December 2020
BR REVIEW: SOVEREIGN IHT SOLUTION
Sovereign Media Group / Thompson Taraz Managers Limited
Positives Issues
► Strategy: To purchase, develop and ► Diversification: The company is new Why invest exploit music publishing rights. and has a single trading strategy.
► Team: The directors have a strong ► Track record: Although the team has Management track record in the film and music experience of music publishing, this is a industries, and an extensive network of new strategy for Sovereign. contacts. Nuts & bolts ► Governance: The company board will have no independent directors. ► Diversification: With no investments to date, we cannot comment on diversification.
► Valuation: There will be a third-party valuer and trades will take place at audited NAV plus fees.
► Annual fees: Stated annual fees total 1.25% p.a. plus VAT. With no directors’ fees, Fees additional company costs should be limited. Overall costs are at the lower end of the sector.
► Other fees: A 2% entry fee and 1% on exit; no performance fee.
► Target returns: The target return is 3% p.a.. Modelling would suggest that, once Risks invested, the company has a good chance of meeting or exceeding that target. This is unusual within the sector.
► Investment risk: In common with most products in the non-AIM BR sector, Sovereign targets a lower return than the yield on the underlying assets. The fee and expected cost structure keep this gap reasonable.
Manager information Manager contact details
Analyst ► Fund assets: £0m (Oct’20) Sovereign Media Group ► Fund target: n/a 020 3940 7600 Brian Moretta
► FUM in similar strategy: £0.2m 020 3692 7075 [email protected] [email protected] ► Total FUM: £50m (31/10/20) www.sovereign-group.com ► Launch date: 2020
Disclaimer: Attention of readers is drawn to important disclaimers printed at the end of this document
BR Review: Sovereign IHT Solution
Table of contents
Factsheet ...... 3 Product aims ...... 4 Summary of risk areas ...... 4 Risk commentary ...... 5 Investment strategy ...... 7 Governance and product structure ...... 11 Company structure ...... 12 Valuation processes ...... 13 Fees ...... 14 Track record ...... 15 Sovereign Media Management ...... 15 Other funds ...... 16 Team ...... 17 Appendix 1 – due diligence summary ...... 18 Appendix 2 – example fee calculations ...... 19 Disclaimer ...... 20 Status of Hardman & Co’s research under MiFID II ...... 20
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Factsheet
Sovereign IHT Solution Product name Sovereign IHT Solution Product manager Thompson Taraz Managers Limited Product advisor Sovereign Media Group Tax eligibility Business Relief Target return 3% p.a. Target income n/a Company type Public Limited Company Term Open-ended Sectors Lending: none Assets: media
Diversification: Number of loans n/a Number of assets 0
Fees Amount Paid by Initial fees: Initial fee 2.0% Paid by company from subscription Annual fees: Annual management fee 1% + VAT Company Annual administration fee 0.25% + VAT Company Exit fees: Exit dealing fee 1% Investor Performance fee none
Advisor fee facilitation Yes Advisor fee amounts As agreed with investor
Reporting Accounts every six months, quarterly updates Financial year end 30 September Expected liquidity method Redeemable shares, six months guaranteed, every month in practice Fundraising: Minimum investment £25,000 Current funds raised £0m Current product size £0m Fundraising target n/a Dealing date(s) Target of 15 days Source: Sovereign Media, Hardman & Co Research
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Product aims
Sovereign IHT Solution is a non-AIM/unquoted Business Relief product. It is an Alternative Investment Fund, which will invest wholly into Sovereign Media Management Limited. The latter will purchase and develop music publishing rights. It may add other strategies in due course. Summary of risk areas
Note: There are generic risks from investing in unquoted companies, in addition to the specific ones commented on below. Comments on relative risk refer to other BR investments and not to wider investments.
Investments Investment strategy risk There is an active market in music publishing rights at a range of sizes and multiples. Sovereign intends to purchase smaller-sized assets at multiples lower than those of the higher-profile transactions. Together with Sovereign’s work on marketing the songs, this should provide a good degree of downside protection.
Purchased royalty streams should be fairly stable, although may evolve over time. While these could decline, Sovereign aims to enhance them through marketing and active management and any change across a portfolio would be slow.
Portfolio and company risk Sovereign has set no targets for diversification. As a new company, it will be limited at outset but should improve as the company grows. We note that the intended size of each rights purchase is smaller than for other market players, suggesting that diversification should be obtained even when the company is relatively small.
The company structure is simple, with almost all the economic activity in the single subsidiary. There will be no borrowings.
Governance All the directors will be part of the Sovereign team. While not ideal, this is not uncommon in the sector. We are not aware of any intention to have related-party transactions.
Liquidity Formally, liquidity is provided to investors on 30-days’ notice. The aim, in practice, is to provide it within 15 days.
The long-run target is for the company to run liquidity of ca.10%. This is likely to be higher in the near future, particularly while assets are small and investments are relatively lumpy. While there will be a market for the assets, if required, they may take two to three months to realise.
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Manager/Consultant Team The Sovereign team brings a huge amount of experience in music and film. Although it has grown recently, the team remains relatively small. While the team seems adequate for the expected scale of operations in the near term, there are plans in place to grow it should the product start to attract significant assets.
Track record Sovereign IHT Solution track record FY 2020 CAGR Ordinary shares n/a n/a Source: Hardman & Co Research
As a new product, the Sovereign IHT service does not have a track record yet.
Regulation Product The product has had no successful BR claims as yet. Sovereign has checked with PwC that the company should be eligible. Given the company will be marketing and exploiting the rights, it would appear to be a genuine trading company.
Manager The manager of the Fund is Thompson Taraz. It is FCA-registered (number 226978), with fund management permissions. Submissions to Companies House appear to be up to date.
Sovereign Media Group is not FCA-registered. Risk commentary The overall company and product structure appear sound, with no major concerns.
While music publishing rights is a new strategy within the unquoted BR market, and is receiving increased interest from other investors, there is already a well- established industry. It offers good prospects of stable income. Sovereign’s active management strategy and a favourable legislative background mean that investors have good prospects of improved cashflows too.
Actual returns will depend on Sovereign’s ability to source attractive rights at a reasonable price. By avoiding the large-value and high-profile portfolios that some prominent investors are looking at, this seems a reasonable prospect. Fortunately, the fee structure does give Sovereign some scope to pay up a bit and still reach the target return. If purchase prices are close to target multiples, then the enhancement strategy gives good prospects of materially exceeding the target return. Good purchase prices should also underpin some capital protection.
From a portfolio perspective, returns should be largely uncorrelated with other assets in the BR sector, meaning this could provide meaningful diversification. As a new product, internal diversification will be limited until the company grows.
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Return waterfall (based on model)
► Assumed 80% invested
► Assumed company costs of 0.5%
► Modelled return comfortably ahead of target
► Early returns may be lower until assets invested
Past performance
► No past performance data yet
Liquidity as a proportion of net assets (modelled)
90% 80% ► Long-run target is 10% cash 70% 60% ► Assets will be music publishing rights 50% 40% ► No planned gearing 30% 20% 10% 0% Cash Assets Borrowings
Source: Company data; Hardman & Co Research
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Investment strategy
The company will purchase established music publishing rights with a track record of stable income and seek to enhance their value.
Music publishing rights The music industry has a well-established process for ensuring that the royalties due to creative artists are paid. There are two copyrights on every song: one for the composition (publishing) and one for the recording (performance). Clearly, there can only be one publishing right on a song, but there can be multiple recordings. These rights attract a payment for use in three ways:
► Mechanical rights: when the song is reproduced. Historically, vinyl and CD sales made up the largest part of this.
► Performance royalties: payable for any public performance of the song. As well as live music, this includes radio broadcasts, online radio or being played in a bar or pub.
► Synchronisation rights: use in other works, such as television, film or video games. On-demand streaming (Spotify, Apple Music) is classified as a reproduction as well as a performance and earns payments in both categories.
The publishing rights are also split into two parts: the writer’s share and the publisher’s share. It is possible for these to be the same person and, by default, the latter will remain with the writer until/unless it is assigned. The publishing part of the performance rights is split equally between the two shares, while the mechanical rights accrue entirely to the publisher. It is the publisher’s share that Sovereign will buy.
These rights last for a long time. There is some international variation in details, but publishing rights remain in place until 70 years after the death of the longest-lived writer.
Collection There is a well-established international infrastructure for collecting the royalties due under these rights. Most countries have a performing rights organisation (PRO), which administers the scheme. In the UK, it is the PRS (Performing Rights Society). There are also collective management organisations, which overlay that structure and fill in some gaps. This process is essentially administrative and, historically, was slow. It has benefitted from digitisation. Kobalt Music, which has been at the forefront of this, will be doing the collections for Sovereign.
Digitisation has made tracking actual plays a lot easier, but is far from complete. For example, pubs and clubs do not submit a list of what they have played but make a payment that is split according to a formula.
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Payments The rates of payment vary widely. Performance rights rates are broadly proportional to the size of audience, although blanket arrangements can mean these vary. In 2018, the BBC’s average payment for a minute of play on Radio 1 was £10.98 and £22.77 on Radio 21. On Radio 6, the rate was £4.89 per minute. In the US, radio stations pay ca.1.7% of revenues for each PRO licence, although, uniquely, they have three PROs.
Average streaming royalties on Spotify are approximately ¢0.06 per play, of which the publishing share is ¢0.012. The mechanical royalty for a download is ¢9.1, although sometimes other parties get a cut of that2.
The payments for an individual play of a song can be quite small, often a few cents in the US, but they can add up. PRS collected £810.8m for its members in 2019. The three big record labels generated more than $3.2bn in royalties that year3. Publishers’ shares are the smaller portion of these figures relative to performers, at around a fifth. Nevertheless, the aggregate market is huge.
According to Hipgnosis, across the market, roughly half of publisher royalties are generated from performance rights and a quarter each for mechanical and synchronisation. Within performance, roughly a third is terrestrial radio, a third streaming audio and the balance from television, satellite radio and streaming audio/visual.
Stability of income From an investment perspective, the revenues from many publishing royalties can be surprisingly stable. Although new songs may be volatile – current hits can be forgotten or become classics – back catalogues can be very consistent in their revenue generation. Good examples are the playing of old hits on golden oldie radio stations or incidental/theme music in films when they get repeated on television. Sovereign will be only investing in established songs.
There is an active market in publishing rights, with the focus being on the publisher’s share. The writer’s share can be assigned as well, but it is much less common. In the investment market, publishing rights have gained a higher profile in the past year or so. In the UK, Hipgnosis Songs was founded in 2018 and is now a FTSE250 company. In the US, Warner Music had an IPO in June 2020, raising $1.9bn. There are several large private investors too.
Although the market would appear to be becoming more competitive, Sovereign believes it has some advantages. Most notable is the alignment due to the split between the publisher and writer. In particular, Sovereign will prefer publishing rights that still reside with the writers that it believes it can add value to by promoting.
If the publisher is able to promote use of the writer’s material, then it will increase revenues for both. Sovereign’s established position in the film and theatre world, as well as its experienced publishing team, mean it has infrastructure that most financial players do not.
1 https://www.musicbusinessworldwide.com/bbc-radio-1-is-paying-songwriters-26-less-per- minute-than-it-was-5-years-ago/ 2 https://www.royaltyexchange.com/blog/mechanical-royalties 3 https://www.rollingstone.com/pro/features/the-three-major-publishers-generated-more-than-3- 2-billion-in-2019-thats-369000-per-hour-959699/
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Sovereign will also be able to provide more intense management than the large publishing houses. While the latter have enormous back catalogues, they don’t have the staffing to actively promote all, or even most of it. Most writers will get limited individual attention in such an arrangement, while Sovereign will be able to give them greater support.
Sourcing Participation in most markets works best with some inside knowledge, and music publishing is no exception. Sovereign is already active in the business through companies established under EIS. While these focus on new writers, it does raise their market profile. However, the main strength is the team, including a former President of Sony Music, the former MD of Warner/Chappell Music and several experienced media producers.
Market valuations The market in publishing rights is private and public data is somewhat limited. Valuations are measured as multiples of net publisher’s share (NPS), being the publisher’s share less collection costs. There are estimates of the market trading range being from 5xNPS to 15xNPS. Sovereign believes it can buy at multiples of around 8x-10x. Hipgnosis’s average acquisition multiple is over 14x, although it has focused on larger- and higher-profile collections than Sovereign will.
There are some signs that the influx of capital in the past few years has led to some increase in multiples. However, it is not clear if this is across the market or just at the large end.
Sovereign will assess multiples based on the average of the NPS over the past three years. This should help ensure stability of income, as well as implicitly reducing exposure to new songs. The intention is to purchase rights with phased payments, with an up-front payment and deferred consideration contingent on the NPS being in line with expectations.
Capital security While market prices can go down as well as up, there are some good reasons why the downside risk may be limited for Sovereign investors:
► By focusing on the rights that have lower multiples on purchase, Sovereign will avoid hot market areas and reduce possible multiple reduction. It perceives multiples as being more stable in its target market segment.
► When publisher’s share is managed by the writer, there are often incomplete registrations or overlooked collections. These will be reviewed and corrected where necessary, which may increase revenues by a small (probably low-single- digit) percentage.
► This process makes the portfolio more “institutional” and easier to sell to another buyer.
► Larger portfolios are more attractive to financial buyers, so growing the company may increase its value. Although the strategy is essentially a buy-and-hold one, Sovereign currently expects good liquidity if it needs to sell any assets. Nevertheless, like many private markets, sales may take some time (Sovereign estimates two to three months) and, though the market has been strong for some time, liquidity may reduce. In the latter circumstances, there may be an adverse effect on prices/multiples too.
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Possible return enhancements Although the financial model for the company suggests it should have a good chance of beating its target return using expected NPS income, there are some opportunities for enhancing them too. As well as the efforts that Sovereign will make to improve royalties from individual songs, there may be some changes that affect the whole market.
Broadly speaking, the trend in the past few years has been to improve protection for copyright holders. Forthcoming EU legislation on digital copyright will continue that trend. In the US, the Department of Justice is re-examining possible monopolies in music that may lead to improved publishing royalties. Also, industry discussions with streaming services are proposing significant increases in rates for the next five years.
While each of these is complex and difficult to quantify for any particular portfolio, the direction of travel is clear. Streaming revenues, in particular, are growing quickly and are seen as not properly rewarding the creatives yet. It seems likely there will be some benefit to holders of publishing rights over the next few years.
Portfolio With no investments yet, we are unable to comment on diversification. We do note that this may be limited at inception, but will improve as the company grows.
Business Relief eligibility The investment process, with active promotion of the songs, indicates that the trade of the company should be qualifying for Business Relief. Sovereign has also obtained an opinion from PwC on its eligibility. As a new product, it is unable to have achieved any successful claims so far.
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Governance and product structure
Board Sovereign Media Management has one director, while the subsidiary Sovereign Music has three directors. All directors are also directors of the investment adviser. While this is not ideal from a governance perspective, it is not unusual for the BR sector.
Andreas Roald – Sovereign Media Management, Sovereign Music Started his media career as a presenter on national Norwegian television. He has been producing and financing films, music and theatre productions with Sovereign since 2006. These include the award-winning musical Kinky Boots and film Cradle of Champions. He is CEO of Sovereign Media Group.
Donald Rosenfeld– Sovereign Music Has had a film career spanning 29 years. During 11 years as President of Merchant Ivory Productions, he produced several award-winning films, including Mr & Mrs Bridge, Howards End, The Remains of the Day and Jefferson in Paris. Since then, he has continued in film production, with more recent critical successes including The Tree of Life and Anton Chekov’s The Duel.
Richard Rowe – Sovereign Music Has a strong background in music publishing, having spent more than 26 years with CBS Records/Sony. He founded the music publishing division and, for the past 15 years, he was President. He negotiated the deal between Sony Music and ATV Music Publishing, which included the Beatles catalogue. Since 2010, he has been Vice Chairman at Roundhill Music.
Decision-making Purchases will be agreed by the investment committee, which will consist of Andreas Roald, Richard Rowe and Richard Manners.
Related-party transactions There have been no related-party transactions and we are not aware of any intention to conduct any.
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Company structure
Sovereign Media Management corporate structure Sovereign Media Management Limited
Sovereign Music Limited
Source: Hardman & Co Research
The investee company has a relatively simple structure. Sovereign Media Management Limited has one subsidiary, Sovereign Music Limited. All music publishing activity will take place in the latter.
Voting rights for shareholders are on the basis of one person, one vote.
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Valuation processes The share price for transactions will be based on the NAV per share from the audited accounts.
There will be an annual valuation of the catalogues by a third-party valuer (still to be confirmed, with two credible options being considered). Newly acquired catalogues will also have an independent valuation before acquisition and will be held at cost until the next valuation.
Share trading and liquidity Redemptions Formally, Sovereign aims to supply liquidity within 30 days, with an informal target of 15 days.
New shares The transaction price for new shares is calculated as the NAV per share divided by 1- (Initial Charge). The redemption price is the NAV per share.
Fundraising history As a new product, there is no fundraising history.
Business not as usual Should Sovereign Media Management require to liquidate its entire assets, then it would have to rely on the market for publishing rights. As indicated above, there appears to be a strong and stable market but detailed information on its scale and liquidity is limited. There is clearly demand for these assets, and portfolios have added attractions to some buyers; however, it is not clear whether the forced nature of a sale could affect the value received.
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Fees
The stated fees are listed in the Factsheet on page 3. The additional costs incurred are discussed under expenses in the Track record section.
Initial fees As indicated in the previous section, the initial fees are charged by an increase to the NAV to give the price used for purchasing shares.
Annual fees The annual fees will be deducted from the company quarterly.
Exit fees The only exit fee is a dealing fee. Like most products in the sector, there is no performance fee.
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Track record Sovereign Media Management As a new offering, Sovereign Media Management does not have a track record that we can look at yet. Nevertheless, we can outline a financial model for returns to investors.
Model waterfall for Sovereign Media Management
Source: Hardman & Co Research
Balance sheet utilisation While publishing rights can be resold, if required, this is a process that will take a little time. Nevertheless, the intention is to satisfy redemptions from existing liquidity where possible. While the long-term intention is to run a 10% free cash balance, in the near term, it may be lower as cash takes time to invest.
Expected balance sheet utilisation
90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Cash Assets Borrowings
Source: Hardman & Co Research
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The assets will be lumpy in size, so at outset it would seem likely that the cash level could be volatile until the company achieves some scale. We also note that delayed consideration for purchases will also raise cash balances, although the commitments will mean some of this may not be available for redemptions.
Revenue generation Income will be the NPS, which is the share of revenue after collection costs. These are typically 7%-10% of total revenue, but are proportionate so present no risk to investors. Payments start arriving once performance rights organisations are notified, which is typically three months after acquisition.
If Sovereign can buy rights at its estimate of 8x-10x NPS, then this suggests a revenue yield of 10%-12%. Taking the conservative end of that, with 80% balance sheet utilisation, gives a revenue yield to investors of ca.8%. If we stress that by assuming 13x NPS for acquisitions (similar to Hipgnosis) and 70% balance sheet utilisation, then the revenue yield would fall to 5.5%, which would still generate the 3% target return by our modelling.
Ensuring correct registrations should give a quick, but small, uplift to revenues. Hipgnosis’s experience suggests low-single-digit percentages. As described, there is the opportunity for Sovereign to enhance revenues further, but the revenue yields should be adequate without that.
Expenses The largest expenses will be the management charges. There will be some corporate expenses, but these are expected to be small. There will be no directors’ fees. In our modelling, we have assumed 0.5% of assets, which we believe is conservative: once assets become meaningful, this should become smaller.
Corporation tax will be paid at the normal rate, currently 19%.
Net results As indicated above, the 3% target return can still be achieved if Sovereign falls short on its expected level of investment and its entry price. Unusually for the BR sector, investors have good prospects of beating the target return. Other funds Sovereign also has music publishing companies within its EIS offers. These are focused on new commissions from songwriters rather than buying existing portfolios of songs. Although Sovereign’s activities in the sector are currently relatively small, the scale of operations seems likely to increase.
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Team
The Sovereign team is small, but experienced. The directors of Sovereign Music Limited will be active in the management and improvement of the portfolio, with Richard Rowe being the key person among them. There are two other key people who do not sit on either of the boards.
Richard Manners – Investment Committee His first music success was in A&R at Blue Mountain Music in the 1980s. He became MD at Island Music in 1990, keeping the same title when it merged with Polygram in 1994. He moved to Warner/Chappell UK in 1999, where he was MD for 17 years, and recently has returned in a new role.
Howie Payne – 235 Music Publishing Formed The Stands in 2002. They had several Top 40 hits, and he went solo in 2009: https://en.wikipedia.org/wiki/Howie_Payne
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Appendix 1 – due diligence summary
Summary of core due diligence questions Manager Validated by Company Thompson Taraz Managers Limited Founded 2002 Hardman & Co Type Limited Company Hardman & Co Ownership Thompson Taraz Group plc – see below Hardman & Co FCA Registration Yes – 226978 Hardman & Co Solvency Confirmed Company EISA member Yes Hardman & Co
Consultant Company Sovereign Media Group Limited Information Memorandum Founded 2008 Hardman & Co Type Limited Company Hardman & Co Ownership Sovereign Group Holdings Hardman & Co FCA Registration No Hardman & Co Solvency n/a EISA Member No Hardman & Co
Company Sovereign Media Management Limited Validated by Founded 2020 Hardman & Co Type Private limited company Hardman & Co Last accounts n/a Hardman & Co
Fund Custodian Company Thompson Taraz Depository Limited Information Memorandum FCA Registration Yes – 465415 Hardman & Co Source: Hardman & Co Research
Regulation The manager of the Fund is Thompson Taraz Managers Limited. It is FCA-registered (number 226978) with fund management permissions. The balance sheet is healthy for a small firm. At the latest accounts (31 March 2019), it had £364,000 of shareholders’ funds. It is categorised as an IFPRU €125k Limited Licence Firm by the FCA.
Thompson Taraz Managers Limited is wholly owned by Thompson Taraz Group plc (formerly Thompson Taraz Group Limited), which, in turn, is owned by Martin Heffernan, Afshin Taraz (40% each) and Kelvin Gray. The latter is a director of the subsidiary, together with Simon Webber.
The Consultant is not FCA-regulated. Sovereign Media Group Limited is a subsidiary of Sovereign Group Holdings Limited, which is ultimately owned by Andreas Roald. Until March 2018, it was named Sovereign Film Finance Limited.
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Appendix 2 – example fee calculations
This calculates the estimated total amount payable to the manager under certain assumptions.
Basic assumptions Term 5 years Investor amount £100,000 VAT Offset against company income Other costs 0.5% p.a. Source: Hardman & Co Research
Charges Target Net return (p.a.) 2% 3% 4% 5%
Required gross return 4.63% 5.86% 7.10% 8.33% Initial fees Rate Initial subscription £100,000 £100,000 £100,000 £100,000 Initial fees 2.0% £2,000 £2,000 £2,000 £2,000 Net subscription £98,000 £98,000 £98,000 £98,000
Year 1 Charges 1.25% £1,237 £1,243 £1,250 £1,256 Other costs 0.50% £495 £497 £500 £502 Net fund at year-end £99,960 £100,940 £101,920 £102,900
Year 2 Charges 1.25% £1,262 £1,281 £1,299 £1,318 Other costs 0.50% £505 £512 £520 £527 Net fund at year-end £101,959 £103,968 £105,997 £108,045
Year 3 Charges 1.25% £1,287 £1,319 £1,351 £1,384 Other costs 0.50% £515 £528 £541 £554 Net fund at year-end £103,998 £107,087 £110,237 £113,447
Year 4 Charges 1.25% £1,313 £1,359 £1,406 £1,454 Other costs 0.50% £525 £543 £562 £581 Net fund at year-end £105,537 £109,737 £114,061 £118,512
Year 5 Charges 1.25% £1,339 £1,399 £1,462 £1,526 Other costs 0.50% £536 £560 £585 £610 Net fund at year-end £107,648 £113,029 £118,624 £124,437
Exit charges 1% £1,082 £1,136 £1,192 £1,251 Final fund value £107,118 £112,473 £118,040 £123,825
Total charges £9,521 £9,737 £9,960 £10,189 Total other costs £2,575 £2,640 £2,707 £2,775 Total taxes £2,393 £3,661 £4,980 £6,351 Total expenses £14,489 £16,039 £17,647 £19,315 Source: Hardman & Co Research
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