Dedicated followers of the Hipgnosis Songs Circus will remember that two weeks ago the London-listed Hipgnosis Songs Fund, or SONG, released a regulatory filing telling investors everyone needed a haircut. In keeping with what seems to be becoming a tradition, it’s a Monday and that means more bad news from SONG. This time it’s another mark down in value, or “amendment to operative net asset value” in city parlance.
Today’s announcement, released before trading opened on the London Stock Exchange, alerted investors to what SONG is calling an “identification of an error” in the way accrued revenue was being applied in calculations of the “operative NAV”.
As a result, SONG is yet again reducing its operative NAV, this time by a further 7.6% on top of the 26.3% haircut the fund took based on independent valuer Shot Tower Capital’s new valuation, which was communicated to investors two weeks ago on 4 Mar. When that happened, the operative NAV per share dropped to 92.08p from 142.49p on 30 Sep 2023. Today that operative NAV per share is just 85.03p, and represents a 40% discount from the 30 Sep valuation.
Hipgnosis Song Management, the separate Hipgnosis company that acts as investment advisor to SONG, issued its own statement shortly after SONG’s initial statement stating that SONG was trying to “incorrectly place blame” regarding the latest revaluation, going on to say that it thinks it is is everyone’s interest for SONG and HSM “to work constructively together.”
What is startling about SONG’s statement is the gloves-off nature of its language, which talks about “error”, “double counting”, and “overstatement”. Sources familiar with the finance industry told CMU that it was “unusual” and “unnecessary” for a formal Regulatory News Service announcement to be made about the matter, which could have been addressed as part of the ongoing “strategic review” at SONG, which concludes soon. However, other sources argue that the ongoing mess surrounding Hipgnosis means that anything that is “material” to investors should be communicated immediately.
Beyond the obvious and immediate effect on the share price of SONG, there’s another implication to that huge discount, which is contained within the coda to the announcement.
“As the Operative NAV is a key valuation metric in defining the market capitalisation of the Company, the Company has almost certainly been overcharged investment advisory fees by the Investment Adviser. The Board has reserved all the Company's rights against the Investment Adviser.”
What does that even mean? In the investment management and advisory world, companies like Merck Mercuridias’s Hignosis Song Management - the “investment adviser” referred to - are usually paid based on the performance of the fund. If the underlying value of the assets backing the fund has been miscalculated, then this means the share price will have been higher than it would have been if that miscalculation had not occurred - meaning the advisory firm will likely have invoiced higher fees than it would otherwise have been due. In this context, “reserved all rights against” is code for “we may take legal action”.
Has a miscalculation actually taken place though? HSM’s own statement says that the Operative NAV was “not defined” by HSM, and that up until 31 Mar 2022 the Operative NAV was “calculated by the company’s administrator” before becoming part of its responsibilities. “Since then”, says HSM, it has “made the calculation using the same methodology, consistent with the APM’s definition”. APMs are “Alternative Performance Methods” and more on those in a moment.
One of the key issues with song royalties is the length of time it can take money to move through the system. At the point that a song is used - whether that’s in a stream, broadcast or performance - a payment is due, but unlike for recordings - where the majority of money is coming from streaming platforms who directly account and pay the sound recording owner or its distributor - song royalties can take much longer to work their way through the system.
This means that when catalogues of songs are bought or sold there may be money due from past usage of the music that has not yet worked its way through the system.
In the statement released today, SONG says that “the valuation methodology used by the Company’s valuers assumes the transfer of rights to all future cash receipts including any income accrued at the date of sale”. Effectively what this means is that at the point an acquisition of a catalogue of songs takes place there may still money be floating around within the collective management organisation infrastructures, moving from one CMO to another, relating to use of those songs that has taken place, but hasn’t yet been paid over from one international CMO to another.
Normally what happens is that this is priced into the overall deal being offered to the songwriter, and they file a letter of direction with their CMO saying that any money that comes in from the date of the acquisition should be paid through to the company that has acquired the catalogue.
If that company is Hipgnosis it will then make an entry in its accounts that reflects the sum paid for the catalogue - which becomes an asset - as well as an entry for the cash that is due to come in for usage that has taken place but not yet been paid through. This all then feeds into a particular financial metric, “Leveraged Free Cash Flow”, which ultimately feeds into the Operative NAV. At the point that the cash actually hits the bank account, those metrics need to be rejigged, and it appears that, for whatever reason, they were not.
Obvious mistake to make, you’d think - but actually, perhaps not so obvious. There’s another level of - extreme - complexity added into this, which comes down to the difference between the International Financial Reporting Standards - or IFRS - and “Alternative Performance Measures” or APMs referenced earlier.
APMs are essentially information contained within regulatory filings which say “here’s a number we are using, here’s how we arrive at it, and this is why we think it’s important - it’s not a IFRS number, but here’s how it relates to the relevant accepted IFRS metric”.
In last year’s Annual Report, SONG detailed the APMs it uses - and listed out five APMs that it had changed over the course of the year. City sources who spoke to CMU today said that it’s not uncommon for APMs to be redefined, and that in reality this may not be an “error” but simply an “adjustment”, pointing out that Citrin Cooperman, the previous independent valuer before Shot Tower Capital took on the job, did not flag any concerns, and that the previous board seemed happy with any APMs being used.
This is also addressed in the last Annual Report, which says “During the year, we discussed and reviewed the internal controls frameworks in place at the Investment Adviser, the Administrator, and Hipgnosis Songs Group. Following the transition of responsibility for the maintenance of the Group’s accounting books and records and financial reporting from the Administrator to the Investment Adviser we received a presentation and report from Deloitte in relation to their review of the procedures, processes and internal controls the Investment Adviser has in place for the Group’s financial reporting”.
What’s for certain is that - in the typically restrained language of the city - there’s escalating fury on both sides. As we head into spring, there’s a very real prospect that things might escalate, with SONG perhaps looking to claw back fees from HSM based on what they would argue was a misstated Operative NAV, while HSM itself may look for SONG to row back on “incorrectly placed blame”.