Shares in Hipgnosis Songs (SONG ) slid to a new all-time low today after Shot Tower Capital, the Baltimore-based valuer appointed after the fund’s new board questioned the accuracy of half-year results in December, slashed 26% off the fund’s valuation leaving the board scrambling to reduce a $674m debt pile.

SONG shares slumped 9%, or 5.7p, to 57.4p as the company said that due to currency movements the writedown in the dollar-based fund’s operative net asset value (NAV) per share would be higher, a third, or 33%, off. 

This leaves NAV at 92p per share at 31 December, compared to 142.49p at 30 September, leading investors to conclude that fund manager Merck Mercuriadis had, in the words of Investec analyst Ben Newell, badly ‘overpaid in the goldrush to acquire assets’ after its launch nearly six years ago. 

‘Material difference’

While a resumption in dividends had not been expected after the board suspended the interim payment in November, there was shock at what chair Robert Naylor called the ‘material difference’ from the previous valuation by Citrin Cooperman. 

The New York-based valuation agent resigned before Christmas after Naylor issued an almost unprecedented ‘health warning’ over what was perceived as the over-valuation of the fund’s 146 song catalogues.

Analysts said the negative impact of lifting Citrin’s overly law discount valuation rate from 8.5% to 9.6% was anticipated after the interims explained that a 1% increase in the rate would knock the valuation by 14.4%.

However, the nasty surprise was Shot’s reduction in forecast cash flows from the fund’s 65,000 songs. In a preliminary report it revealed nearly two-thirds (or 65%) of SONG’s income came from ‘passive’ rather than fully controlled royalty rights, which restricted the amount of added value Mercuriadis’ commercial team at Hipgnosis Song Management could provide.

Shot estimated the portfolio’s fair value at 1 March to be between $1.8bn and $2.06bn. This falls to $1.74bn and $2bn if $59.9m of contingent catalogue bonuses are deducted and compares to the 30 September fair value of $2.62bn, or $2.55bn with a bonus provision. The only good news here was the bonuses had fallen from the previous estimate of $68.1m when the dividend was chopped.

Manager ‘lacked competence’

With analysts saying total debt including bonus provisions had soared from 28% to 47% of net asset value, Naylor, the former chair of Round Hill Music Royalty, warned the board would prioritise debt repayment and not reinstate dividends ‘for the foreseeable future’. 

Debt reduction is urgently required to bring down borrowing below a limit of 30% of NAV, until which point the fund is prevented from drawing more on its credit facility.

Naylor, who was appointed after SONG shareholders rebelled and voted against the company’s continuation in October, said the new board was making good progress with due diligence work in its strategic review. This will determine whether the fund winds up, sells its assets to bidders and returns capital to shareholders, or appoints a new fund manager to replace Mercuriadis (below).

Stifel analyst Sachin Saggar said: ‘First and foremost attention will turn to how the board extricate themselves from a manager who has lost the confidence of its shareholder base and based on these findings also lacked competence.’

‘The manager clearly overpaid for catalogues given strong growth in the industry over the past few years as the valuation is lower than all capital raises since IPO,’ Saggar said in reference to the £1.3bn SONG raised at its initial public offer in July 2018 and seven share issues in the next three years.

Blackstone bid more likely

Christopher Brown, analyst at JPMorgan Cazenove, a joint corporate broker for SONG, said it was ‘imperative’ the company sold some catalogues to repay its debt if it were to continue as a London-listed fund. 

He suggested shareholders might now regret not having approved the sale of around a quarter of its catalogues to a fund managed by HSM on behalf of its majority owner Blackstone. 

The transaction was blocked on the same day as the continuation vote failed over shareholders objections to the wide discount at which it was priced and the conflict of interest it raised with Mercuriadis’ firm.

However, Brown believed the writedown made a bid from Blackstone more likely.

‘Somewhat ironically, it [SONG] would have already have done this [sold catalogues] if shareholders had voted in favour of the asset sale to Blackstone, with this now looking like a missed opportunity,’ said the analyst.

‘But, by paying NAV now, Blackstone/HSM could acquire all or part of the portfolio at a lower valuation than the aborted partial offer. Thus, overall, the only silver lining of today’s announcement is that it increases the likelihood of a bid from HSM, backed by Blackstone, that would no longer be seen as low ball.’

Brown said the situation also increased the value of HSM’s controversial call option which gives the Blackstone-backed firm the right to offer fair value or above if the company receives a bid within six months of the fund manager being served notice.

‘Previously, we thought that a bid would have to be 100-110pps to succeed, but 90pps would now look a more realistic income,’ the analyst said.

Analysts see upside

Ewan Lovett-Turner of Deutsche Numis said at 57p, SONG shares traded at a 38% discount to the new NAV. ‘Changes in the management contract is likely to be the news flow that will be most impactful to sentiment in the medium term. Investors will be hoping that is writedown marks the low ebb of sentiment.’

Shot Tower said SONG’s cash net revenue after reduction for third-party royalties and administration expenses was $121.7m for the 12-month royalty statement to 30 June.

This was consistent with the $119.4m cash figure for the 12 months to 30 September derived by auditor BDO as part of its ‘quality of earnings analysis’, which Lovett-Turner said provided ‘some reassurance’.

However, the $1.93bn midpoint of Shot’s valuation reflects a multiple of 15.9 times net royalty income before deducting catalogue bonuses – that means a 26.3% reduction from the half-year results that the board repeatedly challenged HSM about.

That cuts the operative NAV of its dollar shares at 1 March by 33% to around $1.17 per share compared to the $1.74 reported for 30 September 2023. Based on Friday’s exchange rate, the operative NAV of the sterling shares would be 92p per share down from 142.49p.

Investec’s Newell said while ’significant challenges’ remained such as the litigation from Mercuriadis’ former business partners and the taxation of asset sales, he believed there was ‘considerable upside to the current share price’ and upgraded the fund from ‘hold’ to ‘buy’.

Brown maintained an ‘overweight’ rating saying while confidence had been eroded, the shares were trading at a big discount to a ‘much more realistic valuation’ and so offered ’good short-term upside’. Stifel also remained ‘positive’ on the shares that have nearly halved since launch.