Hipgnosis Stock: What The Future Holds (OTCMKTS:HPGSF)

The Hipgnosis problem

The Hipgnosis (OTCPK:HPGSF) problem (a company we might know better as (LON:SONG)) is really that it’s a rather new idea. Sure, the company’s been around a few years now, but the idea of buying up songbooks in order to gain the royalties over time is still pretty new as a business model. Therefore, ideas about how to value either the stock of such a business model or the income from it, well, opinions differ. The biggest difference here being between what the company thinks it ought to be valued at and what everyone else – in aggregate and on average – is willing to pay for it.

You’ll not be hugely surprised to find that management thinks it’s worth much more than everyone else does.

Back two years I said

In Jan ’21 I said here that I thought the basic business model and idea was just fine. Exchanging a future income stream for a current capital value is hardly sophisticated financing after all. However, I worried about valuations, prices being paid and, perhaps most importantly, that I expected interest rates to start rising. This would, by increasing the appropriate discount rate, make that net present value of the future income stream lower – whether we want to talk about the internal to the company song royalties or the dividend payments that result from them.

It’s also true – as I said – that rising inflation might make that future income stream worth more. For we might be able to assume that song royalties will keep up with inflation over time, which might indeed be true.

I was sufficiently worried about all of this that I said I was out. Too unsure to verging on it might not work out well. That call is grand on the ego, of course, for the price is down some 35% or so since then, 30% odd if we include the dividend. Investors in sterling (in London) had some brief periods when they could have profited, but dollars in this quote, HPGSF, it’s been pretty much all downhill since then.

But the future

All that really matters is the future, of course. We are where we are and what happens next is what matters. To work that out we do need to think of the recent past though.

The fund is largely closed

One thing to note is that Hipgnosis used to work by issuing new stock in order to buy the next song catalogues. But when the share price fell below the catalogue valuation, that meant new issues would be dilutive. There have, therefore, as per the FT, been no recent issues or purchases. This does mean that the accounts aren’t clouded by valuation decisions over new purchases, an earlier worry.

Sadly, that also lays bare the performance of the owned catalogues, where revenue has actually been falling. Not a good sign at all. Finally, there’s worry over being able to finance the debt burden and the dividend together.

Debt and buyback

Hipgnosis insists that the catalogue is worth very much more than the market thinks. Therefore, it recently (also as per the FT) launched a debt buyback financed by more borrowing. It seems to be paying 6% on the debt and the dividend yield is currently 6% so that’s not an obviously attractive piece of financial engineering. That announcement and set of purchases does seem to have stopped the fall in the share price, but not – as yet – reversed it all that much.

Inflation

There is one thing here though. Yes, we’ve all seen interest rates rising. But inflation has also jumped, meaning that real interest rates are – at that 6% borrowing cost – negative by 4% for borrowings in sterling (UK CPI is today 9.6%).

This leaves us with a question. Being able to borrow at negative real interest rates – as long as you can cover the nominal coupon of course – to own assets which will maintain their real value after inflation is a great, great, way to make money. So, that means we need to have a view on inflation – will it persist at these sorts of levels? – and interest rates – are they going to peak soon, or are we about to get back to ’70s levels?

The lower interest rates stay, the higher inflation goes, then the better it looks for Hipgnosis. On one further assumption. Which is that the revenues from those songbooks do indeed track prices rising with inflation. I can think of all sorts of reasons why those revenues might not move in lockstep, but I would expect to broadly keep up with inflation. Maybe stutter in odd years, catch up in even, that sort of idea.

So, Hipgnosis is really a bond

We’ve a somewhat inflation-protected revenue stream, much of which is paid out as the dividend. Those song rights aren’t perpetual, but at 70 years after composers’ death, they’re close. Yes, tastes change, but that’s the point of having a portfolio. So, back-of-the-pants valuation is a perpetual, inflation-protected bond.

Which is pretty much my earlier valuation

I didn’t like Hipgnoisis back at higher prices when the yield was 4%. I didn’t think that was high enough to cover the implicit risks. I was right about that, but then before my ego gets too polished, even the blind squirrel finds a nut occasionally.

So, now? At 84 p (to use the London price) the yield is a little above 6%. I still don’t think that’s enough. Yes, management says that the asset value is double that but, you know, they would.

However, if there’s another step down in, that would change. I think we’re getting into the region where the yield would make it worth it.

My view

At some yield, those risks rather go away. Or, are at least adequately compensated for perhaps. I’m still not sure that 6% does it either. Shaky asset valuations, paying 6% for debt to make buybacks, well, no. But at some point, that potential inflation-proofing of the revenue stream would become attractive.

At which point, there’s no real valuation model to help. It becomes an entirely personal one rather than an equation that can be used. I would find 8% here attractive – so, if the dividend is maintained, around 60 to 65 pence as a buying in price. And if the yield went to 10% (so, around 50 pence as a share price) then I think it would be a no-brainer as at least an interesting speculation.

The investor view

All of this assumes that there’s no horrible gremlin inside Hipgnosis. Which I don’t think there is. It also rather depends upon thoughts on interest rates and inflation. Higher inflation will benefit them – it’ll eat away at that fixed price debt burden. Higher interest rates will harm the share price as the yield will become relatively unattractive.

At some current yield, these concerns balance out and the yield becomes worth the risks. Where that level is, well, that’s up to each individual investor. My trigger probably gets pulled – in the absence of other news – somewhere in the 50 to 60 pence per share space. Yours?