The real book

 SONG’s share price remains at a price that we think is an overreaction to legitimate worries…by Alan Ray

 
Just over a year ago, I got the chance to study part-time at Boston’s Berklee College of Music, in a way that allows me to combine a ‘real’ job with a very personal project.

All the signs of a post-pandemic mid-life crisis are contained right there in that sentence, of course, but I can offer the following encouragement to anyone in the same boat: patience comes with age and if learning new skills later in life takes more time, at least you will have the patience required to do so. If nothing else, it’s a more effective way of maintaining cognitive function than a daily dose of Wordle.

One of the first things you are encouraged to do at Berklee is buy a copy of something called The Real Book. This is a ring-bound collection of a thousand or so jazz standards and a single page packs in all the information needed to bluff your way through a song.

Generations of musicians have come to rely on their dog-eared copy to get them through a gig or two but, surprisingly, it was only in 2004 that the composers of all those songs started to receive royalty payments from the publisher.

Music and, specifically, music royalties have become an asset class with very specific relevance to the investment trust sector in recent years. All of the scene setting for the recovery focusses on the consumer and how the early days of digital music led to a collapse in revenues.

Musicians, quite rightly, were getting very angry and despondent over the blatant theft of their work. But I wonder how many of them owned a pre-legal version of The Real Book? All of this went through my mind when last week I attended Pershing Square Holding’s (PSH) investor day.

This included the opportunity to listen to the chair of Universal Music, Sir Lucian Grainge, in a wide-ranging discussion about his career and the music industry, with PSH’s Bill Ackman. PSH is a shareholder in Universal and thanks go to them for providing the opportunity to hear one of the most important figures in the music industry speaking as freely as his lawyer, who was stage right, would allow.

One of the most striking comments Sir Lucian made in this talk was about an early music service which he signed Universal up to. Back in 2004, Nokia launched a service that came with their phones called Comes With Music, which was an early ‘all you can eat’ music platform.

Given that mobile data speed and coverage was so patchy in 2004, subscribers were allowed to download up to 3000 songs onto their phone. Sir Lucian’s insight was that allowing people to download 3000 songs was not the same thing as forgoing $3000 of revenue from customers buying each song, given download pricing per song at the time was $0.99.

Remember, this was a time when people were obsessed by ‘how many tracks does it hold?’ when they were buying an MP3 player. The music industry still thought that people would want to own, rather than rent, their music, even if it was an electronic copy on a hard drive rather than a beautiful piece of art with a vinyl record tucked inside.

What he was basically saying was that this was a way to monetise listeners who would never actually spend that $0.99 on buying the track, but might listen to it once or twice as part of a general backdrop, and so he signed Universal up. Ultimately, the service was too clunky, in his view, and didn’t succeed.

However, when Spotify’s Daniel Ek came knocking a few years later with an early version of Spotify, he immediately saw the opportunity to sign up Universal’s vast catalogue and to invest in the fledgling company. The recovery in the music industry since those days has been well-documented.

Sir Lucian went on to talk about how the data from streaming services allows Universal to better understand local markets and so helps them target which genres are popular in local markets. He cited Latin America as an example of where, due to widespread historical piracy, it was hard to know what music people were really listening to.

Now, though, there is a much clearer picture that allows Universal to invest in new artists who would never have had that opportunity before. He sees it as his role to bring artists with him on the journey to embrace new technology and, for example, seems totally unphased by TikTok, which pays very small amounts of money to use music.

He gave the example that when, almost a hundred years ago, there was live music on radio for the first time, there was a widespread belief that this would mark the end of live music attendance. As ever, technology and art seem to find ways to co-exist and thrive and, overall, he seemed incredibly positive about the future.

I was lucky enough to meet Hipgnosis Songs’ (SONG) manager and founder, Merck Mercuriadis, for the first time in 2017. This was when SONG was just an idea on the back of a proverbial envelope and there was still quite a despondent feeling in the music industry.

What I find striking, looking back on those early conversations, is how accurately Merck predicted what would happen; how major artists would sell their ‘babies’ to a careful owner and how streaming would make it just too inconvenient to carry on with downloading individual songs, either legally or illegally.

Many people who probably very rarely bought a CD or a record now think very little of the monthly subscription that allows them to have all the music, all the time. The point of that little Real Book anecdote is that even the musicians were using other musicians’ compositions without paying, but they got there in the end because the publisher who took the book on in 2004 gave them a legitimate and, crucially, more accurate version.

SONG, of course, is currently trading at a very wide discount and is constrained in what it can do to alleviate that, as it owns private assets and currently carries some gearing. With interest rates rising so dramatically, in my view, there is a completely legitimate debate about whether the value of SONG’s assets should change more than they have.

Many of SONG’s shareholders are institutional fund managers who look at a broad range of assets and it’s their job to reassess the value of SONG if, for example, they are currently being offered corporate bonds at yields several hundred basis points higher than two years ago.

So, the question comes down to this: if other assets are suddenly so much more attractive, why has SONG’s valuation, and the discount rate that is used, stayed the same? By the way, the same legitimate argument exists for all kinds of assets – interest rates are a fundamental part of almost all valuations.

For SONG, the counter-argument is that its valuation has stayed the same because the independent valuer is giving more weight to the fact that revenues are increasingly subscription-based, rather than discretionary. Or, as they’d say in the world of corporate bonds, the spread has narrowed as the risk has reduced. This trend has been underway for a while, but is solidifying even as interest rates have risen and I think it’s a powerful counter.

Investors also worry that even subscriptions will suffer in an inflationary environment and, again, this is a totally legitimate concern. No one really has the data to say otherwise, as this is the first time that TV and music streaming services have existed in times of inflation.

But subscriptions of all kinds are sticky and the SONG share price implies a discount rate on the assets of c.12%, compared to the 8.5% which the independent valuer has used to calculate the net asset value. I think this leaves quite a bit of room for the more negative view to play out and still come out the other side with a discount to net asset value.

PSH’s Bill Ackman seems to agree on the general principle, with PSH’s largest holding being Universal Music Group, which is a more complex business to value but which is exposed to all the same trends that SONG is. My Real Book anecdote also shows how much of life and investment exists in the grey area between absolute certainties.

I’ve come to learn that share prices are often a consequence of smart people with intelligent views and I don’t feel any of the negative arguments are plain wrong. But I’ve also come to learn that the structure of the fund management industry and the stock market can lead to overreactions in share prices and I think that’s what is going on here. Patience will, in all things, be rewarded.
 
See the full research on SONG here >
 

Disclaimer

This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.
 

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