Hipgnosis Chair Robert Naylor Acknowledges Investment Advisory Agreement Concerns, Seeks to Address ‘Perceived Mismanagement of the Conflicts of Interest’

Hipgnosis Songs Fund (HSF) chair Robert Naylor has formally addressed investor concerns about possible conflicts of interest regarding the terms of the company’s agreement with its Blackstone-powered investment adviser, Hipgnosis Song Management (HSM).

Naylor, formerly the chair of Round Hill Music’s since-sold songs fund, commented on the investment advisory agreement and several other noteworthy topics as part of HSF’s newly published earnings report.

Dated December 20th, the firmly worded comments from the Intuitive Investments Group CEO Naylor have come just days after HSF’s board, upon delaying the earnings report’s publication, expressed “concerns” about the appraised worth of the fund’s catalogs.

The underlying valuation methodology has long been a subject of discussion, and HSF’s market cap has for some time represented a steep discount to the advertised worth of its music IP. Bearing in mind the points, Naylor reiterated that the HSF board had approached HSM seeking clarity about the valuation.

As we previously reported, Merck Mercuriadis-led HSM issued a public response to the request and the earnings delay. However, behind the scenes (at least as described by Naylor), the investment adviser “at first declined to give an opinion but, after repeated requests…eventually provided an opinion which was heavily caveated.”

“In the absence of further evidence or insight from the Investment Adviser,” proceeded Robert Naylor, “on which to base a judgement on the valuation of the Company’s assets, the Board has concerns as to whether the Fair Value is reasonable.

“Consequently, the Board recommends that investors use the Fair Value and the Operative NAV with a higher degree of caution and less certainty than might otherwise be attached to it as an accurate reflection of the fair value of the Company’s assets,” he drove home.

The Status of HSF’s Strategic Review – and the Future of the Investment Advisory Agreement

In October, soon before investors voted against its continuation, HSF officially launched a strategic review. And in connection with the evaluation, Naylor has confirmed that the company “requested Hipgnosis Song Management propose alternative terms for their future investment advisory arrangements.”

In brief, HSM collected a not-insignificant $5.4 million in advisory fees from HSF between April and September of 2023 despite a complete lack of new acquisitions for the fund, the appropriate earnings report shows.

Additionally, HSF had proposed to sell 29 catalogs to Hipgnosis Songs Capital (an HSM-Blackstone partnership) for a price that investors, who overwhelmingly rejected the planned deal, believed too low. Some investors further claimed that the terms of the bidding process and the transaction’s structure had dissuaded third parties from submitting offers.

More pressing yet, HSF relayed in November that it had opted against cutting loose HSM (a piece of which belongs to Mercuriadis) as investment adviser – a move that it said would require cause or at least “12 months’ notice, with an additional one-time termination fee equal to one year’s advisory fee calculated on NAV as at the termination date.”

Explaining the decision, the board noted that parting ways in this manner would, among other things, trigger a “call option” through which HSM would (somewhat astonishingly) be able to “acquire the Company’s [HSF’s] portfolio on termination of its contract.”

As summarized by Naylor in today’s report, personal meetings with “diverse shareholders,” possessing a cumulative 60 or so percent of HSF’s total shares, have had “two key themes,” one being “the failure of the financial reporting and controls at” HSM, the other being the possible mishandling of alleged conflicts of interest.

“Secondly, the perceived mismanagement of the conflicts of interest,” penned Robert Naylor of investors’ chief worries, “both in the recently failed sale of assets to Hipgnosis Songs Capital, a fund that is majority owned by Blackstone, at a material discount to fair value of those assets and in the terms of the Investment Advisory Agreement with Hipgnosis Song Management. This is harder to address, but we will seek to do so in the coming months.”

Elsewhere in the lengthy text, Naylor made clear that if HSM fails to propose terms “in the best interests of the future of” HSF and investors, the board “will explore bringing forward alternative proposals to shareholders.” Of course, it’ll be interesting to see in the new year exactly what these possible alternative proposals involve.

HSF’s Operational Future With Regard to Banking Covenants

Looking forward to the next 12 months, Naylor signaled that the board, factoring based on information from HSM – the same investment adviser with which all manner of HSF investors have taken issue, that is – believes HSF “should have sufficient headroom to operate within its banking covenants.”

Even so, the chair also emphasized inherent operational uncertainty stemming from “the continuation of issues around financial reporting and controls,” citing as an example an unexpected multimillion-dollar contractual obligation that the board learned about on December 15th.