Sentiment towards the music royalty funds has waned, as interest rates have risen amid concerns over portfolio valuations.
Nevertheless, Liberum Capital Markets believes the robust outlook for streaming and the sector’s uncorrelated revenues remain attractive.
“The tailwind from discount rate reductions has now been removed and investors’ focus on cash returns will increase,” the broker said.
Based on the latest valuation multiples, the cash yield from the catalogues is roughly 6%, Liberum calculates.
There is work to be done to improve ongoing charges ratios and the funds need to be able to demonstrate an ability to drive dividend growth, it said, as it downgraded Round Hill Music to ‘hold’ while sticking with its ‘buy’ recommendation for Hipgnosis Songs Fund Limited (LSE:SONG) “given its elevated discount”.
The International Federation of the Phonographic Industry’s (IFPI) Global Music Report for 2021 revealed that global recorded music revenues in 2021 rose by 18.5% from the year before to US$25.9bn.
This was primarily led by streaming, which saw revenues rise by 24% year-on-year, and now represents 65% of global revenues.
Both Round Hill and Hipgnosis’s funds are focused on publishing rights, as opposed to recorded music, but should nevertheless benefit from the continued growth in streaming, Liberum postulated.
According to IFPI data, the number of paid streaming subscribers reached 523 million by the end of 2021 (+18% compared to the prior year).
Spotify’s recent first-quarter results surpassed expectations on a number of levels, Liberum noted. Subscribers grew by 15% year-on-year despite the loss of 1.5 million Russian subscribers.
The company also guided to 187 million subscribers by the end of June 2022. The number of total monthly active users increased by 19% year-onyear. Importantly, average revenue per user rose by 3% on a constant currency basis, the broker reported.
“At the recent investor day, Spotify outlined its ambition to reach over one billion users globally by 2030 (422 million monthly active users in Q1 2022), focusing on growth in emerging markets,” Liberum said.
“Looking at the two listed funds, the lack of performance revenue has affected earnings, but the impact has been lessened by streaming growth and the resilience of catalogues that are over 10 years old,” it added.
In addition to uplifts from a recovery in performance revenue, both Hipgnosis and Round Hill should benefit from several regulatory changes and potential new licensing deals with emerging digital platforms, Liberum said.
The broker expects the dividends of both companies to remain fully covered but it believes both e funds will need to demonstrate an ability to drive earnings growth in order to significantly improve share ratings.
“We expect the cost base of both funds to come under greater scrutiny. To an extent, this has been overlooked as a result of NAV [net asset value] progression from capital gains. Costs have been distorted by transaction expenses on new acquisitions, but we believe costs still remain relatively high even after stripping out legal and professional fees. The ongoing charges for the two funds are c.1.8%. We believe the funds need to reduce the cost base towards 1.5% of NAV in the near term,” it said.
Liberum’s target price for Hipgnosis has been trimmed to 130p from 135p while the price target for Round Hill is now US$1.08 versus US$1.15 previously.
Shares in Round Hill currently trade at 1.02p, down 0.5%, while Hipgnosis trades at 112.2p, down 0.2%.