Run the Numbers on Royalties! Here's How...

Dec 05, 2014

Investing in music royalties, just like investing in stocks, bonds or mutual funds, requires analysis.

Because royalty investments are income streams, that analysis involves comparing their anticipated flows against the other alternatives in the marketplace. A start is to extrapolate the potential value of a royalty auction based on its history.

For example, consider Royalty Exchange, Inc.’s recent auction of Anastas Hackett’s writer’s royalties. In this auction format, a fixed future royalty amount is sold as a discount. Auction winners receive royalty payments up until the fixed amount is reached.

Here’s the fundamental bet: all things being equal, weighing the time value of the cash flow investment against other investment opportunities, based on his or her estimation of the song’s popularity.

Royalty stream analysis
Source: Howard Simons Research, Ltd.

The Hackett sale was for $117,040 of future royalty income from a package of reggae songs that have yielded an average of $11,704 over the past three years. That income is plotted in blue on the chart above. Based on an estimated quarterly decline of 2.2%, a best-fit decline curve is depicted in red, showed a quarterly decline of 2.24%.

At the offering price of $50,200, the estimated 10-year internal rate of return would be 2.42%, as compared to the current 3.8% yield for the Bank of America/Merrill Lynch Corporate & High-Yield Master index of corporate bonds. All things being equal; the royalty stream would need to decline at 2% in order to match the current corporate bond yield. That forecast is depicted in green.

But while all things are equal in economics, in real life they never are. For example, should the royalties exceed the current average, as is often the case when a song is covered or used in a feature film, the return will improve. The comparative return will also improve should interest rates overall continue to decline, as has been the case in Japan since the early 2000s.