The Hardships of Hipgnosis Songs Fund in Light of Phonorecords III

by Kaja Deric and Vincent Williams

Introduction

In the years following the enactment of the Music Modernization Act, there have been numerous advancements in royalty rates for streamed music. However, many artists still face issues of being underpaid by streaming platforms. One such victory which raised royalty rates was Phonorecords III. This law, passed by the Copyright Royalty Board (CRB), increased the mechanical royalty rate for interactive streaming from 10.1% to 15.1% for all streams during the period 2018 to 2022. The decision was officially reached in June 2022, and successfully cleared the final determination on August 23, 2023. As a result, songwriters who released music within that time frame are slated to receive retroactive back pay for the royalty increase from the Mechanical Licensing Collective (MLC) by February 2024. Streaming platforms, “including Spotify, Amazon Music, Apple Music, were left on the hook for lump-sum payments to music rightsholders to cover these retrospective rate rises.”¹ This law is a monumental milestone for all songwriters and music publishers, but also has the potential to cause some issues for digital service providers (DSPs), music management companies, and intellectual property investors. This was seen recently with the British company Hipgnosis Songs Fund. 

Hipgnosis Songs Fund

Hipgnosis Songs Fund (HSF) is a prominent British music intellectual property investment and management company, specializing in the acquisition and oversight of song-related rights. Established in 2018, Hipgnosis strategically concentrated on procuring the rights to blockbuster songs, operating under the premise that these musical assets constitute enduring investments resilient to economic fluctuations, poised to appreciate in value over time. In the span of the last five years, Hipgnosis successfully secured rights in some of the most iconic songs in history and modern times, such as “Shape of You” by Ed Sheeran, and “Deja Vu” by Olivia Rodrigo, as well as entire catalogs from globally renowned artists, including the Red Hot Chili Peppers. One of their largest purchases occurred in November 2020, when Hipgnosis bought 42 complete catalogs, which included 1,500 songwriters and 33,000 songs, for $322.9 million from the management and publishing company Kobalt Music Group.² This purchase also included Kobalt selling HSF 20,000 non-core songs to inflate the average revenue of their main songs. After this purchase, Hipgnosis’ capital continued to increase and it became one of the most profitable music investment companies in the world. At one point, the company owned “nearly 25% of all Songs played over a billion times on Spotify.”³ 

Shortly after Phonorecords III passed, Hipgnosis made a public announcement on its website regarding the ruling and was clearly in favor of the CRB’s determination. HSF stated, “The Board of Hipgnosis welcomes the decision of the US CRB to disallow the appeal by various streaming services against the Phonorecords III determination to increase mechanical streaming royalty rates for songwriters and publishers.”⁴ Although they greeted this announcement with optimism, it now is apparent they overestimated the impact Phonorecords III would have on the royalties they would receive.

The Start of Trouble

In the year following the Phonorecords III decision, Hipgnosis experienced severe financial difficulties. When the company was founded and debuted on the London Stock Exchange in 2018, they made it clear they were “founded on the premise that hit songs are long-term predictable assets unaffected by economic cycles that will increase in value as the worldwide music streaming market grows.”⁵ At the time this seemed very plausible; songs will continue to be streamed regardless of the state of the economy. However, Hipgnosis did not account for such a high rise in interest rates. “Higher interest rates mean future discounted valuations are lower, as the discount rate used for future cash flows is higher,” which for Hipgnosis means a dip in both stock price and the future value of their assets.⁶ “Hipgnosis Songs Fund’s share price is down more than 25% over the past year and closed at 66.31 British Pence (USD 0.80).”⁷ Since the final determination of Phonorecords III in August, things have progressively gotten worse for Hipgnosis Songs Fund. 

In September 2023, the first signs of HSF’s downward spiral showed when they announced a plan to sell $440 million of their catalog to Hipgnosis Songs Capital (HSC), the Blackstone-led funding group which is separate from HSF. This strategic initiative also encompassed a $25 million sale, encompassing 29 catalogs acquired during their 2020 Kobalt acquisition.⁸ In a shareholder statement by CEO Merck Mercuriadis, the rationale behind these divestitures was articulated. To originally facilitate the aforementioned acquisitions, Hipgnosis was compelled to acquire “20,000 non-core songs,” without perpetual ownership, along with enduring royalty and administration obligations to songwriters.⁹ This posed a challenge to their internal framework as a “company that manages extraordinarily successful songs of great cultural importance rather than a traditional publisher.”¹⁰ This move was coupled with a financial motive, as later in the announcement, Mercuriadis mentions this move would increase the value of each remaining song HSF controls by $1,990 per song to $3,500.

The reason for this push was revealed in October, when HSF announced they had severely overestimated the royalty potential of their catalog in light of Phonorecords III. Backtracking on their 2022 predictions, their new royalty calculations were “down roughly 54% from $21.7 million to $9.9 million.”¹¹ Hipgnosis was losing a lot of money fast, so much so that they did not have enough available to pay its interim dividend to its shareholders, which they halted alongside this announcement. With the company “out of money to buy new rights,” the future looked bleak.¹²

Hipgnosis then faced a dilemma during their annual general vote on October 26th, 2023, as they just announced they would not be paying the very people deciding the fate of the company. There were two matters to be deliberated: (1) a continuation of the company in its present form, and (2) approval of the sale to Blackstone.¹³ Both proposals were shut down, meaning Hipgnosis held onto its impressive catalog, but was given no plan forward. Within the next six months, the board needed to figure out how to either “reorganize or wind up the company.”¹⁴ Still recovering from major setbacks, the company now no longer expects to pay dividends until their next fiscal year.

HSF Annual Report

In conjunction with higher interest rates, another unanticipated liability led to HSF’s ruin, which is revealed in their 2023 annual report. Hipgnosis carries a liability called “Catalog Bonus Provision,” which is defined as “payments to Songwriters where the recognition of a performance bonus is contingent on certain performance hurdles defined in the catalogue acquisition agreements, based on actual and expected future performance that is highly probable.”¹⁵ Excluding this liability and interest, HSF’s annual operating costs actually decreased roughly 21.2%. However, with many performance thresholds reached in the past year, the bonus provision jumped from $925,000 to $33,080,000. Combined with high interest rates, these two factors alone turned a 21.2% year-on-year decrease in operating expenses into an increase by 26.4%.¹⁶ Though such bonuses are not paid in their entirety immediately, rather being expected to be distributed over the course of several years, the liability they represent for the company causes problems now. The entire cost of these bonuses is represented on their Consolidated Statement of Profit and Loss in the current year, which shows despite the staggered payment plan, the bonuses contributed to a loss over the past fiscal year of over $70 million more than was incurred in 2022.¹⁷ 

The future of catalog acquisitions

It is yet to be seen what effect this will have on the recent climbing valuation of music. Catalog acquisitions have been a major trend in the past few years, with some catalogs, such as Bob Dylan, Pink Floyd, and Stevie Nicks, each selling for upwards of $100 million.¹⁸ Due to the unique circumstances surrounding Hipgnosis’ recent debacle, it could be the case that the perception of the value of music is not shaken, and catalogs continue to sell for increasingly high prices. However, it remains that Hipgnosis was at the forefront of public music trading, and its recent failure may nonetheless skew perception of how secure music is as an asset, regardless of whether or not that failure had anything to do with the strength of the HSF library.

Endnotes

1. Ingham, Tim. “Citrin Cooperman Reduces CRB III Royalties Windfall Estimate for Hipgnosis Songs Fund by $11.8m, Causing HSF Board to Halt October’s Interim Dividend.” Music Business Worldwide, October 16, 2023. https://www.musicbusinessworldwide.com/citrin-cooperman-forecast-windfall-for-hipgnosis-songs-fund-from-crb-iii-by-11-8m-causing-hsf-board-to-withdraw-interim-dividend/#:~:text=As%20a%20result%2C%20those%20same,cover%20these%20retrospective%20rate%20rises. 
2. Hipgnosis Songs Fund. “Kobalt Portfolio of Catalogues Acquisition.” Hipgnosis Songs, November 2, 2020. https://www.hipgnosissongs.com/kobalt-portfolio-of-catalogues-acquisition/. 
3. Hipgnosis Songs Fund. “Hipgnosis Songs Fund Limited Annual Report: For the year ended 31 March 2023.” Hipgnosis Songs, July 12, 2023. https://www.hipgnosissongs.com/wp-content/uploads/2023/07/HSFL-AR23-web.pdf 
4. Hipgnosis Songs Fund. “Impact of Copyright Royalty Board III decision,” Hipgnosis Songs, July 4, 2022. https://www.hipgnosissongs.com/impact-of-copyright-royalty-board-iii-decision/ 
5. Zargar, Ahmad. “Investing in the Music Business.” Exploration, October 4, 2021. https://exploration.io/investing-in-the-music-business/#:~:text=Hipgnosis%20Songs%20Fund,-Hipgnosis%20Songs%20Fund&text=With%20continued%20success%20over%20the,the%20global%20music%20market%20expands.  
6. Hall, Mary. “How Do Interest Rates Affect the Stock Market?” Investopedia, July 22, 2023. https://www.investopedia.com/investing/how-interest-rates-affect-stock-market/#:~:text=Higher%20interest%20rates%20also%20mean,or%20shorter%20life%20alternative%20assets.
7. Marshall, Elizabeth Dilts. “Hipgnosis Songs Fund Cuts Dividend to Investors — and Share Price Drops 10%.” Billboard, October 16, 2023. https://www.billboard.com/pro/hipgnosis-songs-fund-cuts-dividend-share-price-reaction/ 
8. Ingham, Tim. “Hipgnosis’ Blackstone Fund Set to Spend $440m Buying 29 Catalogs from Hipgnosis’ UK-Listed Fund; Competitors Have 40 Days to Try and Outbid Its Offer.” Music Business Worldwide, September 14, 2023. https://www.musicbusinessworldwide.com/hipgnosis-blackstone-fund-spend-440m-buying-29-catalogs-from-hipgnosis-fund/. 
9. Ibid.
10. Ibid.
11. Robinson, Kristin, and Glenn Peoples. “Other Music Publishers Say They Aren’t Experiencing Anything like Hipgnosis’ Accounting Issue.” Billboard, October 25, 2023. https://www.billboard.com/pro/hipgnosis-accounting-repeated-other-publishers/. 
12. Thomas, Danial. “Hipgnosis Shareholders Vote against Continuation of UK-Listed Music Investment Trust.” Financial Times, October 26, 2023. https://www.ft.com/content/71e2c7fc-805e-4f45-acb8-76317d0a1009.   
13. Matthews, Eva, and Aby Jose Koilparambil. “Hipgnosis Shareholders Reject $440 Mln Music Catalogues Sale | Reuters.” Reuters, October 26, 2023. https://www.reuters.com/business/media-telecom/hipgnosis-shareholders-vote-against-catalogue-sale-2023-10-26/. 
14. Ibid.
15. Hipgnosis Songs Fund. “Final Results for the year ended 31 March 2023.” Hipgnosis Songs, July 13, 2023. https://www.hipgnosissongs.com/wp-content/uploads/2023/07/230713-RNS-2023-Annual-Report.pdf 
16. Ibid.
17. Ibid.
18. Melas, Chloe. “Why Bob Dylan, Bruce Springsteen, Stevie Nicks and More Artists Have Sold Their Music Catalogs.” CNN, January 26, 2022. https://www.cnn.com/2022/01/25/entertainment/music-artists-selling-catalog/index.html.

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