September 12, 2022 | Barron’s PENTA
I Wanna Dance with Somebody, a biographical film about the life of late singer Whitney Houston, will be released in December by Sony Pictures. Music streaming of Houston’s 1987 single “I Wanna Dance with Somebody (Who Loves Me)” is likely to spike soon after on services such as Spotify and Apple Music.
A benefactor of that uptick will be Primary Wave Music, a New York-based independent music company that in 2019 acquired 50% of Houston’s estate, including a stake in the singer’s royalty streams from her songs and master recordings and profit-sharing in her films, such as 1992’s The Bodyguard.
In return for the cash flow, Primary Wave is acting as a manager, publicity representative, and brand builder for the “icons and legends” it represents—such as the late musicians Bob Marley, and Prince, and living acts Smokey Robinson, Stevie Nicks and Def Leppard, says founder and CEO Lawrence Mestel. The company’s goal is to boost revenue for these artists, including for songs that long ago topped the charts. “Anybody can collect a dollar. Not everybody can turn $1 of revenue into $3—that’s what differentiates us,” Mestel says.
Several music companies and specialist investment firms, including Hipgnosis Songs Fund, Round Hill Music, and Lyric Capital Group, and newer additions Seeker Music and HarbourView Equity Partners, have been scooping up music rights from the likes of Justin Timberlake, Tim McGraw, and Shakira at a fast clip over the past three years. Music giants Universal Music Group, Sony Group, and Warner Music Group, among other labels and publishers, also are buyers.
Catalog deals confirmed by London-based MIDiA Research totaled $5.3 billion in 2021, up from less than $370 million in 2019. As of May, an additional $700 million in deals were struck, according to an industry report by Goldman Sachs Group released in June.
Musicians and songwriters have been motivated to sell rights to future cash flows from their work in response to losing tour income during the pandemic, Goldman said. Tax considerations have been another motivator for U.S. artists.
Buyers have been driving these sales because of the rise of paid music streaming, which makes it easier for consumers to discover songs and for investors to analyze past and future trends, including cash flows, Goldman said. The record-label share of paid streaming became an approximately $12 billion market last year, up from about $2 billion in 2015, Goldman said, citing data from London industry group IFPI.
Catalog acquirers are also driven by the promise of boosting revenue for songs by pairing them with advertising or film—known as “sync” deals—or by using songs in newer media, says Evan Bogart, an award-winning songwriter and founder of Seeker Music. “There’s all these different approaches to improving catalogs and reintroducing them to people who are already fans in new ways and to a whole new generation who never heard the music before,” says Bogart, who’s penned songs for Beyoncé and Rihanna.
From the Past to the Future
For the Houston family, Primary Wave so far has acted as a producer on I Wanna Dance, guided creation of a Whitney Houston collection of M.A.C. Cosmetics, and assisted in the sale of a nonfungible token of an unreleased recording the singer made when she was 17. The NFT sold for $1 million in December, raising money for the Whitney E. Houston Foundation.
“Primary Wave bridges the legacy to keep it moving and relevant,” says Pat Houston, Whitney’s sister-in-law and executor of her estate, whose connections with Mestel stretch back to his years as an executive at Arista Records. “It’s all about dignity and integrity—they are all over it and I appreciate it.”
How $1 can be turned into $3 was clear a year after Bohemian Rhapsody—the biographical film about Queen—was released in October 2018. Suddenly the band’s Greatest Hits album climbed to the Billboard Top 30 from a spot outside the top 200 in 2017, Goldman’s report said. The movie also lifted royalties for Queen’s music catalog by three times.
Banking on future streaming revenue can potentially backfire. The $1.42 billion Hipgnosis Songs Fund, one of two music royalty funds that trade on the London Stock Exchange, was said to have taken a hit after Neil Young left Spotify because the platform continued to distribute Joe Rogan’s podcast despite backlash for spreading Covid-19 misinformation. Hipgnosis bought 50% of Young’s global copyrights and income interests for about $150 million in January 2021, according to the Goldman report.
Industry factors aside, music catalog sales have also exploded because interest rates were so low for years. The low rates made it inexpensive for private-equity firms and music companies to borrow to buy catalogs. The easy financing helped push costs for buying music from a historical 8 to 12 times cash flow to 18 to 20 times, Goldman said.
Low rates also helped because companies evaluate catalogs—considered long-duration assets—according to a discounted cash flow model to get the present value of projected future cash flows. The calculation to determine that depends on the weighted average cost of capital and debt, which are sensitive to interest rates. The increase in rates is among factors affecting the performance of share prices for music companies such as Universal and Sony.
Rising rates also may make music royalty funds less attractive to investors. These funds typically offer dividend yields, which have been one of the few ways investors could find to clip a coupon. The prospective dividend yield for Hipgnosis Songs Fund as of March was 4.4%, for example, according to a Stifel Financial report. Private-equity funds may offer higher yields, and certainly did when rates were lower.
“That has been higher than what you could get in other areas of fixed income,” says Peter Martenson, a managing director at Eaton Partners, a Stifel Financial company that connects institutional investors—including family offices and wealthy individuals—with private-market funds.
Differing Investment Strategies
In the music royalty business, Eaton has focused on the “middle market,” musicians and songwriters who may not be superstars, but who have steady long-term followings, Martenson says.
In March 2019, Eaton worked with Lyric Capital Group, a New York private- equity firm focused on middle-market music royalties, to secure $350 million in financing. Those funds allowed Lyric to recapitalize the portfolio of its Spirit Music Group, a New York music publisher founded in 1995 that owns or manages more than 75,000 songs from artists ranging from writer and producer Frank Rogers to bigger stars such as Tim McGraw and Usher.
The arrangement gives Eaton’s investors access to experts in the music industry, who can leverage their long-term relationships and understanding of the business to make catalog deals and oversee the royalty rights once they have been purchased, Martenson says.
“Otherwise, if not, you and I will step in and say, ‘Hey it’s the Beatles, let’s pay up for it!,’” he says. “We are probably not going to get the value out of it that we should unless we have someone who can help us operationally with it.”
When private-equity vehicles buy music catalogs they are expecting to get a revenue stream that will create an internal rate of return of about 15% for its limited partners, Martenson says. Investors will expect higher returns for riskier catalogs, which generally are those that include younger artists whose longevity hasn’t been tested yet.
The advantage of buying catalogs of middle-market artists is that future income streams from their music is predictable yet not as pricey as those of superstar musicians, Martenson says. Catalogs of middle-market artists cost a more modest 10 to 14 times net revenue.
“When you do the math, your return expectations are a bit compressed” for the superstars, Martenson says. “If you can come down a little bit, that could be a nice middle-market return.”
Individual investors can take part in this surge of catalog buying indirectly through buying shares in big music companies, such as Universal Music Group or Sony Group, or in independent digital players such as Paris-based Believe Music, or with streaming platforms such as Spotify.
For a direct play, investors can turn to Hipgnosis Songs Fund and Round Hill Music Fund, the public vehicles that trade on the London exchange. Wealthy investors and family offices also may be able to get access to catalog deals via private-equity funds focused on music royalties such as Primary Wave and Lyric Capital. A relatively new entrant is HarbourView Equity Partners, a private-equity firm focused on music and entertainment assets, launched last year by Sherrese Clarke Soares, founder and former CEO of Tempo Music Investments.
HarbourView has a $1 billion backing from private-equity firm Apollo Global Management, and has since acquired the catalog rights for “Despacito” writer and singer Luis Fonsi and songwriters and producers Andre Harris and Vidal Davis, known as Dre & Vidal, among at least 33 others.
Unlike Primary Wave, HarbourView’s music royalty strategy is to “underwrite to what is organic to the catalog themselves,” and not to act as a music operator. Instead, the firm will partner with the music label or publisher as “a more efficient way to drive value,” Clarke Soares says. The firm is also “agnostic” when it comes to musical genres, she says. “A lot of platforms lean on instinct and personal taste and we don’t.” Instead, HarbourView analyzes song data to uncover music that should continue to find a broad audience, she says. “What that has led us to is great investments in a pretty diverse catalog.”
Uncorrelated Opportunities
Available private-equity strategies can look different depending on how each firm chooses to structure investment vehicles. Some may aggregate several music catalogs in hopes of selling them at a higher price than they paid, either because the catalogs are trading for higher multiples of cash flow at that time or cash flow rates have increased since the initial purchase, says Jordan Stein, a director at Cresset Private Capital with Cresset Partners in Chicago.
Also, if a fund buys 20 catalogs each valued at $5 million and sells the resulting $100 million catalog, “that should produce a higher multiple, because it’s a broader and bigger and more diversified set of underlying set of cash flows,” Stein says.
Cresset is working with Open On Sunday, or OOS, from Atlanta, a specialty-finance and music royalty group that connects with individuals “who worked on major projects with big artists and are entitled to a smaller percentage of royalty rights,” according to Cresset. The firm’s clients can invest in a vehicle and in return get access to ownership and cash flow coming off the catalogs of these artists.
“It’s pretty unique,” Stein says. “The overall intention is to create long-term value by aggregating smaller catalogs into a larger, more diversified portfolio with scale and growing cash flow to investors.” Stein doesn’t expect rising rates to create a big drop in catalog deals because predictions for music streaming growth continue to be strong, and valuations of these catalogs are primarily driven by growth prospects. “You have these stable, profitable assets in an industry that’s growing like crazy and each year beats expectations—that will keep prices fairly high,” he says.
Also, as Stein and many others in the market point out, music and entertainment revenue generally is untethered from the broader economy and markets. Even in periods of stress in the U.S. or globally, consumers stream music and go to shows as a relatively low-cost distraction and a “way to engage with their family that feels like a durable, not a discretionary item,” Clarke Soares says. “It’s truly noncorrelated to the market. Especially as we head into this period of volatility and uncertainty as it relates to supply chains, raw materials, recessionary risk, inflationary risk, etcetera. We are bullish on owning this asset class right now.”
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