Analysis

Royalty Exchange: music is ‘one of the most undervalued asset classes today’


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Royalty Exchange was set up in 2011 to act as a broker/marketplace to connect owners of copyrights with private investors looking to buy a share of the future earnings of those copyrights.

The company says the model is not about surrendering control of copyrights but rather is based on an earnings-share model. It has just announced that it has closed a $6.4m convertible note to fund its future growth and expansion. Royalty Exchange says it had originally planned to raise $3m but, due to demand, increased the offering.

The company claims that “royalties are the world’s largest asset class without an established marketplace” and it aims to bring greater transparency to this space by creating an online auction platform where bids and final deals are made public – rather than happening in private. They feel this gives a more visible measurement of the value of copyrights.

For example, as of 19th June and with two days left on the auction, a share of public performance royalties earned by jazz saxophonist Kim Waters has attracted 10 bids and has a current price of $21,500 – which increased from a starting price of $17,000.

It lays out the investment term (life of author + 70 years), the investor share (50%) as well as what Waters earned in royalties in the past year ($4,624).

The company says the new funds it has raised with be used to hire additional staff (including those in business development, marketing and artist/label relations) and also invest in new technologies.

Music Ally spoke to Matt Smith, Royalty Exchange’s CEO, about transparency, passive investment, the proper valuation of music rights and why a liquid marketplace will value assets more highly than any other opportunity.

Why was the company set up and what was it hoping to address?

The business was started in 2011 but I was not part of it at that time. It was launched in 2011 essentially to do exactly what it is doing right now. I and some partners acquired the business in October 2015. We got into this because we, from a finical perspective, were looking for alternative assets that had yield.

One of my partners stumbled across Royalty Exchange and thought that it was theoretically interesting. At the time, there weren’t any assets [in the market in general] that we could take a look at buying. We entered into talks with the founder and acquired the assets of the business from them that October. Then we relaunched the business in February 2016. Since then, we have done quite a bit. We actually did more in the first five months than Royalty Exchange had done in its entire history up until that point.

We have raised close to $6.5m of capital for artists – mostly songwriters – since we launched a little over a year ago. We did $1.7m in Q1 this year at auctions – and that’s up 64% from what we did in Q4 on 2016. That 60%+ rate is something we would like to maintain – but I am not sure how long we can keep that rate up. That is helping to raise the bar.

Royalty Exchange

What rights are mainly being traded on the platform?

We are finding that most of the people we deal with – our customers – are songwriters; not all of them, but most of them. Some own their own publishing as well. Mostly the audience we have tended to serve have been songwriters.

For songwriters, there aren’t a heck of a lot of opportunities out there to raise capital on terms that are at all reasonable. I don’t mean what is ‘reasonable’ outside of what is available typically in the music industry; I mean ‘reasonable’ in terms of what the cost of money actually is today, the way that other assets are valued and the way that public equity markets are valued now. When you look at those standards, I feel like a lot of the artists that have been either selling their catalogues or taking out debt against their catalogues have been doing it under completely unreasonable terms.

Our thought is that this is, truly, one of the most undervalued asset classes today. And that is because of the lack of transparency in the marketplace and the lack of options that are available to these artists. That is a problem we intend to solve.

Most of the deals we have done so far are for composition copyright-based royalties. We have done some sound recordings as well. It is, though, mainly publishers and songwriters.

Who are the buyers?

We are an independent third party in the mix trying to create transparency and to make sure there is fair dealing on both sides – from the investor side and from the seller side.

We have more than 17,000 investors on our platform and most of them are high-net-worth individuals outside of the music business. We do also have music industry people and companies that have acquired assets on our platform, but for the most part they are high-net-worth individuals who are interested in getting a reasonable yield on their investment. There is certainly a ‘sexy’ factor also, so that probably drives the price up for them.

They aren’t looking for something they can exploit or control. They are looking for passive interest in these assets. It’s like the artist or publisher is taking on a silent partner who basically pays them a big lump sum up front. It is done in a competitive atmosphere so there are investors actively bidding against other investors for the right to be the silent partner, essentially. That tends to produce the best possible outcome for the artists.

Do you feel you are broadening the investment pool outside of what we can call the “traditional music business”?

We are definitely outside of the traditional music business in terms of the catalogue we are bringing to the market that is not catalogue that is traditionally invested in by the music business. Most of the sales we have supported so far are individual artists.

It’s not large divestments of catalogues by some of the big players out there. Those are generally still handled by [deals] behind closed doors and without a lot of transparency around what’s happening. Ultimately, we think that we can create a compelling argument as to why all parties would be better off to sell those catalogues in the light of day in a transparent and competitive environment. For now, our primary goal has been serving the individuals that are totally underserved in this market.

Why do private investors go into this area? VCs are increasingly wary of getting involved in any music copyrights or licensing deals.

I can understand why they might think that. Look at the approach that Ole and others have used, where they have come into the market and thought they were – well, at least this is my interpretation – coming into it looking to accumulate the high-quality assets; instead they became active managers of assets so had to develop whole new sets of expertise to be successful in the space.

It is highly competitive. You are not just buying an asset, holding onto it and earning income on it; you are buying assets that come almost with a liability and you have to work it to make sure you are maximising the value of the investment you have made. I agree with that and I think that large players – VCs and private equity firms – may look at that with a little bit of dismay about how to proceed.

There are big differences in our approach to this.

What is sold in our marketplace is almost entirely passive interest. That means that the owners of the assets still work them and still have a vested interest in them. In most cases, they retain the copyrights and they’re still using their knowledge about what it takes to succeed in the industry and to work the catalogue.

The investors are coming in from a passive position. They are just getting a percentage of the income that comes in. These investors don’t need new expertise in order to succeed so they just look at what the track record is to date and make reasonable assumptions about how it might be valued.

There are certain places in this industry, we have noticed, where assets are more than fairly valued. People are paying way too much for them with an impression, with scale, that they can make it work better. Ole is another example of this where they are developing the in-house expertise to exploit catalogues. Assuming they have the expertise, it’s about scale and having more and larger catalogues. I think that is hard to do. It is hard to actually get that scale. But they pay a lot for these things with the idea that, through scale and almost like a Walmart strategy, you can make the thing work.

You have that on one side and on the other side we have these individual songwriter rights that, because they are relatively small, people can’t come out and write a $1bn or even a $100m cheque for them. They tend to be undervalued and, if people are even able to sell them at all, they could maybe sell them for three times what they could earn in 12 months.

The average asset – passive interest – sold on our platform is six times that last 12 months’ income. That is our average and includes commercial music as well as production music – and production music is dramatically lower in terms of its typical multiple.

Royalty Exchange

You say that Royalty Exchange is about less of a speculative play and more of a cash-flow play. What do you mean by that?

The investors that we bring to the market are primarily just looking at passive income streams. So you could imagine some of the other assets they would consider owning would be things like commercial real estate.

They are not speculators. They are not looking at it from a “buying low, selling high” perspective. Instead, they are looking to generate reasonable levels of income over time.

Music Ally spoke to Sound Royalties recently. It takes a loan approach to royalty-based earnings rather than an acquisition approach. Why is your approach different or better?

Theoretically, the difference is not substantial. Look at Apple. When it needs or wants to raise capital, they can do it a couple of different ways. They can issue more stock and bring equity holders or shareholders into the business and they can sell the stock to the public. Or they can do a bond offering and take out debt. Which option they choose depends upon which one of those options is going to treat them best.

Theoretically there is not one that is better than the other. In my mind, it’s much more about what the specific terms are. There are a couple of ways to look at this as it really comes down to maths.

When you look at the people selling passive interest on our platform, they are essentially selling the equity in their business around their catalogue. In the US specifically, the income that they get from that sale is treated differently. It is taxed at a much lower rate – as much as half the rate [of] the normal income they are getting from that royalty stream. The tax issues are certainly a big benefit for a lot of the people we deal with.

When you do the numbers and extrapolate over a 10-year time horizon, what scenario would leave the artist better off? If they hold onto the royalties or sell a portion of the royalty streams? Or if they take out debt against the royalty streams? You just plug in the variables there and the answer become pretty self-evident.

Managers increasingly talk of wanting to retain rights fully and think selling them or giving up a share is a bad move. How do you appease them?

That is an important point and I think we have done a bad job of communicating this so far. The artists that we are generally working with are not selling their rights; they are selling a percentage of the income associated with the rights. They retain the rights.

They are seeing a percentage of the income at such a multiple that it can make a lot of financial sense for them. Many of the auctions we have done have gone for eight or nine times last year’s earnings – which is an incredible multiple for the artists that are listed there.

With all things, it depends upon the details. We work with the artists to structure things so that it meets their needs while retaining their rights. I think that solution overall is the biggest innovation that we can bring to this industry. And I think it makes a huge difference for folks.

A lump sum of money at the right time in an artist’s career can make a huge difference in the choices they have going forward. So instead of signing up for a bad publishing deal, they can stay independent a little longer and make better choices. Or they can negotiate with a publisher or label from a position of strength instead while still retaining their copyrights – but just giving over, say, 15% or 20% of their income on their back catalogue only, not their forward works.

What they are giving up is clearly defined and clearly known. And the investor who are paying for it are competing with each other to pay the most for the right to the income, not the underlying copyrights.

How will you expand what you are doing?

We are continuing to scale. Of the 100 or so transaction we have done on the platform in the past year, you can see all the details of them; exactly what was being sold, how many bidders there were and all the details. So people can see that these assets are really worth and what they sell for in an open and transparent market.

What we see over time is that the number of participants continues to grow – sellers, bidders and buyers. We believe that a transparent and liquid marketplace is going to value these assets more highly than any other single opportunity might. That outcome, we think, is the best case scenario for the rightsholders in the business.

Our primary focus for the next 12 months is on the US market. We have done, and will continue to do, deals concerning international rights. Those are just things that tend to come our way rather than us proactively going out there to secure them. We have only just scratched the surface of the value that we can create in the US and so we are just trying to stay focused primarily on that for now.

Close to two thirds of people who have sold on our platform have either returned for a second round or they have referred a friend. We don’t have an office overseas, but we have advocates overseas who draw people our way.

Eamonn Forde

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