Nanalyze

Investing in Music Royalties as an Asset Class

In a recent article, we talked about how the term “asset class” refers to a category of investments like stocks, bonds, or real estate. While these examples represent popular asset classes, some are not so mainstream. Art, wine, and timber could all be considered asset classes, each with their own historical performance and varied reactions to external economic stimuli. Each of these asset classes will have unique cash flows and risks. For example, art will have very low liquidity and wine will be subject to the risk of storage methods that make sure it doesn’t go bad.

The reason why investors look for different asset classes is primarily for reasons of diversification. These days fintech companies are trying to create new asset classes out of anything they can get their hands on so that they can collect fees on the transaction. There’s even talk about marketplaces where you can invest in the future performance of athletes, a form of “human IPO”. Just yesterday, we came across the strangest IPO that we’ve seen in a while and just had to share it with our readers. If anything, it’s pretty darn interesting, and it all starts with a man named Marshall Mathers.

If you’ve never heard of Eminem, you should check out his music. Unlike the catatonic rhymes coming from most rappers today that promote a life of crime, incarceration, domestic abuse, and heavy drug use, Eminem puts a twist on his lyrics so that he actually starts to sound like someone with a triple digit IQ. Sure, there isn’t anyone alive that he hasn’t offended, but when you hear him rap you can tell the man has genuine talent – and he really hates his mom. That talent has won him 15 Grammy awards and made him the best selling rapper of all time. In fact, he’s sold more albums than U2, The Eagles, Billy Joel, or Aerosmith. Wouldn’t you be totally stoked to be getting a percentage of all his royalties? Well, now you can.

Our story starts with a Colorado startup called Royalty Exchange which was founded in 2011 and has taken in $6.4 million in funding to develop the leading online platform for buying and selling royalties. The concept is pretty much what it says on the tin. Royalties from industries including music, book publishing, television, film, pharmacy, or intellectual property can all be listed on Royalty Exchange. An auction then takes place where investors from around the world bid on percentages of these royalty income streams that are generally paid on a quarterly or biannual basis. We were surprised to see that you don’t have to be an accredited investor to participate. The exchange has dealt with assets varying from Kanye West songs to music from Disney films.

Now that we understand how Royalty Exchange works, the IPO works along the same lines but is quite different. The stakeholders of Royalty Exchange are planning an IPO to raise the funds needed to acquire a percentage of Eminem’s royalty streams from his work produced between the years of 1999 and 2013. If you can think of this as an income producing asset (which it is), then here are the cash flows that the asset has produced historically:

  • 1999-2010 $33,267,344
  • 2011 $9,800,897
  • 2012 $3,718,323
  • 2013 $14,530,426
  • 2014 $10,144,374
  • 2015 $4,232,731
  • 2016 $4,760,556
  • As of March 31, 2017 $1,942,408

In order to try and value this transaction, let’s do some basic math forgetting for a second about all that crap we learned in our MBAs regarding discounting cash flows and such. The average yearly income of Eminem’s royalty portfolio over the past 6 full years was $7.86 million per year. Let’s assume that we receive this amount every year going forward. Of this income stream, Royalty Flow plans to acquire 15% interest for $9.75 million or 25% interest for $18.75 million. Let’s assume that they purchase a 25% interest which represents $1.96 million per year in royalties. This means that all things being equal, it would take 9.54 years to pay back our initial purchase price. So after nearly a decade has passed, let’s still hope that Eminem is as popular as he was and we’re generating $1.96 million in royalties. Of course all you MBAs will point out that we’re not actually generating $1.96 million in today’s dollars. This is because of something we refer to as “discounted cash flows” and it looks like this:

The value of money decreases over time which is a pretty easy concept to grasp. Inflation makes things more expensive every year so a fixed income stream will lose its purchasing power as time goes by. How much purchasing power do we lose? Well, if we assume an inflation rate of 3% per year, then by the time we get to Year 10 we’ve paid back our initial capital expenditure, and the value of our royalty payment has fallen to just $1.46 million per year. Of course we haven’t taken into account the fact that this “company” needs to pay employees, find future music royalty deals, pay for the “equity incentive plan”, etc. (It seems odd to have an equity incentive plan when the people who are negotiating this transaction are adding very little value after the fact. And let’s face it, Eminem has already done all the heavy lifting here.)

Then there’s the problem of putting all your eggs in one basket with a single recording artist who has a track record of offending everyone. Royalty Flow lists this as a risk stating:

Future negative publicity could damage Eminem’s reputation and impair the value of the Acquired Assets

That’s indeed a risk, though there’s also a flip side. If he is shot by another rapper or if he decides to off himself, then royalties will probably go through the roof for a year or two. You think that’s tacky to discuss? It’s no different from when an actuary tries to figure out when you’re going to die in order to price your life insurance policy appropriately so it generates a profit for the underwriter. This is the hard truth behind “human IPOs”, or in this case, the IPO of one human’s future popularity which happens to be declining over time:

UPDATE: 10/5/2017 – The company reached out to us with the below comment regarding our “human IPO” comment:

More importantly though relates to “all your eggs in one basket.” While that indeed is something investors should watch, the investment proposition for Royalty Flow is not to solely hold the Eminem catalog royalties. Royalty Flow intends to acquire additional catalogs over time to diverstify the assets it holds. That will change your math on returns, etc. The Eminem catalog is merely the first, and serves as an example of the kind of overperforming, premium assets that Royalty Flow intends to pursue.  So it’s not a “human IPO.”

Another risk factor here is the litigation required to capture some of those cash flows. If we go back to looking at historical payments, those “spikes” you see in 2013 and 2014 are the result of successful attempts at suing some entity in order to recover royalties that should have been paid. Can we assume that the majority holder of this portfolio will continue to be as aggressive in collecting royalties as time goes on, or that continued opportunities will exist?

While the business model looks like fun, it’s not something that prudent investors would take a second look at. The biggest problem here is the unpredictability of cash flows and putting all our eggs in one basket by betting on a musician who has a track record of doing unpredictable, crazy isht. While this is probably the most interesting investment opportunity we’ve come across since The Game’s ICO, we’re going to give it a pass. Music royalties as an asset class present far too unpredictable cash flows, and we’ll choose instead the predictable cash flows from a well-diversified portfolio of dividend growth stocks any day.

UPDATE: 10/5/2017 – The company reached out to us with some other good feedback. Eminem is a strong artist today (based on albums charting on Billboard 200)and is rumored to put out a new album soon which typically results in a spike in streams of prior songs. FBT Productions (which enforces his copyrights) is very aggressive and took a New Zealand political campaign to court just earlier this year for using a clip of the music without permission. We can expect that aggression to continue. Also, Royalty Flow expects to run a very lean operation. 

If this thing gets off the ground and you want a piece of it, Royalty Flow plans to trade under the ticker “RLTY“.

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