Hipgnosis Songs Fund (SONG ) has warned investors hoping a forthcoming continuation vote could trigger a sale of the company that an unexpected corporation tax liability could limit shareholder returns.

In annual results yesterday for the year to 31 March, the investment trust revealed that music catalogues - of which it owns 146 - are considered intangible fixed assets and are not tax exempt within a closed-end fund structure.

Were the company to sell its entire $2.8bn portfolio of 65,413 songs, the potential tax charge of $245m would knock up to 10.6% of operative net asset value (NAV).

However, this estimate does not include brought forward tax losses that could reduce the tax liability, the company said.

‘Vertical slice’

Fortunately, an outright sale of SONG’s royalty assets does not appear to be what investors are looking for as they press the company to take steps to lift a share price stuck at discount of around 50% to NAV.

Solomon Nevins, portfolio manager at CCLA, was one of two top 10 shareholders telling the Financial Times this week of their desire to see a disposal to validate the portfolio’s valuation and to ramp up share buybacks, of which there were just £1.7m in the 12-month period.

Nevins told the FT he wasn’t after the sale of specific catalogues, preferring a 5% ‘vertical slice’ off the portfolio to demonstrate value.

Questions for board and Merck

Although the tax liability does not necessarily preclude such a disposal, it dismayed Investec analysts Ben Newell and Alan Brierley who said. ’This is a surprise to us, and we question why this tax treatment has not been disclosed before. We note that the tax treatment on the sale of assets was not disclosed in any of the company’s prospectuses, and this raises very significant questions over the board and manager, given the quantum.’

SONG, which is managed by Blackstone-backed Hipgnosis Song Management, has faced repeated questions over its valuations and disclosure policies and the latest revelation is perhaps the last thing it needed ahead of its first five-year shareholder vote.

Hipgnosis founder Merck Mercuriadis (above) said he shared the ‘frustration and disappointment’ of investors at the fund’s share price performance. Despite generating a 69% underlying investment return since launch in July 2018, the shares, according to Numis Securities data, have provided a total loss of 12% including dividends.

Having consulted with SONG’s largest investors, Mercuriadis said he was working with the board on specific proposals to enhance shareholder value that would be announced before the annual general meeting and continuation vote in September.

Shares in SONG dipped 2% yesterday to 74p, a 51% discount to joint corporate broker JPMorgan Cazenove’s latest estimate of 151p NAV per share.

Weak dividend cover

While JPMorgan Cazenove analyst Christopher Brown described a 4% rise in fair value as a ‘pleasant surprise’ after a year of surging gilt yields and interest rates, he said this was offset by news of a $43.8m accrual for bonuses that SONG might have to pay on some of its better-performing catalogues.

Investec’s Newell and Brierley said this was likely to require a payment of around $12m in the current financial year, putting further pressure on the 7%-yielder’s dividend cover. SONG is holding its dividend target at 5.25p per share this year, having just covered the quarterly payments through cash flow in 2022/23.

Jefferies analyst Matthew Hose said despite improving income generation, the 6% financing cost of SONG’s $594m debts weighed on a portfolio generating a free cash flow yield of 4.5%.

Excluding one-off items, pro forma annual revenue rose 12.1% year on year to $130.2m. Against a strong dollar, this reflected strong growth in streaming, ‘synch’ usage of songs in films, programmes and games, and performance rights after Covid. 

Mercuriadis said this performance validated the fund’s thesis about the growing value of songs in the global, interconnected economy. 

Valuation debate

The decision by the trust’s independent valuer Citron Cooperman to maintain the discount valuation rate at 8.5% raised some eyebrows but there was reassurance that its assumptions had again been checked by corporate adviser Kroll.

This valuation reflects a multiple of 20.89 times historic income compared to the blended acquisition of 15.9 times, indicating the value the fund manager has added. Unlike previous years, no new catalogues were bought as SONG’s discounted share price prevented fund raisings. 

Alternative income funds like SONG are highly sensitive to changes in discount rates, which set the present value of future cash flows. Numis said a 0.5% rise in the discount rate to 9% triggered by interest rates staying higher for longer would knock fair value by 7.9% or $222m.

SONG shares have plunged 27% in the past year as rising interest rates have pushed yields on gilts, or UK government bonds, to an attractive level of 4.5%-5.1%. 

Acknowledging this, Andrew Sutch, the trust’s chair, said: ‘Whilst government securities may currently provide a similar current income yield, they do not offer the opportunity for the significant capital growth that we believe your company will also provide.’

‘Buy’ on windup potential

Analysts broadly agreed, despite their misgivings on disclosure and the lack of specific proposals that Jefferies’ Hose said could risk the company losing the vote. If that triggered a windup, it would see the shares rise sharply at the prospect of capital being returned at close to asset value.  

‘The results highlight some good revenue growth from the underlying portfolio, particularly from the younger catalogue cohort. Unfortunately though, a failure to announce anything concrete at this stage regarding addressing the significant share price discount runs the risk of any action by the fund being too little, too late, in the context of the forthcoming continuation vote,’ Hose said reiterating his ‘buy’ recommendation.