Puerto Rican artist Tainy’s catalogue, known or his work with whales such as Bad Bunny, J Balvin, Rosalia, Cardi B’s ‘I like it’ and Shawn Mendes.?

Litmus Music

Launched in August 2022, Litmus had a $500m backing from Carlyle Global Credit and aims to buy the recording rights as well as the publishing rights from across genres. In Deember 2022, Litmus purchased Keith Urban’s master recordings for an undisclosed amount.

Round Hill Music Royalty Fund

Portfolio of fifty-one catalogues representing more than?12,000 songs. They have a 29.1% stake in Carlin?(June 2021), which built up a catalogue with rock and pop classics such as Elvis Presley’s Are You Lonesome Tonight.??

Reservoir media??

An independent music rights company headquartered in?New York. In 2020 they bought the famous US music publishing house Shapiro Bernstein, as a result,?taking position of?copyrights songs recorded by the Beatles, Frank Sinatra, Ella Fitzgerald, Michael Jackson, Elton John and many more.??

Concord: Michigan Retirement System (Pension Fund)

In 2021 Downtown sold its portfolio of 145,000 owned and co-published copyrights to Concord in a deal speculated to be for over $300m.???

Concord is majority-owned by a pension fund, Michigan Retirement Systems, which has invested over $1bn into the company.???

Author: Robert May, CAIA , Associate Director, Alvine Capital

About Alvine Capital

Alvine Capital was founded in 2005 and has maintained a constant focus on alternatives ever since. In our near 20 year history, we have partnered with large and established managers, as well as those seeking seed investment. We have developed deep relationships with key decision makers at sophisticated institutions, with a focus on the Nordic, UK, Swiss and German markets. Our work has seen us raise capital within traditional private equity buyout and direct lending strategies, as well as more esoteric and differentiated, uncorrelated niches.

Find out more here: https://www.alvinecapital.com/