• 3QFI

How I Analyze a Royalty Exchange Investment

Updated: Feb 27



As I've written about previously, I've added music royalties to my investment portfolio. I find that they are a great way to diversify. I don't see them as an investment that will return hockey stick growth numbers, but I do see these as a way of earning nice, steady returns that are largely untethered to other investment classes (primary stocks and real estate). If you haven't read my article on music royalties, pause here and go spend 5 minutes reading it. I'll wait.


Before we begin there are a a few disclaimers I want to get out of the way:

  • I'm not an accountant. I'm not an investment adviser. Please do your own due diligence on any investment you make.

  • I've only been investing in music royalties for a short time, so do not have years of personal experience or personal results I'm drawing from (although I've been doing everything I can to learn as much as possible about this investment class).

  • I subscribe to the KISS principle (Keep It Simple Stupid). I could absolutely overcomplicate this, but so many of the variables are unknowable - thus there's diminishing returns to the effort.

Okay, with that out of the way lets jump in.



Variables

Let's break down the variables I use in calculating what I'm willing to pay for a music royalty investment:


  • Purchase Price: This is simply the bid amount I'm analyzing for the royalty I'm interested in.

  • Years Remaining: The number of years I'll own the rights to this royalty. For royalties that are Life of Rights, I just put in 10 years here. Even though for Life of Rights I'll continue to earn royalty payments after that 10 year period, it's next to impossible to tell how much those payments will be.

  • Estimated First Year Revenue: This is a best guess judgement. If a royalty has been earning consistent royalties for many years, I'll reduce the last 12 months of earnings by 2-10%. If the royalty hasn't been earning for long (less than 3 years), OR if these earnings are driven more by radio play than streaming (radio play drops off after the early years), OR if the historical royalty payments have been erratic, then I may reduce by up to 20%. If there's too much variability for me to derive a percent I'm comfortable with, then my decision is easy - this isn't the royalty for me.

  • % Royalty Decline / Year: This is another gut call. If the royalty is an established earner over many years, then I plug in a 2-10% decline per year here. If the royalty has only been earning for 3 years or less, then I'll raise it to 10-20%. These numbers align to my own analysis of how royalties perform, but your mileage may vary. Another critical thing to note is that the future of royalty payments is changing. There are changes to the mechanical royalty payouts coming (increasing 44%) & streaming services are experiencing significant growth globally. That being said it's always best to be conservative in estimates.

  • Depreciation: According to my accountant and everything I've read (including on the IRS website) you can depreciate royalties over time. The consensus seems to be a 15 year depreciation but I've also heard 10 years. Please discuss with your own accountant however! For my calculations I assume I'll be able to depreciate the purchase price of the royalty over 15 years.

  • Tax Rate: This is simply the tax bracket you're in (for those if you in the United States). I use this number to determine the tax savings from depreciation, as well as the tax bill I'll have to pay above what I'm able to depreciate.



Hypothetical Example

Okay, lets analyze a hypothetical example before we get into real world examples. Here's the calculator I built and use for this analysis. Feel free to download it and use it as you wish.


For this example lets assume the following:

  • Purchase Prices: $10,000

  • Years Remaining: 10 years

  • Estimated First Year Revenue: $2,500

  • % Royalty Decline / Year: 5%

  • Depreciation: 15 years

  • Tax Rate: 22%

Based on those variables this is what the payout estimates looks like:

So based on this analysis, this deal is estimated to return 7.2% per year for 10 years (after tax). However since most of the time investments will tell you the return before you pay taxes, a better number to compare is the 8.3% return.


Remember this is an investment that is there to provide diversification to your portfolio. The goal isn't massive, life changing return percentages (if you can find them, however, please send them my way!). So an 8.3% return estimate to me is extremely appealing, and a deal I'd make every time.


Now lets look at a real world example from a royalty that's for sale on Royalty Exchange.



Actual Example 1: D-12 & Eminem Catalog

There's currently a catalog up for auction from D-12 and Eminem that I'll analyze.


(Here are some of the screen grabs from Royalty Exchange for this offering that I'll use inform my analysis).


As you can see this catalog has been earning money for a long time (15+ years). It looks like there's been a bit of a drop off in earnings over the last 12 months when compared to the last three year average ($938 LTM vs. $1,228 3yr Ave).


Lets dig into why that could be.


Under the Sale History you'll see a section where you can Download Raw Data File. This is where you get all of the details that feed into the top level charts.




I downloaded the data file, added a quick pivot table and found the anomaly. It looks like in 2017 some songs from this catalog were used in a television show (you can go further into the details to see what shows etc., but not important for this analysis). These TV-Film royalties were $1,060 from that year, and it obviously dropped off significantly in 2018. From this you'll see the streaming numbers have remained constant over the past few years (note: 2020 data is only from 2 quarters).


You can see over the last 12 months the majority of the revenue has come from Online Streaming. The International Sources tend to be a mix of all kinds of stuff, so are hard to nail down the exact source there.



In the quarter over quarter earnings you can see the big jump in the the Q1 2018 payout from the TV-Film royalties from 2017 (generally royalties are paid out a couple of quarters after they were earned). Not sure about the gap in Q2 2018, but it looks like royalties that would have been paid out then landed in Q3 2018 given the spike up then. Not super relevant to my analysis though, so moving on.



Okay, so based on this information here are my thoughts.

  1. This royalty looks to payout really consistently after backing out the large TV-Film bump. The LTM revenue is $938. I feel good about estimating the next year payout will drop 5% from the last 12 months: so I'm using $891.

  2. Given the Dollar Age (how long the royalty has been paying out), I feel good about the royalty paying out consistently. I'm going to factor in a 5% decrease year over year.

So based on those variables I'd be completely comfortable with an offer of $4,000. This would provide a 7.1% estimated return (post depreciation, pre income tax) over 8.5 years. That's not too shabby. Keep in mind these returns are in NO WAY guaranteed, by any stretch of the imagination. But I believe they are a solid baseline to use in analyzing the potential return for this royalty.


Now will the owner accept an offer of $4,000? It doesn't look promising as there have been 2 offers made already for $5,200 that were not accepted. This is part of the game, finding the right match.


Remember, these are not investments to get rich quick. I use them simply to provide good returns and diversify away from the stock market and real estate (my other primary asset classes).


Okay, let us look at another.



Actual Example #2: Tantric Catalog

This one is a catalog featuring the hard rock band Tantric. I adjusted the tax rate on this one to 35% to change it up there as well.


Here are the details:

I really like this catalog. Strong revenue history which has actually grown over time - driven mostly by online streaming (after looking through the data file). This catalog has been earning royalties for over 16 years as well.



Here's the offer breakdown I pulled together for this:


The 5.75% post depreciation, pre tax rate of return might not seem to be amazing, but keep in mind that this is a Life of Rights royalty. So you'll continue to make revenue beyond the 10 years captured in this breakdown. Also keep in mind that this percentage is just used as a baseline for analyzing the catalog, that's it.



Closing

In closing here are some closing answers to questions you may have.

  • Will investing in music royalties make you rich? Probably not.

  • Is there risk involved in music royalty investments? Of course.

  • Are the numbers above make-believe? 100%! But I believe they help make informed investment decisions.

  • Will royalty payouts increase over time? I believe so. I think there's a ton up upside potential in this asset class, but time will tell. Let your own due diligence kick in here.

  • Should I put all of my money into music royalties? Not a chance! I currently have around 5% of my portfolio invested in royalties & sleep like a rock at night.

  • Is music royalty investing fun? I absolutely love it! Analyzing, trying to make a deal is something I enjoy immensely. It's also fun to get checks every 3 months & see how my investments are performing.

  • Will owning royalties make me better looking? Without a doubt!





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