It’s such a fine line between stupid and clever,” observed David St Hubbins, lead singer of spoof 1980s rock band Spinal Tap – a line that he and his Spandex-clad bandmates trod for much of their music-recording career. But the same appears to be true of investing in music: the margins are just too fine.
Private equity investors appear to be on the stupid side of the line. This week, it emerged that EMI is worth £2bn less than the £4.2bn paid for it by private-equity group Terra Firma in 2007. Terra Firma now has to raise £120m by June to avoid breaching banking covenants on £3.3bn of loans. It’s so short of cash that it has put EMI’s iconic Abbey Road recording studio – where The Beatles, if not Spinal Tap, laid down classic tracks – up for sale, just to raise a few tens of millions. As was seldom the case in Sir George Martin’s day, the problem appears to be in the mix. Private equity relies on cost-cutting to improve margins on recurring revenue streams, so it can sell up at a profit after servicing vast quantities of debt. EMI’s EQ balance is all out: all we hear about is the latter. Attempts by Terra Firma boss Guy Hands to cut costs succeeded in saving £200,000 a year on “fruit and flowers” – the music biz euphemism for artists’ less wholesome expenses. It seemed to make a difference at first. EMI’s earnings in the second quarter of 2008 rose to £59.2m, compared with a loss of £45.1m a year before. “There has been a massive reduction in waste,” Hands told staff.
But everything else was too low in the mix: revenues clearly didn’t recur sufficiently, and margins did not get wide enough. Hands now proposes a complete restructuring, valuing EMI Music Publishing at just £1.46bn and the record label at less than £800m.
Later in the week, I experienced the flawed business model at first hand – at the Brit Awards. Cost-cutting does not come naturally to music companies. So hospitable were the organisers, and the sommeliers, that my hosts were dancing on the table to Robbie Williams by 9.30pm, and last seen heading for the bar – via the indoor dodgem cars, post-ironic bingo hall, giant inflatable octopus and crazy golf course – at the after-show party.
Judging by the queue for cubicles in the gents, the excesses gave record company executives indigestion (I hadn’t realised that Rennie can be taken nasally).
Revenues are not likely to improve much, either. While the thousands of fans gyrating wildly to Mr Williams suggested they would gladly pay hundreds of pounds to let him entertain them, the mass sing-along to “Angels” proved that they had paid 79p to download the track many years ago – and wouldn’t need to again.
Live performance has a potential for recurring revenues that greatest hits albums now lack.
Venture capital investors appear to realise this, from the clever side of the line. Earlier that day, I visited Ingenious Media Investments – now the largest operator of venture capital trusts in the entertainment sector, having raised more than £85m for six funds.
Its Live VCTs employ a simple business model: encourage private investors to put money in with 30 per cent upfront tax relief, invest this money into music festivals and concerts with predictable or recurring revenues, achieve margins of 30-40 per cent, and return capital to investors after a three or five-year minimum holding period. Their investments have included: more than £1m into Creamfields, the two-day festival of dance music featuring Brit Award winner Dizzee Rascal; £500,000 into the 80s Rewind Festival, the multi-artist event for old New Romantics; and £1m into Underage, the parent-friendly summer music festival for under-18s where the only stimulants literally are fruit and flowers. Net asset value was up 4 per cent in October, and three out of its four 2009 events were profitable.
Edge Performance VCT takes a similar approach with live tours and concerts – it has invested in 200 gigs since December 2006 featuring artists ranging from Kanye West to Blur. It aims to invest in events with a high level of capital protection, through contractual revenues or capital guarantees from financially sound promoters and partners. Its latest ‘F’ share offer has a target return of 130p in cash for every 100p invested, which only costs investors 70p after tax relief.
An earlier share issue turned a 60p per share investment into 85p in just three years – an internal rate of return of 12 per cent, equivalent to 20.17 per cent for a 40 per cent taxpayer.
Both VCTs are exposed to a growth market. Mintel research forecasts that the number of live concerts and festivals will increase by 106 per cent over the next five years.
Even EMI has belatedly realised this: last November, it launched Abbey Road Live, enabling fans to purchase recordings of shows they had just attended.
But as for private equity investors, they probably wish they could wind back the years as effectively as the reunited Spinal Tap at last year’s Glastonbury.