Will Hipgnosis actually work?

By:Cherie Hu

Published:2020-09-11

Editor’s update — March 28, 2024: Nearly five years after Hipgnosis’ IPO on the London Stock Exchange, Shot Tower Capital just published a scathing independent report on Hipgnosis’ major missteps as a fund, including overpaying for catalogs, overstating their ownership stakes in said catalogs in public documents, falling short of due diligence standards in dealmaking, and failing to provide the “song management” services that they promised would drive these catalogs’ value in the long term. In other words, we told you so.

If you’ve been following Hipgnosis Songs Fund over the past few years, you probably have a lot of questions.

The investment company founded by long-time artist manager Merck Mercuriadis (previous clients include Beyoncé, Morrissey, Mary J. Blige and Iron Maiden) has been going on a billion-dollar catalog acquisition spree since its IPO on the London Stock Exchange two years ago. As of today, the fund, which counts the likes of Nile Rodgers and Poo Bear as board members, owns stakes in the publishing, public performance and/or masters royalties of over 60 different artists and songwriters.

Recent high-profile examples of the fund’s acquisitions include the writer and publishing royalties of No I.D., RZA, Blondie, Mark Ronson and Chrissie Hynde, the writer and producer royalties of Lady Gaga collaborator RedOne and the recording royalties of Barry Manilow. As of Hipgnosis’ most recent annual report (issued in March 2020), the fund is generating over $80 million a year in revenue from a catalog of 14,000 songs.

Just two days ago, Hipgnosis also announced its buyout of independent publisher Big Deal Music Group, an intriguing contrast to the fund’s strategy to date of focusing on classic, proven catalogs. (The publisher will be rebranded to Hipgnosis Songs Group, which is separate from the Hipgnosis Songs Fund — likely in a similar manner to how Kobalt has both a frontline publishing business and a catalog investment business).

What is the purpose of all this? In previous media interviews, Mercuriadis has answered this question by focusing on two primary angles:

There’s been little to no public analysis to date of whether these two arguments actually make sense, and whether Hipgnosis will be able to deliver the outsized returns it’s been promising to public investors. Instead, most of the ink spilled in the press has been press-release recyclage. After doing some research myself, I realized the reason for this gap is mostly political: Most of the people doing this analysis are unwilling to talk publicly about it.

Below is my attempt to analyze Hipgnosis’ strategy and pinpoint its potential cracks. The question is not so much whether Mercuriadis and Hipgnosis are “right” or “wrong,” but rather the assumptions you have to believe in order for Hipgnosis’ claims to be true, and whether Hipgnosis is really communicating these assumptions clearly with the public. I had the opportunity to ask Mercuriadis a few questions myself, and also talked with several sources in the publishing and investment-banking worlds — nearly none of whom were willing to speak on the record.

I. The financial argument

It’s worth opening our discussion with some brief background on the current state of publishing from a financial perspective.

Hipgnosis is far from the first company seeking to position music publishing copyrights as an asset class. Because publishing and public-performance revenues are largely uncorrelated with changes in the stock market — according to data from CISAC, they have actually grown year after year since 2008, countering global recessions — the underlying copyrights are increasingly seen as an attractive long-term investment. “Copyrights are essentially annuities,” Jeff Biederman, partner at Manatt, Phelps & Phillips LLP, tells me. “If you buy established songs, you can get a pretty clear idea of what sort of income you can expect to come in over the next five to ten years.”

As a result, the catalog acquisition landscape — which, to be clear, involves acquisitions of older songs that are proven in the marketplace, not signing new talent — is becoming more crowded and competitive. It’s not only traditional publishers like Downtown Music Publishing, Concord Music Group, Primary Wave, Kobalt Music Group, Spirit Music Group and the big three (Universal Music Publishing Group, Warner/Chappell, Sony/ATV) that are paying top dollar to cash in on this perceived “gold mine.” The landscape of non-music players interested in buying or investing in catalogs has also widened significantly, spanning corporate banks, pension funds, long-dated private equity funds and family offices. By listing on the London Stock Exchange, Hipgnosis is tapping into the retail investor market, further expanding the playing field of who can own a stake in music publishing copyrights.

For some songwriters, the prospects of selling one’s catalog has also become more appealing amidst the COVID-19 pandemic, which has likely fueled the acceleration of Hipgnosis’ deal announcements. One publishing source tells me that a lot of touring artists with extensive songwriting or production catalogs under their belts are now “more open to conversations” about a sale than they would have otherwise been, due to dramatic changes in their overall income.

Now, let’s dive into Hipgnosis’ financials. The fund has made several new acquisitions since March 2020, so its annual report is likely no longer accurate, but we can still reference it to get a better understanding of what’s at stake.

One red flag in the report revolves around the age of Hipgnosis’ catalog. As Biederman mentioned, it’s typically easy to predict a catalog’s long-term cash flow after it’s been around for five to ten years. Anything younger than that will likely be more volatile and decline in revenue in the near term; a common assumption in catalog valuations is a 50–70% decay from peak earnings in the first five years.

According to the report, the majority of Hipgnosis’ acquisitions consist of newer catalogs that may have not yet matured. Only 32% of its catalog is over 10 years old; 9% of its catalog is younger than 3 years, with the remaining 59% aged between 3 and 10 years old. Unsurprisingly, this 59% majority registered the slowest annual growth rate for Hipgnosis (11%), whereas revenue from catalogs younger than 3 years and older than 10 years grew by 75% and 80%, respectively.

Multiple sources I spoke with were concerned that this maturity mix would struggle in the long term to generate the returns Hipgnosis is promising for investors, especially given the 13.9x multiple that the fund is paying for its acquisitions. One investor source tells me that catalog acquisition prices with higher multiples are more sensitive to compounding decay rates — and that in Hipgnosis’ case, in order for its 13.9x investments in majority-younger catalogs to pay off over a 35-year period, the catalogs essentially cannot decay at all. “It’s aggressive to assume that a catalog would just grow in perpetuity, especially if it’s older than 10 years,” says the source.

In a phone interview, Mercuriadis tells me that the age proportions in Hipgnosis’ catalog are actually now reversed from what’s listed in the report thanks to the newer acquisitions, with 60% to 70% of catalog now being older than 10 years. In addition, he acknowledges that even though frontline consumption tends to be highly concentrated in just a handful of hits instead of being more diversified, “you can’t tell people that streaming is at the heart of the music industry’s success and not be well-represented in catalogs that are responsible for the explosive growth of streaming.”

He claims that Hipgnosis is protecting itself by paying a lower multiple for newer catalogs than they would for more vintage catalogs. We’ll have no way to know for sure what the true age distribution of Hipgnosis’ current portfolio looks like — and whether the underlying financial performance really adds up – until we see the next report and until his newer catalogs have a few years to mature more fully.

A note on “active song management”

One hypothetical way to counteract this predicted decay in earnings for younger catalogs is to be more proactive in placing them in T.V. shows, films and other forms of media — i.e. to act like a traditional publisher.

In this vein, Hipgnosis’ messaging somewhat contradicts itself. What is most amusing to me about this week’s Big Deal Music announcement in particular is that it came after several months of Mercuriadis claiming in the press that Hipgnosis is “not a music publisher.” Indeed, just a few days before the announcement, Mercuriadis told me that he “will never allow anyone to call Hipgnosis a publishing company. It’s a song management company … I hate the concept of ‘publishing,’ because the term has become a euphemism for someone who writes you a check but doesn’t add any value to your songs.”

In previous interviews, Mercuriadis has made the claim that Hipgnosis’ organizational capacity relative to revenue is much more efficient than that of a major publisher. He has pointed to how Hipgnosis’ team manages “500 songs per person, versus the majors who have 20,000 per person,” and to how, compared to a major publisher, Hipgnosis has generated “between 7% and 12.5% of their revenue on between 0.5% and 0.9% of their number of songs.” The annual report also touts that the team has inked over 1,000 sync placements for its catalog to date.

But sync still accounts for only 9% of Hipgnosis’ revenues, with the majority still coming from digital streaming and from performance income on radio stations and T.V. shows; a lot of this kind of income cannot be “actively managed” in the way Mercuriadis promotes. For instance, Hipgnosis’ recent acquisition of royalties from Mötley Crüe’s Nikki Sixx involved only the writer’s share of SoundExchange and performing rights royalties. This is more like “mailbox money” that you just sit and wait to collect over time — which isn’t a bad thing at all from an investor perspective, but is very different from an active song-management business.

In addition, Mercuriadis tells me that his team includes around 30 employees in London, with the Big Deal Music acquisition adding around 40 new employees in Los Angeles. But many of my sources sense that the majority of Hipgnosis’ 30 employees in London are focused on the financial and regulatory management necessary to maintain a public company, rather than on actively managing the songs themselves. (A quick lookup of Hipgnosis on LinkedIn yields around 20 results for employees, most of whom are on the finance and business administration side.)

Even though Hipgnosis now owns a proper publishing company in the form of Big Deal Music, this doesn’t address whether the company actually has the staff to take care of the metadata, marketing, sync and collections for its preexisting older catalog. In short, there’s conflicting messaging about whether Hipgnosis really wants to be a publisher, or just wants to stay as what Concord Music Group’s Steve Salm recently called a “royalty fund.”

II. The advocacy argument

The second major bucket of Mercuriadis’ argument centers around songwriter advocacy.

Since the beginning of the whole Hipgnosis craze, what has stood out to me is that literally none of the music-industry players that have been lobbying for songwriters’ rights around the world for decades — including SoundExchange and the National Music Publishers Association (NMPA) — have issued any kind of statement about Hipgnosis, positive or negative. It’s as if, in spite of an alleged shared mission, they’re operating in totally different worlds.

And in fact, they are. Because Hipgnosis is a publicly-traded company and not a trade organization, its first and foremost obligation is to its shareholders, not to songwriters. It bought songwriters out of their own copyright interests, and will not be paying songwriters a share of revenue that the fund generates off of their work. Hipgnosis is a “partner” to songwriters only in the sense of signing them a fat check. Yes, that may well pay for those songwriters’ lives and families for decades to come. But on paper, Hipgnosis is now the songwriter for the majority of the catalog under its wing, so in the short term it’s just advocating for itself.

I reached out to the NMPA for comment, and CEO David Israelite did return with the following statement: “Merck is correct that songs have incredible value and currently songwriters are not receiving what they deserve because of outdated laws and regulations that prevent them from engaging in free market negotiations. We are so glad he is a partner in our efforts to push for fairness for music creators, since there are no streaming platforms and no music industry without them. As tech companies continue to dwarf songwriters in their size and power, it is more important than ever to work together to safeguard the future of songwriting.”

Let’s assume Mercuriadis is acting in good faith, and that Hipgnosis’ success will be a boon for songwriters in terms of the perceived financial value of their work, which is likely true. But how can Hipgnosis build enough meaningful leverage to make the sweeping, industry-wide changes of which Mercuriadis speaks in the media?

Based on my conversations with sources, there are two main approaches:

A. Market share

Let’s do some basic math: As mentioned towards the beginning of this article, Hipgnosis is generating around $80 million in revenue a year. A CISAC report pegged the size of the global music publishing and performance collection market as a whole at a much higher figure of around $10 billion back in 2018. Because Hipgnosis isn’t focusing as much on public performance, let’s go with a conservative assumption of around $5 billion for the global publishing market in which Hipgnosis is operating. This means that for all of its aggressive headline-making acquisitions, Hipgnosis still commands only a 1.6% share of where the publishing market was two years ago.

What market share does Hipgnosis need to have in order to wield the political leverage it seeks to change the songwriting landscape? Let’s assume that threshold is around 10% of the market (i.e. $500 million), and that Hipgnosis’ blended acquisition multiple of around 14x stays constant. That means Hipgnosis would need to spend around $7 billion (14 x $500 million) — or more than 86x times its current annual revenue — on proven catalogs in order to get to 10% of where the publishing market was two years ago. This would require a gargantuan fundraising task (Hipgnosis has raised around $800 million in the past two years) — and as we discussed above, it’s not even guaranteed yet that the catalogs he’s bought so far will continue to grow steadily in the near future.

There’s a reason why Hipgnosis’ direct competitors like Round Hill, Concord, Downtown and Kobalt don’t go directly to tech companies like TikTok and Peloton to negotiate their licensing deals, but rather decide to team with an organization like the NMPA to get the job done. The association represents over 3,000 publishing companies globally, including all three majors, which covers more than enough market share to carry the necessary weight in litigation. Trying to do the NMPA’s job of getting to that market share and political leverage as an individual company is prohibitively expensive.

Addressing these concerns, Mercuriadis argues that he has already wielded part of the influence he’s looking for in a way that isn’t tied to market share. “In the space of two years and two months, we’ve become a FTSE 250 company,” he tells me. “We’re one of the biggest companies on the London Stock Exchange, and have gotten to this point faster than any other company in the history of the London stock market. We are also one of the biggest yielders on the market — there are only around 20 companies who pay bigger dividends to shareholders than we have. We’ve firmly established songs as an asset class that is recognized by some of the biggest institutional shareholders in the world, from Aviva to the Church of England. I’m proof positive that you can change any paradigm out there if you want to.”

(Again, publishing copyrights were already pretty well-established as an asset class before Hipgnosis launched, so I would argue Mercuriadis isn’t changing a paradigm so much as aggressively scaling it like no one else has before.)

OK, so maybe Hipgnosis doesn’t need market share to gain attention. But to change the industry landscape, they do need to own not just songs, but the right kinds of rights to those songs, and to control the royalty flows of those rights. This is perhaps the biggest crack in Hipgnosis’ messaging to date.

B. Administration rights

In investor reports, Hipgnosis claims it now “co-own[s] 5 of Billboard Magazine’s ‘Top 10 Songs of the Decade’ (including 4 of the Top 5) and 8 of Spotify’s 30 most streamed songs of all time.” A separate JP Morgan report writes that the fund “owns 18 Songs in the Billboard top songs of the 2010s.”

In many cases, this characterization is either inaccurate or missing a big part of the truth. Hipgnosis does not “own” any song outright. Instead, for a given song, it owns the share of income generated by one songwriter or producer.

Especially with newer catalogs, which feature multiple songwriters on a given track, this translates to not that much ownership at all. For instance, Hipgnosis claims to “own” the hit song “Shape of You” due to the fund’s buyout of co-writer Johnny McDaid’s catalog. But that’s the thing: McDaid is just a co-writer of “Shape of You.” The song has five other songwriters in its credits apart from McDaid, and all three major publishers have a stake. The power is distributed among many players, which doesn’t give Hipgnosis alone that much leverage in a hypothetical negotiation.

In addition, in order to maximize your leverage against tech companies and the government, it’s not enough to own the copyrights: You also have to own the administration, i.e. have a direct hand in collecting the money.

It’s common for catalogs to be owned by one publisher, but administratively controlled by another, competing publisher (e.g. Concord recently acquired the back catalog of Imagine Dragons, but Universal Music Publishing still controls the administration). Some of Hipgnosis’ competitors, however, like Round Hill, make the intentional business decision to control the administration for all of their own catalogs.

“We’re often understandably asked why we don’t outsource the administration to Kobalt or other companies in our key markets,” Round Hill CEO Josh Gruss said in a recent interview with Music Business Worldwide. “And we answer that by saying like, ‘Well then the cash wouldn’t come to us. Our catalog would sit next to hundreds, thousands of other catalogs and not necessarily get any special type of attention, and we wouldn’t be in the driver’s seat’ … If [a publishing admin partner] has your catalog and is earning 8% from it, but also has their own repertoire where they’re earning 100%, which one do you think they’re going to focus on?”

To my knowledge, Hipgnosis is not in the driver’s seat, in that it does not own the administration for most of the catalogs it is buying. This is in part because administrative control is “very hard to come by” in publishing catalog sales now, because those kinds of opportunities were bought out several years ago, one publishing source tells me. A major publisher “would never buy any of the assets [Hipgnosis] is buying now, because the last thing they would want to do is buy something that another company controls the cash flows on,” says the source.

A few examples: Sony/ATV, not Hipgnosis, still handles publishing administration for “Shape of You.” Similarly, Hipgnosis may own a stake in Wu-Tang’s back catalog thanks to its recent deal with RZA, but as of three days ago, Downtown now controls the administration.

For the acquisitions that do involve administration rights, Hipgnosis is outsourcing the work to Kobalt Music Group. Aside from the fact that there’s an inherent conflict of interest — Kobalt is also interested in acquiring its own catalogs, and has its own frontline publishing business — a JP Morgan Cazenove report from July 2020 states that Kobalt “took on seven catalogs for Hipgnosis from prior administrators” in the past year. Seven is only a small minority of the 60 catalogs that Hipgnosis now oversees.

As one source puts it to me: “No one is going to care if [Hipgnosis] has Bon Jovi or Journey or Mark Ronson. That alone doesn’t give you power. It’s actually being able to control the cash flows and move catalogs from one place to the next that gets you the leverage.”

Conclusion

I’ll close with a consideration of Hipgnosis’ messaging in press releases as an “artist-friendly” company.

Mercuriadis certainly has enough decades of management experience under his belt to understand how artists and songwriters feel about a major deal involving their catalog. “Very few people in the space understand that this is a highly emotional transaction,” he tells me. “Most songwriters and producers who care about their work are only going to sell to someone like myself who understands the ethos around which they’ve built their careers, and who knows how to protect their legacy while doing the best for their songs.”

But as I alluded to earlier, Hipgnosis is only “artist-friendly” in the sense of writing one-time checks to artists. To survive, Hipgnosis actually needs to be “shareholder-friendly” before anything else. And the speed and multiples at which the fund is buying out songwriter catalogs make it difficult for many investors and publishers alike to have a clearer picture of whether Hipgnosis is really making the right kinds of acquisitions. As one source puts it to me, “we’re not going to have any idea how this set of assets is really doing until two to three years after the dust has settled within their financial systems.”

To be clear: Many people in the industry, including the NMPA, want Hipgnosis to succeed. If it fails, investors may develop a negative impression of the music IP market, which would have a negative impact on the perceived value of the music industry as a whole. But especially given that public money is involved, many are also rooting for a reality check.