Final Wednesday (Could 4), the Federal Reserve issued the US’s greatest rate of interest hike in 22 years.
The next day, the UK’s Financial institution of England raised its personal charges for the fourth time since December, as its Governor, Andrew Bailey, warned Brits of a “sharp financial slowdown” in 2022.
Simply as all of that was happening, the music business was exhibiting its energy.
Within the house of three days: Common Music Group introduced Q1 revenues up 16.5% YoY; Reside Nation introduced its “greatest first quarter ever”; Imagine noticed Q1 revenues soar 30.9% YoY; and HYBE, house of BTS, revealed a whopping 59.8% YoY rise in its Q1 turnover.
The bull case for music property was robustly summed up by that unfold of numbers.
The bear case, nevertheless, now incorporates the aforementioned rate of interest rises.
In any case, every thing involving borrowing simply acquired dearer. That features bank cards, mortgages… and shopping for music property for megabucks costs (utilizing debt).
But at the very least one music enterprise firm – proper on the middle of the trendy catalog rights acquisition increase – isn’t breaking a sweat.
Nari Matsuura is Accomplice and co-leader of the Music Economics and Valuation Companies apply (previously Massarsky Consulting) at Citrin Cooperman.
As such, alongside Barry Massarsky, she leads a bunch that has been within the thick of valuing music biz offers involving Hipgnosis Songs, Spherical Hill, Major Wave, Shamrock Capital, Reservoir and Lyric Capital amongst many others.
Final yr alone, the New York-headquartered Massarsky/Matsuura apply valued music property price over $6.5 billion in whole.
Massarsky and Matsuura’s apply has additionally turn into well-known in business circles as the continuing valuer of Hipgnosis Songs Fund’s NAV [net asset value].
To know Matsuura’s calculations on her crew’s music biz valuations – and why rates of interest don’t have an effect on them as a lot as you may suppose – we first want to clarify what a Low cost Charge (DR) is.
A Low cost Charge is a instrument factored into valuations by practices like Citrin Cooperman throughout discounted money move (DCF) evaluation. i.e. Calculating future ache factors associated to rates of interest that will render an asset price lower than it first seems.
Matsuura is assured that, with a Low cost Charge of ≈8.5% set in stone for a while, Citrin Cooperman has comfortably protected its shoppers, each previous and future, from over-valuations – and from dropping their shirts on rate of interest rises.
As Matsuura confidently places it: “We won’t have to lift our Low cost Charge once more. And in consequence, we’re defending all of our shoppers: valuations won’t go down.”
Right here, in an unique interview, Matsuura (pictured inset) explains exactly how Citrin Cooperman got here to its Low cost Charge determination, and why it spells excellent news for music funds preserving a watchful eye on the Fed…
Easy query to begin: Why does the Low cost Charge matter a lot if you’re valuing property within the present atmosphere?
As you realize, music valuations are buying and selling at excessive multiples. And there’s plenty of funding cash being poured into this asset class.
Individuals are understandably asking plenty of questions, given the present rising rate of interest atmosphere. Will that have an effect on the Low cost Charge? And in flip, what is going to that do to music valuations?
“Our Low cost Charges don’t change [in tandem with] a purchaser’s capacity to purchase… We stay utterly agnostic to the customer’s profile.”
Earlier than we reply that, it’s necessary to ensure folks know that [Citrin Cooperman] conducts market valuations. We have to present an goal view of the market worth of every asset.
As such, our Low cost Charges don’t change [in tandem with] a purchaser’s capacity to purchase, or if a purchaser has a decrease fee of return – or the next fee of return – required for his or her buyers. We stay utterly agnostic to the customer’s profile.
There are two Low cost Charge calculations you need to clarify right now, each of which have ended up roughly in the identical place. The primary is the easy one – the tough and prepared one!
We symbolize a big selection of buyers – anyplace from pension funds [i.e. long-term investors looking for a steady ROI] to personal fairness [i.e. shorter-term investors looking for a more spectacular ROI].
These two kinds of corporations’ hurdle charges could be very completely different: 4% versus 14%, for instance. [A ‘hurdle rate’ is the minimum rate of return required by an investor.]
We thought our [starting Discount Rate] needs to be the center level of this vary, so we arrived at about 9%. This clearly isn’t a technical calculation! We had been merely wanting on the vary of the market and arriving on the midpoint.
“We determined to decrease the low cost fee by half a p.c [to 8.5%]. We thought of that to be a conservative adjustment.”
We had been utilizing 9% [as an average ROI rate for music investors] in 2019, into 2020… after which COVID hit. And in March 2020, that month all of us bear in mind, the Fed rate of interest dropped to close 0%. They lower it by 1.5%.
We as an organization need the music market – and the person catalog [performance] – to information valuations. How is it performing? The place’s the expansion? What’s happening throughout these earnings streams?
However the query was raised: what will we do with our Low cost Charge? And we determined to carry the place we had been [at 9%].
We didn’t know the place issues had been going, and we didn’t need to simply react for the sake of reacting – as a result of each time you react with a brand new Low cost Charge, you’re going to have an incredible impact on valuations.
So we waited round six to 9 months, earlier than deciding to decrease it by half a p.c [to 8.5%].
That reducing [of 0.5%] was a 3rd of what the Fed did to rates of interest at the moment (-1.5%). We thought of that to be a conservative adjustment.
In the meantime, we’re heading in the direction of late 2020, and COVID is preserving us all indoors…
Sure. And we knew that in the long run, the Fed was not going to stay with a 0% rate of interest without end.
So behind our minds, when the Fed began adjusting charges upward once more – which we knew it could, finally – we additionally knew we wouldn’t need to do the identical factor to the Low cost Charge.
If you find yourself rising your Low cost Charge [having prematurely/overly lowered it in the past], you’re going to decrease your valuations [of music assets].
“We utilized worst case situations, for the entire completely different inputs into the [calculation]. And we ended up in the identical area.”
So certain sufficient [in March 2022], the Fed introduced its first enhance. When that occurred, we moved into part two: a full blown technical evaluation of our [music asset] Low cost Charge, utilizing the entire completely different inputs accessible to us.
We utilized worst case situations, for the entire completely different inputs into the [calculation]. And we ended up in the identical area [of 8.5%] we’d already determined upon.
Okay, that is half two: The technical evaluation. What was that course of?
Right here’s the place I nerd out a bit!
So to calculate a Low cost Charge, step one is to calculate the Value of Fairness. The Value of Fairness consists of some inputs: (i) the Danger Free Charge; (ii) the Beta; and (iii) the Fairness Danger Premium.
- The Danger Free Charge is the typical return of long run authorities bonds. 2.5% is taken into account to be a really fundamental means of viewing long run authorities bonds.
- The Beta is the volatility of a bunch of shares towards the general inventory market. [An index for music-specific stocks] is more durable to calculate as a result of there aren’t that many public music corporations. The closest that we might get to for music was leisure, utilizing the Kroll Value of Capital Navigator. Kroll urged that the Beta for leisure needs to be 0.89. Something lower than 1.0 suggests decrease volatility than the general inventory market, which signifies that leisure is much less risky than the general inventory market. That’s a simple factor to know, in fact: the demand is mostly at all times there for leisure whatever the state of the financial system;
- After which we now have the Fairness Danger Premium. That is the surplus return that investing within the inventory market offers over a risk-free fee. So the danger free fee is 2.5%. And you then add one other couple of p.c for the Fairness Danger Premium. And that Fairness Danger Premium, through the Kroll Value of Capital Navigator, got here out at 5.5%.
So if you happen to then simply roll by these numbers (2.5% + 0.89 X 5.5%) the Value of Fairness turns into 7.4%.
Then we put the Value of Fairness into the Weighted Common Value of Capital (WACC). After which we added a value of debt, the supply of which was Professor Damodaran of NYU, who’s sort of the guru on Low cost Charges.
After which [to calculate the Discount Rate] we assumed an aggressive proportion of financing [in acquisition funding] of fairness versus debt at 75% / 25%. And naturally, we put in taxes.
That’s plenty of calculations. The place did you come out?
We got here to a Low cost Charge of 6.2%. That sounds very nice and low, proper? [Remember, the lower the discount rate, the higher the music asset valuations.]
However a fee can’t simply take the current into consideration, it has to take the longer term into consideration too.
By this level, Goldman Sachs had already raised its forecast [i.e. a prediction of how much the Fed would increase future interest rates] to incorporate eight to 10 fee hikes of 25 foundation factors every.
That’s a complete [projected interest rate rise for the Fed] of 2% to 2.5%.
“In case you take the Low cost Charge that we calculated (6.2%), and also you add the typical of Goldman’s forecast – 2.25% – you get to an approximate Low cost Charge of 8.45%. And that’s what we’re utilizing.”
[Basis points are a common unit of measurement for interest rates: one basis point is equal to 1/100th of 1%. So a 1% change = 100 basis points.]
So if you happen to take the Low cost Charge that we simply calculated (6.2%), and also you add the typical of Goldman’s forecast – 2.25% – you get to an approximate Low cost Charge of 8.45%.
And that’s what we’re utilizing.
[To explain further: In her rough, quick-math version, Matsuura got to a Discount Rate of ≈8.5%. And in her let’s-just-check-that, long-math, everything-calculated-fastidiously version, she got to 8.45%.]
So what does this really… imply?
It signifies that when rates of interest go up, we won’t have to lift our Low cost Charge. It’s that straightforward.
You imply when rates of interest go up from this level onwards?
Sure. And in consequence, we’re defending all of our shoppers: valuations won’t go down.
However What if rates of interest go even larger than Goldman predicted?
Bear in mind, we put in a extremely conservative debt-to-equity profile in our calculation of 75% / 25%.
If we shift that to one thing that resembles extra like what the market [typically uses to fund acquisitions] that’s 50% / 50% [i.e. 50% debt and 50% cash].
Debt to fairness in sure offers could be 35% / 65%; it’d even flip the opposite means round. However let’s simply say 50% / 50% in the interim.
From there, we began to mess around: We performed round with the Beta, we performed round with the Fairness Danger Premium, and we performed round with the Value of Debt.
“So once more, we simply really feel that we’re on a really, very safe footing with these funds, with the long run outlook.”
For the Danger Free Charge, we put in 5% as an alternative of 2.5%. For the Value of Debt, we put in 8.5% as an alternative of 3.5%. That’s a extremely, actually excessive price!
We actually didn’t suppose we would have liked to place the Beta at greater than 1, as a result of we don’t consider that music is extra risky than the [overall] inventory market. We’ve seen that already, throughout COVID: when every thing else was falling, Hipgnosis was standing robust. Customers are usually not as delicate to cost modifications in music; in a recession, folks received’t purchase automobiles however they may pay for his or her Spotify.
After which we in-built an Fairness Danger Premium of 6%. And I’ll simply say proper off the bat: the fairness danger premium has risen above 6% solely thrice since 1960.
However even if you put all of this collectively, you come out at a Low cost Charge of 8.6%.
So once more, we simply really feel that we’re on a really, very safe footing with these funds, with the long run outlook.
Valuations are being lifted by the expansion within the music business, which is simply persevering with to barrel by.
In essence, you took a conservative view when COVID hit due to the uncertainty. and it seems, successfully, the finger within the air estimate you had there has now been backed up by proof, primarily based on what’s occurring with the Fed’s fee rises?
Right.
Everyone asks what’s going to occur in a rising rate of interest atmosphere. Is that going to decrease the values of those catalogs? In the long run, will buyers begin to pull out?
We expect that we now have positioned these catalogs – utilizing the Low cost Charge that we did – such that none of that may come to go.Music Enterprise Worldwide
