Learning that lesson has led to an increased interest in finding assets that fundamentally do not correlate with financial markets. That means to look out for investment opportunities beyond the large asset classes that attract the chunk of the world’s investable money, such as most of the stock markets, hedge funds, private equity and real estate. Some of these niche investment themes have high barriers to entry; the expertise necessary to invest successfully is not readily available, often very deep specialist knowledge or operative involvement is needed, with the result that the majority of investors will never enter these asset classes in the first place. One such area is intellectual property with regular and completely uncorrelated cash yields in the form of royalties.
The foundation of these assets is usually an act of creativity or research that subsequently is protected through, for instance, a copyright or patent. The performance of these assets in the form of royalty income is fundamentally uncorrelated to financial markets. In addition to generating stable cash income the fluctuations of the asset price itself is limited, even in the toughest times. Slight fluctuations occur occasionally as a result of an imbalance in the demand/supply equation. However, this is something a sensible and disciplined long term investor can take advantage off. Altogether, these asset classes have remained very stable during any crisis of the past.
Within this group of assets there are very different sub categories, such as intellectual property in the pharmaceutical industry involving patents, or film libraries or music publishing rights. As an illustration one asset class that bears the attractive characteristics in this asset class is music publishing. In this area investors can find stable and attractive cash income as well as stable valuations that make these assets bankable. The barriers to entry are high because of the expertise needed; many investors instinctively react with a “not interested” simply for lack of, expertise, knowledge and insight.
Currently the music publishing industry is experiencing a big dislocation from which an advantage can be taken. There are four major publishers left, controlling about 70% of the market - EMI Music Publishing, Universal Music, Warner Chappell Music and Sony/ATV. For a variety of reasons all four are not currently active in the acquisition of copyright. Furthermore, most of the mid-cap players have been acquired by the majors over recent years.
Over the past decade a wall of PE funding has seen the founding of a dozen PE-backed start up ventures all acquiring copyright. Of these only very few are currently operational, with the rest having been acquired by the one entity left in the market place still active, being BMG Rights (a JV between KKR and Bertelsmann).
As a consequence the supply demand equation has changed dramatically and pricing has generally become a lot more attractive as the competition has fallen away.
In this unique environment a buy-and-build roll-up strategy can achieve several things. Firstly, the opportunity to acquire iconic copyrights at sensible pricing and further improve revenues through better asset management of the portfolios. Secondly, to take advantage of the arbitrage that exists once a portfolio has reached critical mass and size. At this level the value of such a catalogue is enhanced not just through better management and exploitation of
the copyrights in ownership but also of the increased multiples that are achieved from the sale of catalogues of a larger size. There are many examples to support his contention.
Focusing on the increase in income streams to be derived from the titles under ownership is a big part of the task that the dedicated management team must achieve. This is done in two ways:
1\. The efficient administration of copyright, the technical task of ensuring that all income is gathered from the multiple sources around the world; seasoned professionals that concentrate on previously under-managed assets can and do enhance the earnings achieved.
2\. The creative exploitation of the catalogue generally takes the form of generating opportunities in the synchronization arena, where income is generated from the use of music in films, television, commercials and third party licensing around the world (one of the main income streams enjoyed by this form of IP).
On the basis of conservative levels of gearing (specialised banks are ready to lend, attracted by a very stable asset class that is easily valued) stable returns in excess of 20% are perfectly possible with very realistic assumptions. Investors looking at this sector should focus on some key parameters relating to the assets themselves, these being:
• A long term stable income stream associated with each significant title in the portfolio.
• Proof of good chain of title, i.e. the flow of rights from the inception of the title through to its proposed owner –
all located in a territory with good rule of law and statutory copyright regulations.
• No impending litigation that may derogate any rights being acquired.
• Ideally historical inefficiencies in the management of the copyright that creates the opportunity for the acquirer to gain some immediate benefit.
• A seasoned professional management team with a track record in acquiring such rights successfully and then managing the portfolio to generate the benefit as discussed above.
The most common mistake made in this sector is to overpay for the rights acquired. It is fair to say that over time it is very difficult to lose money in this asset class; and, with a disciplined approach to pricing of these assets, it is nigh on impossible to lose money. Additionally, with the application of the skills described above it is highly probable that a good return can be achieved in a stable and uncorrelated asset class.
