A cacophony of concerns

Hipgnosis Songs Fund (LSE: SONG) is a FTSE 250 investment trust focused on music royalties. It has a portfolio of some 40,000 songs from a wide range of artists including Blondie, Shakira and Neil Young.

In theory, I like the idea here. Music royalties typically provide a steady stream of income over time. This is generated from various sources, including radio, adverts and streaming services like Spotify.

However, in reality, this fund’s been a major disappointment, so far. The stock’s down 34% since listing in 2018 and there’s been constant uncertainty around the true value of its intellectual property.

To help clear things up, the company hired banking firm Shot Tower Capital last year to conduct due diligence on its assets. It found the fair market value of the fund’s song catalogue to be $1.9bn. That’s 26% less than the fund reported it was worth back in December.

Additionally, Shot Tower’s analysis showed that 67 out of 105 acquisitions made by the fund are worth less than the price paid.

Now going on today’s 68p share price, the latest portfolio valuation suggests the fund is undervalued by around 20%. I’d imagine bidders will eventually emerge for some of its hit songs. So perhaps there is value worth pursuing here.

However, the fund said it won’t be paying dividends “for the foreseeable future” as it focuses on paying down its $674m debt pile (as of September). Ouch!

Basically, the whole thing has become a royal mess and I want no part in it.

Another meme stock

The second stock I wouldn’t touch with a 10-foot bargepole is Trump Media & Technology Group (NASDAQ: DJT).

This company operates Truth Social, an alt-tech social media platform that’s affiliated with former president Donald Trump.

It completed its merger with a special purpose acquisition company (SPAC) and started trading on 26 March. SPAC is an entity listed on the stock market that holds cash and merges with a private company.

Currently, the share price is $46.

One plus point here is that Trump Media now has over $200m in the bank and no debt after this merger. It might be able to use this cash to grow subscribers and revenue.

It’ll need to. The company generated revenue of just under $4.1m last year, while it lost $58.2m. And the latest figures I can find suggest around 5m monthly active users on Truth Social after 26 months of existence. That’s not many for social media.

Then again, perhaps that’s not surprising given that its goal is to provide a “home for cancelled content creators“. That sounds like a somewhat niche market to me.

Anyway, we’ve got a company that generated $4.1m in sales with a marke-cap of $6.3bn.

This means the stock’s trading on a price-to-sales (P/S) ratio of around 1,000. And this places it squarely in speculative meme stock territory. History shows that’s not an attractive place to invest.

Needless to say, I think there are far better stocks for me to buy and hold in April.

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The business updated the stock market today (23 November) on its ongoing strategic review.

Options for the future

The company plans to “appoint independent advisers to conduct due diligence on its assets”.

It expects that will “provide a strong knowledge base from which the Board will commence a process of identifying and bringing forward alternative proposals for the future”.

Hipgnosis has asked its investment advisor, Hipgnosis Song Management Limited (a separate company), to propose different terms for its future business relationship with Hipgnosis.

It also announced that it plans to change auditor. On top of all that, it is currently one party on the receiving end of a legal action.

What this means for the business

Ouch!

I am glad not to own Hipgnosis shares at this point.

I do not think the news is necessarily bad. In fact, it could actually turn out to be positive. The company may get a clearer view of the value of its song portfolio. It could also end up with a more favourable financial deal with its investment advisor.

But, like many investors, one thing that I do not like is uncertainty.

All businesses involve some level of uncertainty. But the statement from Hipgnosis reeks of significant uncertainty on multiple fronts.

It remains to be seen what that means for the firm’s underlying and unusual business model of buying up song catalogues and collecting royalty payments for them.

Impact on the dividend

If that business model survives intact, or even improves thanks to a better understanding of its assets’ value or improved terms with its investment advisor, that could help cashflows at the business. That could mean not only that the Hipgnosis dividend is restored, but that it can grow compared to what it has been so far.

But there is clearly a danger of the reverse happening. The current uncertainty underlines the fact that the business model here relies on a series of assumptions about long-term asset value and likely monetization opportunities.

That is true of many businesses, such as property owners. But while their financial assumptions can be based on large data sets, Hipgnosis is a key player in a market trading in unique assets. That can make it hard to assess their real likely long-term value.

That could mean that the strategic review leads to the value and cash generation portfolio of Hipgnosis’ assets being marked down. Any such outcome might be bad news for the Hipgnosis dividend. In such a situation there is a risk it might never come back, or be restored at a lower level than before.

The shares are down 33% over five years. I think that partly reflects investor nervousness about the long-term income generation potential of the business model. The current uncertainty makes me nervous about the Hipgnosis dividend. But it could also ultimately be bad news for the share price too.

For now, I have no plans to add the shares to my portfolio.

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As an investor, the economics of that sound appealing to me. But is there a less attractive B-side to this story? Let’s take a look.

Impressive record collection

The company’s portfolio totals more than 65,000 songs, including Mariah Carey’s 1994 song All I Want for Christmas Is You, which still regularly enters the charts come Christmas. Other hits it owns include Umbrella by Rihanna, Single Ladies by Beyoncé, and Jon Bon Jovi’s Livin’ on a Prayer.

Its revenue is derived from millions of microtransactions, whether that’s streaming, physical purchase, downloading, performance, licensing and merchandising. I like that because people are always going to consume music in some form, regardless of how the economy is performing.

Indeed, Merck Mercuriadis, the co-founder and CEO of Hipgnosis, has likened classic hit songs to gold or oil. He said: “When I say it is as good or better than gold or oil, it is because it is uncorrelated to what is happening in the marketplace…Music is always being consumed.”

There does seem to be some truth in this. Last month, for example, Spotify reported having 205m paying customers from a total of 489m monthly active users. That was year-on-year growth of 14% for paid subscribers, despite high inflation eating into consumers’ budgets.

Problems

The problem with the fund, unlike gold or oil, is it’s difficult to assess the true intrinsic value of the catalogue of hits it has spent over $2bn compiling. This is probably part of the reason the shares have been out of favour since listing back in 2018.

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

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

Accounting standards write off the cost of the fund’s catalogue over 20 years. However, Hipgnosis doesn’t write it off until 70 years after a composer’s death.

In its latest full-year results (to March 2022), that meant an amortisation charge of $106m (approximately £88m). That has now led to cumulative amortisation of $200m.

Value gap

So basically, there’s a big discrepancy here between what the market and the company thinks is the fair value of the fund’s catalogue. This prompted Hipgnosis to recently launch a debt-funded share buyback programme.

I don’t like that this buyback is financed by more borrowing. The company now has net debt of around $559m. It seems to be paying 6% interest on the debt while the dividend yield is also currently 6%.

Meanwhile, the underlying revenues generated by its current song portfolio have been declining. But the falling share price has left the fund essentially unable to raise new equity with which to buy more songs. To me, the company seems to be in a bit of a bind.

Overall, I think there are too many uncertainties here for me to buy any of its shares today.

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Here are two mid-tier stocks I’d be willing to buy if I were looking to build a portfolio with the primary goal of generating passive income.

Opportunity knocks

As a group, housebuilders had a torrid 2022. That’s not surprising when I consider the headwinds faced by the sector. Higher mortgage rates? Check. Cost-of-living crisis? Check. Throw in a post-Covid surge in valuations and that bubble always looked ready to pop.

Even so, I think share prices are now looking very attractive across the board. This is particularly so given recent speculation that interest rates may have peaked.

Vistry (LSE: VTY) is one option, especially when its income credentials are factored in.

Formerly known as Bovis Homes, the £2.7bn cap business changed its name when it acquired Linden Homes and Galliford Try Partnerships back in 2020. Countryside Partnerships was then snapped up for £1.27bn last year.

Patience required

Sure, demand could be hit for a while. Even those who are ready to buy could be holding back in the hope the prices will continue to soften. And who’s to say they’re wrong to do so?

Then again, I think Vistry will be just fine. It’s got a healthy cash pile that can be used to add to its landbank. Indeed, Countryside recently announced the purchase of a 170-acre site in Warrington. This will now be developed into 1,200 home in a joint venture with affordable housing provider Torus.

As challenging as the market might be, the company also announced in January that profits were
“in line with expectations” and ahead of where they were at the start of 2022.

Oh, and let’s not forget those juicy bi-annual cash returns. As I type, Vistry’s forecast dividend yield comes in at 5.8%, covered almost twice by profit. That’s double the 2.9% offered by the FTSE 250 index as a whole.

An ‘alternative’ investment

Clearly, the need to spread my money around is still paramount. That’s why the second mid-cap I’m highlighting today is a world away from the UK property market.

Hipgnosis Songs (LSE: SONG) is an oddball investment opportunity but one that has considerable appeal. The company invests in a portfolio of song catalogues by artists around the world with the aim of generating income through “millions of microtransactions such as streaming, physical purchase, downloading, synchronisation, performance, licensing and merchandising”.

The list of artists that have sold their rights is stellar and growing. Big names include the Red Hot Chili Peppers, Mark Ronson and Shakira. The most recent addition is Justin Bieber, via a partnership between subsidiary Hipgnosis Song Management and Blackstone.

Another monster yield

Clearly, one drawback here is that building a portfolio doesn’t come cheap. The aforementioned deal with Bieber, for example, cost $200m. So, there’s always a concern that Hipgnosis might be overpaying for assets whose popularity might come, go and never return.

Still, I reckon the dividend yield of 6.2% is worth grabbing. One can also argue (and Hipgnosis does) that its business model means it’s not correlated with global markets in general.

This all sounds pretty attractive to me.

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Over the past year, its share price has fallen by nearly a third. The directors point out that it’s currently around 45% lower than the net asset value (NAV) of the fund.

Is now the time to buy?

Back catalogue

The Hipgnosis collection is an impressive one.

The fund owns the rights to 65,413 songs by 146 artists. It claims to have 74 of the 304 songs that have been streamed over one billion times on Spotify.

Now that’s what I call expensive

It’s a costly business acquiring intellectual property rights.

Since it started in 2018, the fund has spent $2.2bn buying songs. Some of this has been funded by equity — $1.3bn has been raised so far — but a large proportion has been funded by debt.

At September this year, the fund had borrowings of $596m. Using current exchange rates, this equates to nearly half of its current market cap of £1.06bn.

Conscious that we are in an era of rising interest rates, the directors have recently re-structured the debt and entered into a series of interest rate swaps, to provide certainty over future borrowing costs.

What about the losses?

Until examining its accounts more closely, I was nervous about the fund’s losses.

In 2022, net revenue was $168m but operating expenses were $185m.

However, the biggest expense incurred ($106m) was for the amortisation of its catalogue of songs. This is a non-cash item necessary to write-off the music rights over their estimated useful economic lives. Accounting standards limit this period to 20 years, even though Hipgnosis claims that, on average, each song has at least 100 years of remaining copyright protected revenue.

Assuming it doesn’t purchase any more songs, within 18 years, its existing catalogue will have a book value of zero. But, there will still be several more decades during which these songs will be generating revenue. The company will then be highly profitable.

Because of this mismatch, cash generation (rather than profit) is a much more important measure.

In its first four full years of trading, the fund has generated $225m of cash from its day-to-day activities.

Some of this has been used to pay a healthy dividend. For the past nine quarters, this has been 1.32p per share, giving a current yield of 6%.

What should I do?

With an impressive catalogue of music rights and revenue rising predominantly from an increase in the popularity of streaming, I’m tempted to invest.

I like the fact that the most recent independent valuation of the fund’s songs gives a fair value of $2.67bn, a 35% premium to its book value of $1.98bn.

The directors have also promised not to raise any more cash (and presumably buy any more songs) until the share price is above the NAV of the fund.

But I don’t like the fact that, last year, nearly all of the fund’s cash generated from its operating activities was used to pay the dividend ($84m).

It appears to me that the current level of dividend is not sustainable and therefore I won’t be investing. For this reason, Hipgnosis is not my Christmas Number One.

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FTSE 250 income

The first company is the music licensing investment trust Hipgnosis Songs Fund (LSE: SONG). 

This enterprise is one of only a handful of publicly-traded vehicles that allow investors to buy into music streaming rights. The group acquires catalogues of music streaming rights and then uses the income to fund additional acquisitions and sustain its dividend. 

At the time of writing, the stock supports a dividend yield of 5.7%. 

Some of its latest acquisitions include a catalogue from Fleetwood Mac songwriter and vocalist Christine McVie. This deal gave the company the song copyrights and writers’ share for seven of the 11 songs on the band’s self-titled album Fleetwood Mac, along with other intellectual property assets. 

The reason why I think this stock is a no-brainer buy is that as well as its market-beating dividend yield, it also trades at its net asset value. The last reported net asset value was $1.68 (125p) per share. I think this is a steal for a portfolio of intellectual property rights, which cannot be replicated. 

Those are the reasons why I would buy the stock for my portfolio today. However, I realise this might not be suitable for all investors as there is a certain level of uncertainty over how much the assets are worth. The most considerable risk the company faces is overpaying for intellectual property, which could lead to lower shareholder returns in future. 

Another dividend share I’d buy

As well as Hipgnosis, I would also buy Direct Line (LSE: DLG). In fact, I already own shares in this insurance company and would not hesitate to acquire more at current levels. 

Insurance can be a tricky business to get right. Correctly pricing insurance policies requires a lot of data, and companies can only really make money if they have economies of scale. 

Direct Line is one of the largest insurance groups in the UK, suggesting it has the economies required to succeed in the business. It is also branching out into other areas such as automotive service centres. The goal of this strategy is to help reduce repair costs for its customers. 

Based on current growth estimates, City analysts believe the stock is trading at a forward price-to-earnings (P/E) multiple of just 11.5. On top of this, the stock offers a dividend yield of 7.8%. This low valuation and high dividend yield are the main reasons I think this company is a no-brainer investment. 

Still, as I noted above, insurance can be a tricky business. As such, there is no guarantee the company will meet its dividend potential. A sharp increase in insurance losses could force management to cut the dividend. That is why this FTSE 250 firm may not be suitable for all investors. But I like it.

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What is Hipgnosis?

Hipgnosis Songs Fund (LSE: SONG) is a fund listed on the FTSE 250 that owns song copyright, collecting royalties when these songs are played. Its portfolio consists of tracks, past and present, that have proven records of consistent royalty income. So far, its illustrious collection includes artists such as Fleetwood Mac/Lindsay Buckingham, Dua Lipa, Mark Ronson, 50 Cent, and many more. It also owns the rights to 36 of the 156 songs in Spotify’s tracks with over one billion streams.

The merits of investing in music royalties

There are several reasons why I believe this is one of the best shares to buy at the moment. Music royalties often provide a consistent level of income over the long term, especially if the songs cement their place in popular culture. How often do we hear the timeless classics of Go Your Own Way, Don’t Stop Believin’, and All I Want For Christmas Is You, decades after their release? Hipgnosis is also latching onto modern successes that will project revenue streams into the future; for instance, Ed Sheeran’s catalogue makes up a significant proportion of its portfolio. With the rise of streaming services, music has become accessible to a worldwide audience, and CEO Merck Mercuriadis aims to expand into South American markets by collaborating with artists from Hispanic and Latino backgrounds. (Some say we’ll never get the catchy chorus of Despacito out of our heads…)

Modern music services also tend not to be tied to the overall economic environment; that is to say this sector has a low economic beta. Artists’ content is played over many types of media (phones, TV, radio, and concerts) so investors are well diversified in case of a downturn. For instance, though the pandemic put the brakes on live performing for 18 months, masses of people turned to streaming services when confined to their homes. This diversification element is important for those who fear any further curbs on artists’ performance revenues.

You wouldn’t steal a song

One drawback worth considering is the threat of piracy that forever looms over digital artistic expression, stealing content and profits from official content providers. But the rise of streaming services has cut down on this illegal, virus-spreading activity as consumers are happy to pay small monthly amounts for the world’s music, rather than limiting one-off purchases like CD and vinyl.  

For these reasons, I believe that Hipgnosis shares are some of the best for me to buy right now.

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Dividend stocks to buy

The first company I would buy is Moneysupermarket.com (LSE: MONY).

The group’s biggest challenge right now is the recently introduced regulation that insurance companies have to charge existing customers the same as new customers. This may reduce the need for customers to shop around, reducing the need for platforms like Moneysupermarket. This could have a significant impact on the group’s growth and income potential. 

Usually, high-growth internet stocks don’t offer much in the way of income. That’s not the case with Moneysupermarket. This online platform currently supports a yield of 4.4%.

The company is highly cash generative, which means it can afford to return lots of money to shareholders while investing in its brand. Over the past five years, its dividend has grown at around 5% per annum.

What’s more, the stock looks cheap. It is trading at a forward P/E ratio of 16.6, compared to the IT sector average of 28. That’s why I’d own the business as part of a portfolio of dividend stocks. 

Royalty income

The Hipgnosis Songs Fund (LSE: SONG) generates income from music royalties. The company’s goal is to produce a steady, predictable income stream for its shareholders that not influenced by economic trends. 

It is targeting a dividend of 5p per share in the long term. If it hits this target, the stock could yield 4.1%. Of course, there’s no guarantee the company will successfully meet this objective. 

One of the challenges the group faces is having to acquire enough music royalties. It isn’t the only enterprise chasing these assets. As a result, Hipgnosis has to pay higher and higher prices. This could impact shareholder returns if the business ends up overpaying consistently.

Another threat to the group’s long-term potential is illegal downloads of music. If there’s an increase in illegal downloads, Hipgnosis will struggle to earn a return on its investments.

Despite these risks, I think this is one of the best dividend stocks to buy. That’s why I would acquire the shares today. 

Investing for growth 

Premier Miton (LSE: PMI) is rapidly becoming one of the UK’s premier asset management businesses. The group has seen its net profit increase from just under £1m in 2016 to £11m in 2019. Analysts are expecting the firm to report a net income of £20m for 2021. It is trading at a forward P/E of 11.2 based on these figures, compared to the financial services sector median of 14.

This growth has funded explosive dividend expansion. For the current financial year, analysts reckon the company can distribute 7.9p, which would give a dividend yield of 5.5%, based on the current share price. 

These are just forecasts at this stage and should be treated as such. However, I think they show the company’s potential. 

Asset management is all about achieving good results for clients. This is the biggest challenge the corporation faces. If it fails to achieve good results for clients, they could desert the business. This may cause profit margins to fall, and the company may have to cut its dividend as a result. 

Still, I would buy this company as part of a portfolio of dividend stocks.

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On song

FTSE 250 member Hipgnosis Songs Fund (LSE: SONG) invests in music royalty rights. Every time someone streams a track it owns, Hipgnosis receives a cut, albeit a very small one. The £1.2bn-cap already had almost 61,000 songs on its books by January. A little over 3,000 of these have hit the top spot in the charts. Recent catalogue additions includes work by Neil Young and Shakira. 

The performance of SONG since it arrived on the market in July 2018 has been solid, although not spectacular. Anyone buying the shares when Hipgnosis listed will have seen their capital grow by around 15%.

As one might expect, it’s not been a straight line up. Like everything else, the shares tumbled in 2020 as the coronavirus took hold. Then again, anyone buying the shares at the bottom of the market crash would have enjoyed an even bigger gain of around 28% by now. Naturally, this is far below the recovery seen in glitzy tech stocks. However, it’s a far better return than that of the FTSE 250 index as a whole over the same period.

Share price performance aside, it’s the dividend stream that interests me the most about Hipgnosis.

Cheap income

Analysts expect the business to return 5p per share to holders in the current financial year. This gives a yield of 4.2%, based on the price of the stock as I type.

Now, 4.2% may not be the biggest cash return I can find in the FTSE 250, but it’s not to be sniffed at. Let’s not ignore the fact that the best Cash ISA currently returns just 0.55% in interest. While keeping some cash in reserve for life’s little emergencies is prudent, holding any more than truly necessary will seriously limit the ability to grow one’s wealth. 

Another attraction to SONG’s dividends is that they’re likely to be covered over twice by profits. This means a cut looks unlikely as things stand. What a contrast to many other supposedly-reliable income stocks on the market!

But the dividend stream isn’t the only thing that makes me think Hipgnosis may be one of the best shares to buy today. A price-to-earnings (P/E) ratio of just 10 looks cheap, even if capital gains aren’t a priority.

It’s also worth paying attention to the firm’s PEG (price/earnings to growth) ratio. As a rough rule of thumb, anything below 1.0 suggests investors are getting a lot of bang for their buck. Hipgnosis’ PEG ratio is just 0.4. 

Not without risk

Although I consider Hipgnosis to be among the best shares to buy, no investment is without risk. There’s always a chance the company may be overpaying for the rights it’s buying. There’s also no guarantee that listening tastes won’t change and the popularity of formerly-lucrative artists may fall. 

On top of the above, you have the 1.35% ongoing charge eating into returns. While nothing in this world comes free, it’s vital to consider the opportunity cost of not buying other income-generating stocks where the only ongoing fee is charged by the broker.

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Going for a song

There are more comprehensive summaries of how music royalties work, but basically, copyright owners licence others to perform, stream, insert into video games and adverts and sell physical copies of their song in exchange for royalty payments. The holder of a portfolio of copyrights thus faces a couple of challenges. One is to get the songs played or performed. The second is to collect the royalties. Piracy is a risk to both companies. There is also the worry that music licensors get larger and use their power to reduce the payments made to copyright holders.

Round Hill, I think, has the edge here. Its team has run a song royalties business for a decade. However, Hipgnosis is no slouch, as its management team includes former music industry insiders.

Tracking performance

Round Hill is buying out the copyright catalogue of a private equity fund — owned and managed by the same parent company — that has reached the end of its life, in two tranches. The first tranche was completed in February 2021 at the cost of $282m. The second purchase is expected to finalise in June 2021 and would exhaust the funds raised so far.

Although private equity assets are independently valued, related-party transactions always make me uneasy. The fund has provided annual revenue numbers for the first tranche of investments from its private equity fund. But there are no operating numbers for the private fund or Round Hill, which has just started.

On the other hand, Hipgnosis has a couple of years of financial data and has built its portfolio from scratch. I will ignore the 800% revenue growth, as Hipgnosis is only a couple of years old and building its portfolio. What is impressive are the net income margins of 33% for 2019 and 39% for 2020. And Hipgnosis has already paid dividends and yields somewhere between 4.2% and 4.4%.

Hipgnosis stock is a buy for me

Almost half of Hipgnosis’s current portfolio is pop music, and the majority of songs were penned within the last 10 years, but there are many contemporary classics in there. According to my calculations, Round Hills portfolio is more focused on rock and country (60% combined) and mature. Although the portfolios are converging, Round Hill’s does tilt towards the timeless classics, with Hipgnosis offering a more contemporary feel.

Song popularity peaks and declines sharply in most cases, and so do the royalty flows. More of Round Hill’s portfolio is likely to be past the peak compared to Hipgnosis’s. However, Hipgnosis’s portfolio is getting less pop-centric and older, suggesting it is building a firmer revenue base.

I favour more financial clarity over less, which, together with the portfolio convergence, makes the Hipgnosis stock a buy for me. Of course, I have the option to take another look at the pair once Round Hill can provide some performance figures.

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