Is this forgotten FTSE 250 stock ‘living on a prayer’?

Hipgnosis Song Fund (LSE:SONG) is £1bn FTSE 250 an investment company that acquired the rights to publish songs. That means you get paid for every track you own that is streamed or used on radio, TV or film.

As an investor, the sound economy is attractive to me. But there is a less attractive B-side to this story? Let’s have a look.

His record collection is impressive

The company’s portfolio totals more than 65,000 songs, including Mariah Carey’s 1994 hit. What I want for Christmas is you, which is still regularly included in the Christmas charts. Other hits he had included umbrella by Rihanna, Single Woman by Beyoncé, and Jon Bon Jovi Live in Prayer.

The revenue comes from millions of microtransactions, whether streaming, physical purchases, downloads, performance, licensing and merchandising. I like it because people will always use music in some form, regardless of economic performance.

Indeed, Merck Mercuriadis, co-founder and CEO of Hipgnosis, has compared classic hit songs to gold or oil. He said: “When I say it is better or better than gold or oil, because it has nothing to do with what is happening in the market…Music is always consumed..”

There seems to be some truth to this. Last month, for example, Spotify reported to have 205m paying customers out of a total of 489m monthly active users. This is a 14% year-over-year growth for paid customers, despite high inflation affecting consumer budgets.

Issue

The problem with these funds is that, unlike gold or oil, it is difficult to assess the true intrinsic value of a catalog of hits that have bought more than $2bn. This may be part of the reason the stock has fallen out of favor since listing in 2018.

Excluding dividends, the stock is down 27% over the past year and 18% since its market debut.

At 84p today, the shares are trading at a 49% discount to the fund’s net asset value (NAV) (or at least a discount to the company’s own estimate of its catalog value).

The accounting standard eliminates the cost of fund catalogs for 20 years. However, Hipgnosis was not written until 70 years after the composer’s death.

In the latest one-year results (to March 2022), that means amortization costs of $106m (about £88m). That has now resulted in a cumulative amortization of $200m.

Value Gap

So basically, there is a big difference between what the market and the company think is the fair value of the fund’s catalog. This led Hipgnosis to recently launch a debt-funded share buyback program.

I don’t like that this buyback is financed with more loans. The company currently has net debt of around $559m. It seems that it will pay 6% interest on the loan while the dividend yield is also currently 6%.

Meanwhile, the underlying profit generated by the current song portfolio has declined. But falling share prices have left the fund unable to raise new equity to buy more songs. To me, the company seems to be in a bind.

Overall, I think there is too much uncertainty here for me to buy the stock right now.