"Money, it's a crime
Share it fairly but don't take a slice of my pie
Money, so they say
Is the root of all evil today
But if you ask for a rise it's no surprise that they're giving none away"
Dark Side of the Moon (1973)
September 6, 2022 | Last week The Institutional Risk Analyst returned to Leen’s Lodge in Grand Lake Stream, Maine, for a Labor Day respite and some salmon fishing on West Grand Lake. This pristine cold water fishery now has so many healthy juvenile smallmouth bass that the daily limit is being raised next year to two fish up to 14” from the single 8-12” fish limit today. There are literally too many healthy, hungry smallmouth bass chasing too few smelts in the vast series of lakes that stretch from the heart of Downeast Maine at Grand Lake Stream Plantation on US Route 1 west toward Lincoln on I-95.
Investment managers likewise face too few real opportunities in the world of asset allocation, too few smelts to chase to borrow the metaphor of the smallmouth bass. There are few asset classes that have not been impacted by demand-pull inflation from hungry investors. Take the market for legacy music portfolios.
Valuations for old rock music catalogs have exploded in the past three years even as the population of listeners has declined. Looking at the prices paid for creative content of all descriptions, it seems that the proverbial horse has left the barn for the FOMC when it comes to controlling the inflation of valuations for creative assets. Keep in mind that the cash flows from music catalogs are a closely held secret, so there is zero visibility into past or future sales.
Some of our most trusted colleagues in the world of mortgage finance get queasy when prices for conventional mortgage servicing assets drift north of 100bp or ~ 4x annual cash flow, yet in the world of legacy music portfolios, add a zero. Variety reports that 20-30x annual sales is the norm today. Yet none of the “prices” for these deals are public and the counterparties are under NDA. If you speak, you lose your LA privileges for life.
Buy Side firms are said to be circling the Pink Floyd catalog, for example, specifically the Hipgnosis Songs Fund backed by Blackstone (BX) with an indicated price tag of $500 million. Is this a fair deal? Maybe by today’s standards, but the question is will this be a good deal for investors a decade from now? When was the last time you listened to Pink Floyd? Ask your children if they’ve every heard of Pink Floyd. Here’s a pretty comprehensive list of legacy music catalogs.
“The truth behind the spate of music catalog sales are threefold,” opines composer and Emmy Award winner Michael Whalen, who spent the past few years curating legacy music portfolios. We consulted Michael back in 2017 about the evolution of the content over the years (“The Economics of Content: Michael Whalen”). Here’s his well-informed take:
“First, names like Pink Floyd are really an ego buy. PF does well on streaming platforms but not enough to justify a $500 million check. Also, past sales say nothing about future streaming revenues. Therefore, the money will have to come from someone who wants ‘bragging rights.’ That said, no one under the age of 40 knows or cares about this music. Artists like Pink Floyd are ‘cashing out’ by selling the remaining sales of these catalogs now.”
“Second, many artists were afraid that the Biden Administration was going to change capital gains taxes upward, putting pressure on making these deals before the change. This pressure now seems to be abating, of note. But people like BMG are pulling in more VC money to finance potential purchases like Pink Floyd, putting more pressure on prices and on monetizing the catalog.”
“Third, record labels and music publishers have commoditized returns from streaming to the point that they can predict within a few hundred dollars a quarter what a music catalog will produce - especially an iconic catalog. In other words, the record companies have calculated NO MORE than 5-8 years to recoup their principal investments on the catalogs they have bought. There is very little risk.”
While the risk of loss of funds invested may be low, we wonder about the real, long-term value of a catalog like Pink Floyd, especially adjusted for inflation. Michael notes that the sales so far are almost entirely and only legacy people. Also, the multiples negotiated are for what the artists are making NOW not what can be earned by the labels through licensing and other means.
“I am very skeptical of the valuations of the legacy catalogs and these latest sales have done nothing to change my mind,” Michael told us last week. “We’ve seen one of these hysterical ‘gold rush’ scenarios that Wall Street insists on pursuing, often fucking the investors in the name of management fees. Said another way, there is a LIMITED window to exploit this music. The labels might recoup but they won’t be ‘raking it in’ for decades.”
With legacy music catalogs are going for 20-30 times annual cash flow, a mind-blowing statistic, recovering the initial cash outlay, especially with leverage, may be a more pressing concern. When Universal Music agreed last year to buy the catalog of Bob Dylan for a reported $300 million, our first reaction was to reject the price. As it turns out, the pricing of legacy music catalogs is about as transparent as the market for 19th Century American paintings sold in gallery sales.
“Everybody lies about the size of their deals,” Doug Davis of the Davis Firm told Variety last year after he sold his catalog to Hipgnosis Songs Trust. “Anyone who’s sold a catalog wants to go around and say they got a bigger check than they got, so there’s pie-in-the-sky aspirations.”
Pie-in-the-sky is a great description for many of the investment manias and speculations we’ve all witnessed over the past several years. Whether it is Bitcoin or meme stocks or legacy music catalogs, the investment community continues to display the collective discretion of a school of small mouth bass, chasing the shinny object hither and yon around the clear waters of West Grand Lake.
No amount of analytics can prepare or protect investors when price volatility has reached double digit rates of change on a weekly or even daily basis. The assumption of price volatility on the part of consumers and business managers is at the heart of inflation expectations, a feature that was seen in the US economy a century ago during the Roaring Twenties following WWI. Ponder that parallel.
Many ask how long it will take for the Fed to get inflation under control. We wonder, to paraphrase James Grant in “The Forgotten Depression 1921: The Crash That Cured Itself,” whether Mr. Market won’t take care of that problem in due course by ushering in a period of asset price deflation to match the recent asset inflation mania. No matter how much fiat money the Fed creates, the secular bias remains deflation.
In that downturn 100 years ago, Grant describes eloquently how the Wilson and Harding administrations, and the Federal Reserve both followed policies contrary to current wisdom. Interest rates were raised and spending was cut. A strong economic recovery ensued. Somehow we don’t think that this next economic adjustment will end so well given the amount of leverage and government intervention in the system.