About that knife-edge Hipgnosis continuation vote . . .  – Beragampengetahuan

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The idea of Hipgnosis is music royalties plus musical management genius. Investors buy pure exposure to the former’s income streams via the London-listed Hipgnosis Songs Fund while group founder Merck Mercuriadis supplies the latter via his external management company.

Earlier this month, HSF agreed to sell some songs to a sister fund owned by Blackstone, which also has a majority stake in the management firm. Buried in the announcement was the following line (with our emphasis):

In addition, the Company has given an indemnity in respect of any reduction in the value of the rights transferred in the event that certain companies which have been dissolved are not restored to the register of companies in order that they can transfer certain rights.

This . . . isn’t good? Dissolving vehicles that hold the assets, presumably by accident, doesn’t really speak of management genius. To monetise song rights it’s usually quite important to have ownership of them.

Shareholders will vote next month on whether to wind up HSF, so mis-steps like this matter even more than usual. One of the main arguments in favour of voting for continuation is that without Mercuriadis and colleagues in charge, the artists on the roster will lose confidence and their songs will become less valuable.

Dissolving special purpose vehicles by accident “appears to poke a fairly large hole in that thesis,” says Stifel analyst Sachin Saggar:

In practice, we expect that these rights were fairly small and that they can be reinstated. But it does raise questions of competence and also why the cost of providing indemnity insurance to the buyer should be borne by the listed fund and not the manager.

Along with consistent issues over transparency, unwelcome surprises in the audited accounts and an accidental soft breach of the RCF covenant in 2021 leads us to only one conclusion: shareholders will be better served if the manager is replaced along with a new Chair of the Board in due course. There are many reputable groups, and we expect that this should be a straightforward process.

HSF is running the asset sale vote in parallel with the continuation vote, which has created a prisoners’ dilemma sort of arrangement that even professional analysts have been struggling to understand:

This week HSF added a layer of complication by rejigging terms slightly, most importantly to add a clause where the manager can be sacked with 12 months’ notice. The practical effect is to disarm the vote, or at least downgrade its importance, since voting “yes” or “no” to continuation now delivers exactly the same outcome.

Other tweaks “appear minor but on the margin are helpful,” says Saggar. These include holding continuation votes more regularly and putting a trapdoor under Mercuriadis’s management firm that can be triggered by the net asset value discount — though since that only comes into play for the month of January 2025 and the board can ignore it, it’s perhaps sensible for investors to do likewise.

The management changes are arguably the significant bit. Andrew Sutch, HSF chair since the fund’s IPO in 2018, will exit by the 2024 AGM at the latest. Andrew Wilkinson, an independent director,* will retire before the end of the year.

None of this fixes the big problem, which is Hipgnosis selling Hipgnosis assets to Hipgnosis. How this deal preserves value for anyone other than Blackstone and Mercuriadis isn’t obvious. “Investors appear in no mood to sell these catalogues to the manager in what their eyes is a heavily compromised process with terms that are skewed in favour of the buyer,” says Saggar.

HSF also said this week that its “go-shop” provision had drawn interest from “credible third parties”. Don’t hold your breath, Stifel adds:

The process has been constructed to prevent potential buyers taking part given the matching right of Blackstone. We would expect buyers to indicate interest as competitors are always keen in mining data on catalogues they do not own. In our discussion with market participants, few appear keen to seriously consider this as a fair process. Hence, our base case expectation is that this is a process in name only.

So if the manager isn’t up to the job, the songbook sale is a lemon and the chances of a counterbid are vanishingly small, how should investors vote next month?

They should vote yes, says Stifel, because Mercuriadis needs to be ejected and it’s best to do that in an orderly way rather than a chaotic one. Voting with management will at least buy the new board some time to sort things out.

A delayed ejection of Mercuriadis may also force Blackstone into action. The many conflicts of interest between the listed and unlisted funds mostly work to its benefit. Losing control of one half would force it to choose between doubling down on the Hipgnosis approach to song monetisation or giving up.

Might Blackstone end up taking HSF private? It’s a long shot. The portfolio sale doesn’t set a very attractive valuation benchmark, being at a 20 per cent-plus discount to underlying NAV, and HSF shareholders won’t jump at the opportunity to crystallise losses on a stock that’s trading at a 30 per cent discount to its IPO price. But stranger things have happened.

So hold your nose and vote for Merck, Saggar advises. The ultimate outcomes may be identical, but serving a winding up order will create the kind of panic that might lead to the dividend being canned, whereas voting to sell the songbook will at least give the new chair enough time and stability to figure things out:

[If the] disposal fails, the fund has limited liquidity. It will also have sunk costs into a process that cannot be recovered, has c.$12m of contingent bonuses to pay in the year to 31/03/24, and potentially a termination fee of c. £11m in respect of the [investment management agreement]. To us, the dividend net of expenses and one-off costs appears compromised, and while we expect there is headroom on the RCF it is not sensible, in our view, to continue to increase leverage.

In effect, we think by voting down the disposal, shareholders are at risk of also inadvertently electing to either cut or suspend the dividend temporarily.

[W]e continue to believe that while the [asset] disposal is not ideal and investors remain uncomfortable with the terms, time is running short and it is better to de-lever the structure and ensure the dividend is maintained as a priority, i.e., it is the lesser of two evils and it is better to support the share price rather than risk an already low share price falling further.

Further reading
— Hipgnosis has sold some songs to itself, and that’s not even the odd bit (FTAV)

* Wilkinson’s Linkedin profile says he’s “Independent Director at Hipgnosis Songs Fund Ltd / The Family (Music) Ltd”, the latter being the old name for Hipgnosis Song Management. A representative for HSF says Wilkinson is not a director of HSG.