Song Case Study

Long before the term ESG had even been coined, we at Asset Value Investors had been strong advocates of the power of shareholder engagement to effect change and unlock trapped value. A recently concluded successful investment in a high-profile London-listed investment company (“closed-end fund”, “CEF”), Hipgnosis Songs Fund, serves as a great demonstration of this in practice.

Low interest rates in the wake of the Great Financial Crisis led to an explosion of issuance in CEFs offering attractive levels of income from alternative asset classes. Investment vehicles operating in the Infrastructure, Renewables, Battery Storage, Private Credit, Forestry, Reinsurance, Aircraft Leasing, and Shipping sectors listed on the London market offering regular high dividends to yield-starved investors.

Backed by music industry veteran Merck Mercuriadis, who had previously managed several high-profile recording artists, Hipgnosis Songs Fund (stock exchange ticker “SONG”) came to market in 2018, raising an initial £200m to acquire a portfolio of publishing royalties and going on to raise an astonishing total of £1.3bn of equity capital that was then further amplified by leverage. The Manager found no shortage of artists willing to turn a long-dated income stream into an immediate up-front payment by selling their back catalogues, and the proceeds raised were rapidly put to work over the following three years.

The rise of streaming had transformed the attractiveness of music rights as an asset class in terms of both growth and quality of earnings following the dark days of peak piracy in the early–2000s. With highly predictable recurring subscription revenues accounting for an increasing portion of music rights revenues, the asset class became significantly more investible. Further attractions were found in the long growth runway ahead from further penetration of streaming subscription services into emerging markets; subscription price increases in developed markets; and new monetisation opportunities from social media and gaming. The low correlation of music rights revenues to equities and credit, and their long duration, made them much sought after by alternative asset managers, insurance companies, and pension funds.

In 2018 we conducted an industry deep dive on music as part of our research into Universal Music Group (UMG), which was then owned by the French holding company, Vivendi, and in 2019 we built a position in Sony, whose eponymous music label is #3 player in the oligopolistic music business. From this we had a strong appreciation of the secular growth attractions of the music industry and the advantaged positioning of content owners in the value chain.

As a pure play on catalogues, SONG had its attractions, and we established a small position in late-2020, with a key part of our thesis being that SONG would likely be a takeout target once it had achieved scale. That element of the thesis broke down in October 2021 with the acquisition of a majority stake in the Manager by Blackstone. The terms of SONG’s Investment Management Agreement (IMA) had granted the Manager an option that effectively gave them a right of first refusal over the portfolio in the event of a sale or the termination of the Manager. Given Blackstone’s deep pockets, we felt the Manager’s call option over the portfolio was likely to impede any competitive sales process in the future.

When combined with growing concerns over transparency, earnings quality, and governance, we took the decision to exit the position and sold over 60% of our shareholding in late-2021/early-2022 at modest profits on our purchase price before the share price began to decline rapidly along with other alternative income vehicles deemed to be interest-rate sensitive. We were left with a residual shareholding that equated to a 0.8% stake in the company.

By September 2023, SONG’s shares were trading on a near-50% discount to their reported net asset value (“NAV”) reflecting, in part, a high degree of scepticism around this figure. Despite the NAV being calculated by a third-party valuation agent, we shared these concerns. Regardless, the still-high margin of safety against what we considered to be a more realistic NAV and SONG’s upcoming continuation vote scheduled for November2023 offered up an interesting dynamic. This only became more compelling in the wake of a takeover bid by Apollo-backed music rights acquiror, Concord, for SONG’s only listed peer, Round Hill Music Royalty Fund (“RHM”), on the 8^th of September -2023.

A read-across from the price paid by Concord suggested that SONG’s portfolio would be worth considerably more in a competitive bid process than implied by its share price. There were flaws, however, with that simple extrapolation. Firstly, SONG’s level of disclosure and transparency were far inferior to RHM’s, making the company more difficult to accurately value from the outside. Secondly, while RHM’s manager also had a similar option to acquire its portfolio, this was of much less significance in their case given Blackstone’s far greater financial resources.

To address the first issue, we conducted a significant amount of due diligence through calls with a wide range of industry participants, several of whom had been involved in some capacity in historic transactions with SONG. The view that the Manager had consistently overpaid for its catalogue acquisitions was almost uniform, and many posed question marks over the nature of the specific rights actually acquired but, crucially, the intelligence we gained from these calls allowed us to better estimate a more plausible NAV range.

We began to rebuild a position in SONG, ultimately increasing our stake tenfold over the following six months and becoming the Company’s largest shareholder.

In mid-September 2023the Company announced their long-awaited strategic update designed to win over shareholders ahead of the continuation vote. Alongside a reduction in management fees, the main proposal was for a related-party sale of certain catalogues to Blackstone, with the proceeds to be used to pay down debt and fund a share buyback programme.

However, although the headline figures suggested the proposed sale would be taking place at a 17.5% discount to the reported NAV, this had climbed to 25-30% by the time readers reached the bottom of the announcement given a series of give-aways, transaction costs, and taxes. The inherent information asymmetry in the process and a lack of clarity around the method by which the catalogues had been selected for sale further fuelled investor fears.

AVI then played a key role in engaging with the Board, making the case in private that shareholders should vote against the related-party asset sale and against continuation, and then releasing a public letter to that effect.

The results were overwhelming, with 84% and 83% of votes cast against the asset sale and continuation respectively at the October2023 AGM. With two directors resigning on the eve of the AGM and the then-Chairman suffering a resounding vote against his re-election, we and other shareholders engaged with the remaining rump to push for the appointment of two new directors – Robert Naylor and Francis Keeling – who had just stepped down from RHM following its acquisition by Concord. Both were appointed in November 2023 with Robert immediately installed as Chairman. Christopher Mills then joined the Board a month later.

In April 2024, a bidding war was triggered when Concord – the buyer of RHM – announced a binding offer for SONG at a price of $1.16-$1.18 per share. Blackstone, however, ultimately prevailed with a bid of $1.31 per share. This represented a premium of +47% to the undisturbed share price.

Such a brief summary of the end-game risks masking the enormous efforts involved by the new directors, who joined the Board at a time of crisis and, displaying considerable fortitude in their shrewd handling of a highly complex situation, engineered an excellent outcome for shareholders in a timeframe few would have felt possible at the time of their appointment. With SONG having no viable future as an ongoing listed vehicle, the key task facing the new appointees was how best to generate competitive tension in a situation where, as a reminder, the Manager had a call option under the terms of the IMA allowing them to purchase the portfolio in the event of their termination. The investigatory work conducted by the Board and their advisors, some of the fruits of which were made public, led to an understandable perception that there existed more than sufficient grounds to terminate the Manager “for cause”, which would invalidate the option.

We think it likely that this, alongside other measures introduced by the newly reconstituted Board, gave Concord the confidence to make their initial bid and resulted in a materially higher price ultimately being achieved for the company than would otherwise have been the case.

The position generated a return on our overall investment of almost double that of the MSCI AC World index and a +39% total return/+73% IRR on the position acquired in late 2023/early 2024 (vs +13%/+24% respectively, for the benchmark).

While we were pleased with an outcome that not only generated a very strong return for our investors, we also believe the investment demonstrated very clearly both the value of shareholder activism and the critical importance of having the right people on Boards.