Accounting scandals may not get the public’s attention like a raid by Homeland Security, but questions about the quality of a publicly traded company’s books is a serious matter. This week, an internal report made public by Hipgnosis Songs Fund, the London-listed company that played a major role in turning music rights into a stable, attractive asset class, confirmed what some analysts and shareholders had long suspected.  

At best, the 26-page report by Shot Tower Capital, the firm hired by the company’s board of directors in the wake of a shareholder revolt in October, details how the investment advisor, the Merck Mercuriadis-led Hipgnosis Song Management (HSM), made numerous missteps in accounting and financial projections of its vast music rights portfolio that includes music by Red Hot Chili Peppers, Shakira and Journey. At worst, the report suggests the investment advisor chose accounting standards that overstated revenue, inflated the portfolio’s valuation and — as the board previously stated — resulted in larger fees paid for managing the portfolio. In any case, information released Thursday presents an unflattering portrait of HSM and its internal operations.   

For its part, HSM considers some “aspects of the report…to be factually inaccurate and misleading,” the company said in a statement on Thursday (Mar. 28). HSM said it received the report the evening before its release and will respond to the board “in due course.”  

To be clear, Shot Tower did not explicitly comment on the investment advisor’s intent in using certain accounting practices. The data-heavy report offers analysis, not speculation. But the report, part of the board of directors’ effort to regain shareholders’ trust, made clear that annual revenue was “materially” overstated and laid out numerous examples where the fund’s numbers didn’t reflect the reality behind its assets. 

Take, for example, something called right to income (RTI), which are royalties that are paid to the buyer at the close of an acquisition. (If the acquisition’s effective date is prior to the closing date, royalties received by the seller after the effective date are credited to the buyer.) Normally, the amount of the RTI is deducted from the purchase price and is not included in annual revenue figures. However, Shot Tower found that some RTI revenue from Hipgnosis acquisitions was counted as annual revenues rather than an adjustment in the purchase price. As the board’s Mar. 18 update noted, including RTI revenue with annual revenue amounts to “double counting.” Misclassifying RTI “significantly” increased the fund’s income in 2021 and 2022, according to the report. In fiscal 2019 and fiscal 2020, zero and 5.3% of deals had RTI periods that extended for more than one year. In fiscal 2021 and 2022, those numbers jumped to 43.9% and 60.0%.   

RTI also came into play with the proposed sale of a portion of the portfolio to Hipgnosis Songs Capital, a joint venture of HSM and investment firm Blackstone. The catalog was presented to shareholders as having a net purchase price of $424.7 million (including RTI revenue of $15.3 million). With pro-forma annual revenue (PFAR) of $24.1 million, HSM assigned a 17.6x multiple to the proposed sale. But Shot Tower believes the catalog’s multiple should have been 14.9x based on higher annual revenue of $28 million and believed the net sale price should have been $416.7 million. Shareholders voted against the proposed sale in October.

In fiscal 2022, the investment advisor changed how it accounted for accrued revenues. The fund is required to make estimates on revenue earned in the period, rather than recognize revenue when the royalties are collected. A new approach, called “usage accruals,” calculated accruals “based on expected usage” rather than when revenues “are paid to, and processed by, collection societies, publishers and administrators.” Shot Tower noted the adoption of usage accruals occurred “at a time when RTI revenue was declining and the Fund could no longer raise capital for continued acquisitions.” In other words, a lack of fresh funding halted acquisitions and reduced the amount of RTI revenue added to annual revenue. Without the change, Shot Tower believes the fund “would have breached its lender covenants” and fiscal 2022 revenue would have been $36 million lower. 

Accrued revenue also caused problems with PFAR, a non-IFRS metric meant to show investors organic growth excluding accruals and RTI. But Shot Tower found PFAR did indeed include accrual estimates of income expected to be included in the period, which “presents a picture of organic growth that is higher than growth suggested by the statement data,” according to the report. As such, Shot Tower warned investors not to rely on PFAR as a metric.

More issues arose in Shot Tower’s due diligence investigations into how individual catalogs were valued. The entire portfolio, which stood at $2.8 billion on Mar. 31, 2023, is instead worth $1.95 billion, according to the report — a difference of some $850 million. Given the transparency into the fund’s accounting practices, however, shareholders were unfazed by the demotion. On Thursday, Hipgnosis Song Fund’s share price jumped 8.3% to 69 pence, its highest closing price since Jan. 31 and 30.4% above its low point in 2024, 52.9 pence, set on Mar. 4. Whether the share price will improve further could depend on how shareholders view the board’s reaction to this report.