Royalties: The Alternative Assets of the Music Industry

Jul 8 2016 | 7:01pm ET

Editor’s note: Recent market volatility has investors seeking greater insight into alternative assets. But not just hedge funds and liquid alternatives are receiving all the attention. 

There is increasing interest in ways to invest in the music industry, which is currently experiencing a turnaround. After two decades that saw overall revenue declines, the music industry has now turned the corner and showed annual growth of 3.2% in 2015. Consulting firm PWC now projects growth in the industry through 2020 thanks to a steep rise in music subscription services. These trends will boost royalty payments to artists and benefit owners of intellectual property.

This switch has sparked interest in an alternative asset that investors lacked real access to just a few years ago. Investors can take part in the buying and selling of music royalties, intellectual property, and other cash-generating investments that also rank among the most uncorrelated of asset classes.

FINalternatives recently sat down with Benom Plumb, a professor in the Music & Entertainment Industry Studies Department at the University of Colorado-Denver and a consultant for Royalty Exchange, a platform that brings investors and musicians together to buy and sell music royalties. Professor Plumb provides some insights into the music business and how to invest in royalty streams. 

Finalternatives: What makes music royalties a unique alternative asset?

Benom Plumb: This is a non-correlated asset and can provide steady cash flow for a number of years. Established popular music copyrights are generally consistent earners and often increase in value over time, regardless of market activity. The overall yield can often mean 10% or more for the non-correlated asset with a strong history of royalty generation.

It’s also important to note that these royalties are paid out at consistent dates, mostly by statutory rate. These aren’t subject to the whim of corporate boards.

What similar benchmarks exist in the investment space?

Music copyrights are considered the “real estate” of the music business. It’s just like owning a piece of real estate, mineral rights or even a patent. The only difference is that it is considered “intellectual property” instead of a tangible property, mineral or product. Excluding “Fair Use” cases, almost any commercial or promotional use of music requires a specific license with fees or ongoing royalties. The various licenses have their own set of standards, government regulations, and shifting rates.

How are royalty payments set up?

There are a few things that are important. First, royalties are paid out on an established timeline. It's usually quarterly, and they are set by a statutory process. When royalties are established, there is a clear claim to the earnings based on the type of royalty stream. There isn't any ambiguity.

Take us through the valuation process of an intellectual property in this space?

The valuation of these assets is based first on the income generation of various royalty categories. Once a net income number is calculated for these royalties, the seller adds a multiple to arrive at the valuation and purchase price. How a multiple is determined is entirely subjective. The multiple is often based on how famous the artist/song is, how often and in what ways it has been licensed and of course - is there a strong consistency of earnings?

Financial analysis is conducted based on the last three to five years of earnings, beginning with three primary income sources:

First, are public performance royalties. These are paid whenever a song is sung or played on the radio, on the Internet, at concerts, or streamed on platforms like Spotify and Pandora.

The second is mechanical royalties, which are paid to songwriters whenever a someone makes a copy of their song.

Third is television and film income, which is the income that comes from when a song is played on television, used in a commercial, or other media.

If The Beatles “Come Together” was a consistent earner over three years and hypothetically totaled $300,000 in public performance royalties – the seller would then add a multiple to the $300,000 for a final valuation and purchase price. A low multiple would be two and the highest multiples go upwards of 20 or more. So in this hypothetical example, the public performance royalty stream on a Beatles song of this stature could easily be valued and sell for $6 million or more.

Therefore, investing in music royalties with consistent earnings and a high volume of commercial activity means strong yields and generations of income for the investor. This is why both Sir Paul McCartney and Michael Jackson were in the business of music royalty investments.

What are the primary and secondary markets for these royalties?

Most transactions in this arena happen between “in the know” established music industry professionals. For example, Michael Jackson became privy to the sale of a significant portion of The Beatles catalog through his attorney and personal relationship with Sir Paul McCartney. I’ve worked on deals that were kept confidential from the general public and investing community, because the seller wanted offers from specific types of buyers within the industry who understood the business and catalog/song valuations. Word got around on who was selling what, because of industry relationships.

Other sale transactions happen within estate cases, where the buyer can purchase assets far below market value.

Public markets are now beginning to appear. There was a recent change to Tennessee law that allowed Nashville Royalty to sell stakes in their music catalog, but investors have to be residents of the state. It is an attractive crowdfunding investment given that the portfolio includes hit songs by Conway Twitty, Reba McEntire, George Strait and Martina McBride. Nashville Royalty's founder Jeff Tweel has said that investors can expect an annual yield from 12% to 15%.

Then there’s Royalty Exchange, which is both a primary and secondary market, depending on the who the interested parties are and their “network” within the music industry at large. This is open to investors all around the world.

The Royalty Exchange platform opens up the “back-room” nature of these deals to investors who wouldn’t otherwise be privy to their availability, including both non-music industry and music industry professionals.

What are the risks in royalty investment?

The music industry has its own set of problems that can add risk to the asset.

Often, if the catalog of music is not managed by a professional pursuing lucrative licensing deals and aggressive royalty collections – the copyrights can degrade in value. A generally consistent royalty stream is the public performance royalty (for music played on radio, satellite radio, Internet, TV, bars, clubs, restaurants and concert venues). Regardless of a professional “working” the catalog of popular songs, public performance royalties have historically shown strong and consistent cash flow. However, recent Department of Justice proceedings with the primary royalty collection societies could bring significant changes in licensing schemes and royalty rates for artists and songwriters.

The U.S. Copyright Act of 1976 allows for a copyright “reversion”, in which a songwriter can terminate the copyright assignment (sale) 35 years after the sale and assignment. It’s possible the asset could be terminated between the 36th and 40th year after the sale. In the event that a songwriter chooses to re-capture the copyright, the publisher and writer shares would go with the copyright reversion.

However, this termination right is only recognized in the U.S., Canada and British Reversionary Territories (any country under former British colonial rule). The current owner of the copyright, if terminated by the songwriter, would retain their ownership in the asset for the rest of the World, excluding the U.S., Canada and B.R.T’s.

Are the issues of liquidity improving in the space?

Liquidating the asset is not always quick. The time frame to liquidate can swing wildly depending on the interested parties and copyrights in the transaction. Generally, transactions can be completed within two to six months. Not many catalog/song sales get completed within 30 days, at least in private transactions. Auctions on Royalty Exchange allow the investor to liquidate quicker than relying on “in the know” music industry personnel and slow negotiations.

Improving the liquidity of these assets requires the “working” of the catalog/songs by a professional, in order to increase cash flow through licensing deals and adding value to the assets.

What is the duration of these deals?

The duration of a U.S. music copyright is the life of the last remaining author, plus 70 years. So the duration of royalty payouts can last literally generations. As long as the copyright is still active and not in the public domain, it will pay out for years to come.

For example, a Lennon/McCartney co-written song will earn royalty payouts in the U.S. 70 years past the death of Sir Paul McCartney. Which, we all hope is a very, very long time from now. However, as mentioned before, it’s possible the songwriter can re-capture the copyright and royalties for the U.S., Canada and B.R.T’s 35 years after a sale.

What type of deals in music rights and royalties have you seen recently?

One of the more popular deals that took place in recent months was for a song catalog that had publishing royalties from songs by the Eurythmics, the Bee Gees, Judas Priest, The Tourists, and others. More than 170 investors took part in the auction. This was a premium collection of songs that consistently paid strong royalties for the last 17 years.

I often see deals that range from $10,000 price and up to $1 million through these public sites, and even larger deals through my private network. Each has its own unique story.

One that I've seen recently on Royalty Exchange that's intrigued me was based on photography rather than a music catalog. I see many of the same valuation elements at work. This deal offers royalties to a portfolio of pictures that includes never before released images of Muhammad Ali, Marilyn Monroe, and Elvis Presley. The same process – and potential value to an investor – applies.

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