HPGSF - Hipgnosis Looks Bad Now But Might Be About To Turn

2023-12-25 04:47:14 ET

Summary

• Hipgnosis faces current problems with delayed publication of interim and discrepancies in valuations.
• The base business model of buying song rights for cash now is sound.
• The value of Hipgnosis shares is tied to interest rates, and as rates fall, the share price is expected to rise.

This assumes I was right last time

But then, I'm really pretty certain I was right last time about Hipgnosis (HPGSF) (LON: SONG). The specific issue that made me most wary of them back a couple of years has now turned, and I think not indicate a decent potential move to the upside. Sometimes it really just is external factors, the economic cycle, that matters, which is the core of my analysis here.

Current problems

Now, Hipgnosis does have some current problems. There was a delay to the publication of the interim. Valuations were being argued about :

The valuation the Company received from its independent valuer is materially higher than the valuation implied by proposed and recent transactions in the sector, in particular, the proposed sale of assets to Hipgnosis Songs Capital for net consideration of $417.5 million, reflecting a discount of 24.3% to the valuation of these assets as at 31 March 2023, and the recent sale of non-core assets of $23.1 million, reflecting a 14.2% discount to the valuation of these assets as at 30 September 2023.

The interim came out a couple of days later . "Operative NAV per share decreased 9.2% to $1.7392 (31 March 2023: $1.9153), driven primarily by a reduction in the Fair Value of the Portfolio" And that's after they seem to have sacked the auditor too .

There's also a certain unholy mess about the detailed structure. Those who advise on what to buy and valuations also seem to have interests in another similar fund and so on, which is not, you know, perfect.

These things make me think that it's never going to be a premium asset. Nor one that trades at a premium to claimed net asset value, either.

The business model

As I mentioned before, the base business model is entirely fine, wholly value additive in fact. A company is - potentially - immortal, which means a different idea of long-term values than songwriters in their 70s and 80s. Those second possibly have a greater desire for cash now. That can also be stated as different discount rates. Shifting an asset from those with high discount rates to low can be profitable for all involved - no, really, everyone gains. So, great idea. Buy 70 years streams of income for cash now. We could even model this as songwriters selling annuities based on future rights income. Actually, that is the model we'd use.

Nothing at all wrong with the base idea. Maybe the prices paid are a bit high, maybe they're not. Maybe there's a bit too much self-referential dealing in there, maybe not. But that base business model is just fine.

Value additive?

There's the claim in there that by centralising the ownership of the song rights, then greater value can be generated. More people out there pushing them onto moviemakers and so on and thus generating fees. Well, maybe. Not wholly keen on that argument myself. With a song book of tens of thousands of songs, there's unlikely to be an outperformance of the whole book from greater use. Sure, it could potentially happen, but it's not a part of the story that I particularly buy. Whether that's true or my problem is up to others to decide.

However, I think this is the bottom

No, not that this is the end of the questions about management. Not that this is the very bottom of the share price fall.

It's worth filling in some of the details from the above by reading that first piece I did on the company . But the core of the business idea is not all of the above. Not to me it isn't - the core of the idea is this:

"But the flip side of that is that the income from Hipgnosis is going to remain at about what it is. Currently, the yield is around 4%, which is perfectly acceptable in today's market. But while that is inflation protected - to a degree, royalties will rise with inflation, even if with a lag - it's not going to rise if interest rates in general rise. That is, the real valuation of Hipgnosis here is as with an inflation protected bond.

My supposition is that the general interest rate environment is going to rise in the coming years. Certainly, we're at the end of the long bull market for bonds. I would insist that QE and money printing are going to lead - over an indeterminate horizon - to a rise in the real interest rate. Exactly the thing which Hipgnosis leaves us exposed to. It offers protection against a rise in nominal rates, but not real.

Further, because it's equity, it will price like a perpetual bond. That means, the capital loss from a rise in interest rates will be greater than would happen to a time limited bond of the same interest rate/risk profile.

It's locking in a yield when I expect interest rates to be rising. That doesn't sound like a clever deal to me."

Back when I wrote that the Fed Funds rate (Jan 2021) was 0-0.25% (Hipgnosis reports in USD), the Bank of England rate was about the same (the Hipgnosis dividend is in GBP for the LON stock). Current Fed Funds is 5.5% and BoE isn't far off that. Hipgnosis is down 47% since then, S&P 500 up 23%.

Gee, things being valued as perpetual bonds fall when interest rates rise, do they?

But the reverse

The reverse is also true, of course. Things being valued as perpetual bonds also rise when interest rates fall. We're all pretty sure that US inflation is now under control. UK inflation is falling, growth seems to be disappearing. We may or may not be right at the peak of the interest rate cycle but we're certainly very close to it. Well, OK, in my opinion, we are.

Thus, from here, where we are, I'm bullish on Hipgnosis. I don't think they're about to rise 100% of percent because that's just not the way that bonds - or bond-like instruments - work. There is, to me, no glorious profit engine here. There's simply an arbitrage across the time value of money, which ends up being valued like an annuity - lower interest rates raise the capital value of an annuity.

Note, please

Yes, of course, it's still possible that the games about corporate structure could impact and all that. But compared to this basic valuation metric, I just don't think they're all that important. What matters here, to my mind, is the time value of money and how that differs across people. That's it, that's the whole game and the complete game here.

Why I could be wrong

Well, it is still possible that they've done something really stupid with those closely interconnected deals and interactions. I think it's unlikely, though.

The real deal here

Hipgnosis is the future income stream for songs in exchange for a capital sum now. The net present value depends, near entirely, upon the discount rate used. Another name for the discount rate is the market interest rate. As that falls, the capital value of that future income stream rises.

Just as it fell when rates rose, it'll rise as they fall.

The investor view

Now, obviously, it's necessary to buy into my view that this isn't, not really, an operating business at all. It's really an inflation-proofed bond, a perpetual one, as the useful economic model for us to use when considering it.

But assume that we do that. Then, yes, as interest rates come down, I expect to see substantial rises in the Hipgnosis share price. Who knows, the equity value might even approach the NPV that management claims. That last I consider a bit ambitious, but higher than today makes perfect sense as rates come down.

A modest buy for the medium term.

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