One of the most common questions asked by creators considering selling their song catalogs is “What do they” – buyers – “know that I don’t know?” The answer is simple: the catalog market has been driven by institutional investors, and they are looking for a return — a predictable rate of return. In the low interest rate environment of the past decade, it has been impossible to find yield in financial instruments like bonds. Music royalties, however, offer a steady return that is uncorrelated to traditional asset classes.
Most sellers, however, don’t think about how macroeconomic factors like interest rates affect music royalties. They are inextricably linked, and with inflation at 7.5% – a 40-year high – and the Federal Reserve indicating that it will start raising rates in March to reduce that figure, a seismic change in the sell market by catalog could be prepared.
Two years ago in Billboard, we pointed to the low interest rate environment as driving the fiery catalog market. We also compared a catalog to a bond, which has become a widely accepted analogy. Historically, interest rates and bonds move in opposite directions: when interest rates rise, bond prices fall. One of the biggest threats to a bond portfolio is interest rate risk.
What is the relationship with royalties? Bonds pay a coupon rate (a percentage of face value); catalogs pay royalties.
Here’s how to determine the “coupon” on your catalog if you sell it. Say you sell your catalog for a multiple of 13 times its net publisher share (essentially the annual gross margin). The effective coupon is 100 divided by 13, which equals 7.69%. When interest rates rise, a bond with a lower coupon rate will generally experience a greater decrease in value than a bond with a higher coupon rate. Thus, a catalog that sells for a multiple of 13 will experience a greater decline in value than a catalog that sells for a multiple of 10 because the buyer places a greater value on future cash flows.
Higher inflation also affects catalog sales as it reduces the value of future royalty payments. The higher the multiple, the more pronounced the effect of inflation, as more royalty payments are required for the buyer to be compensated.
Many catalog acquisitions are financed by debt and leverage. If leverage has a floating (or adjustable) interest rate, then each rate increase results in an exponential increase in cost to the borrower.
What buyers also know is that a 7.69% yield barely beat inflation last year, when it was 7%, and we’re not even factoring in the cost of capital. When rates rise and inflation stabilizes, institutional investors will look elsewhere for yield.
The catalog market won’t disappear overnight, but it will certainly cool down, especially considering all the big deals that have been made over the past few years. Going forward, many looking to sell their catalogs will be newer artists with less revenue history, making deals much more speculative. Investors will pay lower multiples for speculative fixed income securities (royalties), especially in an environment of higher interest rates and higher inflation.
Conclusion: If you are considering selling, the current economic environment offers an unprecedented opportunity to capitalize financially on your success.
Former artist manager Dan Weisman is vice president/financial advisor at Bernstein Private Wealth Management in Nashville. Adam Sansiveri is Managing Director and Head of Bernstein’s Nashville Private Client Group and Co-Head of its Sports, Media and Entertainment Group.