Separating the Signal From the Noise In Royalty Investing Decisions

When evaluating royalty investments, it’s best to focus on measurable similarities rather than qualitative differences between music catalogs.
March 8, 2019

What's “better” for you, an apple or an orange?

You’ll never get the answer comparing them based on appearance, taste, or texture because they look, taste, and feel nothing alike. But you can compare them using common nutritional standards — pick the apple if you want fiber, oranges if you want vitamin C.

The same concept applies to making music royalty investing decisions. There's a strong instinct to make bidding decisions based on "taste." The more recognizable the artist, song, or genre, the greater the confidence investors have in it as a safe investment. Recognizability creates confidence.

But it’s false confidence.

In the classic "signal vs noise" debate, making decisions based on the musical differences between catalogs is focusing on the noise... literally. From a musical and artistic perspective, no two catalogs are the same. So it's impossible to determine value based on these kinds of qualitative differences between catalogs.

What's needed is more signal—measurable, common similarities that all catalogs share which buyers can use as a yardstick to determine the investment risk of one catalog over another. Musical differences or artist popularity doesn't provide enough information to make a confident investment decision.

Consider these recent auctions as examples:

The auction on the left included a catalog of different songs from different artists, with “Redemption” by hip-hop superstar Drake the highest-earning song. It was an RIAA Platinum-certified song, off a Grammy-nominated album, boasting over 80 million Spotify streams.

As you can see, investors bid this catalog up to a 6.4x multiple for the right to collect these revenues for the next 10 years.

The catalog on the right, meanwhile, featured a less well-known artist called Lyfe Jennings. He has no Grammy awards or RIAA certifications. And because investors didn’t recognize the artist or the songs, bidding closed at only a 3.6x multiple.

Neither was a “bad” investment. But let’s look past the qualitative differences between them and dig into some measurable similarities all catalogs share to see which buyer took the greater risk.

In our estimation there are two clear signals that all catalogs share, which we define as LTM Multiple and Dollar Age.

LTM Multiple: this is simply how much the catalog has produced in royalties in the last year. There’s no ambiguity there… it’s a simple quantity of earnings metric that all can agree on. Purchase prices are measured based on how much over the last year’s earnings a buyer is willing to pay to acquire the catalog.

But what about the quality of those earnings? How does one determine which catalog should sell for a higher multiple than the other? That brings us to...

Dollar Age: This metric determines the quality of earnings based on the length of time the catalog has generated royalties. So if two catalogs both earned $10,000 last year, the earnings for the one that has collected royalties for 20 years is considered less of a risk than the one that has collected royalties for only three.

[To read more about how we calculate and apply Dollar Age, click here.]

This is based on the concept of the Lindy Effect, which states:

The future life expectancy of some non-perishable things—like technology, or an idea—is proportional to their current age. Every additional period of survival implies a longer remaining life expectancy.

In other words, the longer a catalog has generated royalties, the more likely it will continue to generate royalties into the future.

So now let’s look again at our two example catalogs applying these metrics to the results...

You’ll see the Drake catalog has a Dollar Age of only 2.4 years, while the Lyfe Jennings catalog has a dollar age of 10.8.

From a risk assessment perspective, the Lyfe Jennings catalog is the less risky investment as it has a longer history of earnings. Although the buyer of the Drake auction gained a respectable trailing yield of 15.5%, the buyer of the Lyfe Jennings auction is getting a mind-blowing 27.8%.

Put another way, the buyer of the auction on the right is getting a much better return for far less risk than the buyer of the auction on the left.

We believe these two metrics — LTM Multiple and Dollar Age — are strong signals worth using to assess risk between royalty investing options in music. They're so strong that we made them the foundation of our new Order Book feature, currently available as a pilot program to our All Access Investor members. The Order Book allows investors to leave standing orders for royalties that meet certain criteria based on these quantitative similarities between catalogs.

Each Order Book “bid” allows investors to determine the maximum LTM Multiple they willing to pay, for the minimum Dollar Age catalog they’re willing to accept, along with standard order criteria like total order amount and minimum fill size.

What you don't see here are things like genre, artist names, and other qualitative differences. And we further filter the “signal” to limiting Order Book bids to only public performance royalties and 10-Year Term deals.

But you don’t need to participate in the Order Book to apply the concepts of LTM Multiple and Dollar Age. All Royalty Exchange listings now feature these metrics in the Overview tab for all investors to see, along with the Theoretical Internal Rate of Return.

Applying common measurable standards like these eliminates the uncertainty and "guesswork" of making royalty investing. It provides the most useful information needed to define and measure the risk factors unique to music royalties.

By focusing on the signals of quantitative similarities, and not the noise of qualitative differences, any investor can make more confident investing decisions.

Visit the Listings Page now to apply these concept to any of the live auctions today.

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