Going For A Song: Is Hipgnosis Songs Undervalued?

The recent acquisition of the Round Hill Music Royalty Fund (LON: RHM) by Alchemy Copyrights at a 67% premium to the share price has reignited interest in this unusual area of the markets. It has left the £1.1bn Hipgnosis Songs (LON: SONG) as the only remaining investment trust in the sector and sparked a debate about its valuation.

Like many other income generating trusts, SONG has de-rated sharply in the last year or so and has slipped to a discount to NAV of around 40%. The price agreed for Round Hill was equivalent to a discount of 11.5%, which if applied to Hipgnosis would imply a value of about 132 pence per share, well above the current price of 81p.

Unfortunately there seems very little chance of realising anything like this after SONG’s underwhelming response to the Round Hill bid. The Board was already under pressure given the approaching continuation vote, but the details announced last week were badly received by the market and have opened up some serious questions about corporate governance at the fund.

Underwhelming Response

Hipgnosis has said that it will make catalogue sales for an aggregate gross consideration of $465m, almost all of which ($440m) is to a related party. If the transaction goes ahead it would allow SONG to repay some of its expensive debt − reducing gearing to less than 20% − and to finance a share buyback programme worth up to $180m.

The broker Investec says that the latter could dampen down some of the volatility in the share price and deliver accretion, although it would depend on what is considered to be the true NAV. Unfortunately the transaction implies that the company is worth little more than the IPO price of a pound a share that was set back in July 2018, with substantial value leakage to related parties that raises significant corporate governance concerns.

Looking at the details, the headline discounts on the disposals are 17.5% for the related party transaction and around 25% for the second smaller sale. After adjusting for all the various complications, Investec has come up with a pro-forma NAV of just 103.3p per share after it has all gone through, although given the environment, they say that any share price is likely to be a significant discount to this.

Murky Waters

It looks like the deal is a lot more favourable for the investment adviser and their private fund backers than it is for the shareholders. This is perhaps not that surprising given that the smaller $25m disposal was subject to a competitive process, whereas the $440m sale was agreed bilaterally with a related party without any competition.

The acquirer of the 29 catalogues for $440m is Hipgnosis Songs Capital, a partnership between Hipgnosis Songs Management (the investment adviser to SONG) and Blackstone. These tracks will continue to be managed by Hipgnosis Songs Management and as it’s a related party transaction, it will be subject to a shareholder vote at an EGM on October 25.

Investec says that the sale fails to address the complexity of owning the administration business (Hipgnosis Songs Group) and sets an unattractive precedent for the terms of any subsequent deals with the Blackstone-backed fund. They think that the Board has fallen short and that shareholders may decide that they are better off voting against the forthcoming continuation and looking for more holistic solutions.