Music assets are a hit when interest rates are low, but will investors change their minds when the Fed introduces hikes?
Money flowed into music catalogs. Major record labels, private equity firms and specialty funds like Hipgnosis SONG -0.85%
spent a total of more than $12 billion on song rights for artists including Tina Turner and The Beach Boys last year, according to data from consulting firm MIDiA Research. The tally was more than double the previous record set in 2020.
Demand for music publishing rights rose as low interest rates pushed investors looking for yield into alternative assets. Song catalogs are sometimes compared to high yield bonds for the regular revenue they pay out in the form of music royalties. Every time a song is played in a nightclub or on a streaming platform like Apple Music, the owner of the rights to the underlying composition gets paid.
Royalties are also considered relatively recession-proof. Even if pinched consumers cancel their Spotify SPOT -0.86%
or YouTube subscriptions, ad-supported free streaming tiers pay rights holders for the songs users listen to.
Catalog valuations have exploded in recent years. In 2021, investors paid multiples equivalent to around 22 times the publisher’s net share of royalties – a standard measure of industry income – compared to 11 times in 2015, according to data from investment bank Shot. Tower Capital. The prospect of higher interest rates has yet to scare off buyers. Deal multiples are up slightly this year, although the average may be flattered by a number of hit deals for established artists such as Neil Diamond, whose predictable royalties are attractive.
Higher interest rates could hurt demand for music catalogs if investors are able to find attractive yields elsewhere or switch to inflation-linked assets such as certain types of real estate. Inflation, currently 7.9% in the United States, will reduce the purchasing power of future cash flows generated by music catalogs. According to George Howard, associate professor of management at Berklee College of Music, mechanical royalty rates set in Washington have not kept pace with changing consumer prices.
Yet the demand for music among consumers is particularly strong right now. Data released last week by the International Federation of the Phonographic Industry shows that the global recorded music industry grew by 18.5% in 2021, more than double the average rate of the previous four years.
If last year’s performance continues, growth forecasts will look conservative. Wall Street expected the music industry to grow about 8.4% per year on average between 2021 and 2025. Based on this estimate, a catalog purchased for 19 times the net share of the publisher in 2020 would offer a 12% leveraged return for investors, even if it were to be sold at a 15x lower multiple in 2025, Shot Tower Capital estimates. Strong growth could allow homeowners to cash in at a better multiple, offsetting some of the drag from higher interest rates.
Streaming platforms are just taking off in emerging markets. Last year, Latin America was among the fastest growing regions in the music industry. One risk to watch is the cost of data: in low-income countries, the price of a gigabyte of mobile broadband data absorbed 7.9% of consumers’ average monthly income in 2021, an increase from 7, 5% in 2020 and well above the 2 Percent Level considered affordable by the Alliance for Affordable Internet.
As the capital to purchase music catalogs becomes more expensive, the royalty returns will inevitably not be as attractive. As Adam Sansiveri of Bernstein Private Wealth Management puts it, “the hurdle of royalty growth and therefore streaming is rising.” For now, however, enthusiastic music fans are keeping the catalog ratings on a high note.
Write to Carol Ryan at [email protected]
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Appeared in the March 30, 2022 print edition.