Weekly Market Report

31 January 2023

Global Report

Music streaming industry.

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Local Report

South African Reserve Bank lifts the repo rate by 25bps.

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Market Indicators

Global and local indicators.

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Global Report

By Carel La Cock

The music streaming industry has seen a significant increase in popularity in recent years, with the advent of streaming platforms such as Spotify, Apple Music, and Tidal. These platforms have revolutionized the way music is consumed, allowing users to access a vast library of songs and albums on-demand. As a result, the music industry has seen a significant shift towards streaming as the primary source of revenue. Spotify, launched in 2008, was aimed at replacing the illegal file sharing taking place on sites such as Napster and Kazaa, and allowed subscribers to stream music on demand at a fraction of the cost of owning it outright. Its success ushered in an era of music streaming services that quickly replaced online music stores as the key driver of digital music revenues.

Music rights holders benefitted from the new business model and music streaming became the buzz word in the industry. Subscriber numbers grew exponentially as competing streaming services such as Apple Music, Deezer, Tidal, YouTube Premium and Tencent Music Entertainment (TME) joined the ranks. Spotify reported c. 18m premium subscribers in the first quarter of 2015, a number it would see grow to 195m by the third quarter last year. Worldwide music streaming subscribers across all platforms stood at 616.2m by the middle of last year, up 17.4% from the year before.

The worldwide music streaming market was estimated to be worth $29.5bn in 2021 and is expected to grow at a rate of 14.7% through to 2030. Much of the growth is expected to come from China where TME has 87.2m users, representing a 13.4% global market share and marking it as the third largest Digital Service Provider (DSP) globally. Spotify is the world’s largest DSP with a market share of 30.5% followed by Apple Music at 15%.

One company that has seen success in the music streaming industry is Hipgnosis Songs Fund. The company was founded in 2018 by Merck Mercuriadis, a music industry veteran who has worked with artists such as Elton John, Beyoncé, and Guns N’ Roses. The publicly traded company is listed on the London Stock Exchange and its primary focus is the acquisition of music copyrights. It owns the rights to over 65,000 songs with 3,854 number one songs in global charts and 156 Grammy winning songs. Some of the notable songs in their catalogue include Beyonce’s “Crazy in Love,” Coldplay’s “Viva La Vida,” and “Black Hole Sun” by Soundgarden.

Hipgnosis was formed with the idea of creating an investment vehicle for music copyrights, which were traditionally illiquid and difficult for investors to access. The company’s goal is to provide investors with access to a diversified portfolio of music copyrights that have the potential to generate revenue over an extended period of time. The company made its first acquisition in 2018 with the purchase of the catalogue of songwriter and producer Tim Blacksmith, which included songs such as Beyoncé’s “Crazy in Love” and “Single Ladies (Put a Ring on It).” This was followed by a series of acquisitions, including the catalogue of songwriter and producer Toby Gad, which included songs such as John Legend’s “All of Me” and Beyoncé’s “If I Were a Boy.”

In 2019, Hipgnosis went public on the London Stock Exchange, becoming the first investment company focused on music copyrights to be listed on a major stock exchange. Since its listing, Hipgnosis has continued to make strategic acquisitions, adding a diverse range of songs to its portfolio. The company has also diversified its revenue streams, generating income from streaming platforms, licensing and syncing.

Last year the share price came under pressure when interest rates started rising and its portfolio valuation came into question. The company’s portfolio of intellectual property rights is valued by an independent catalogue appraiser, Massarsky Consulting/Citrin Cooperman, who resisted adjusting for higher interest rates, stating it took a longer-term view on interest rates. The share price was down 43% for 2022 trading at a 42% discount to net asset value, representing a unique opportunity to own a piece of the music streaming industry at a fraction of the cost. The company itself has been buying back shares in a show of confidence.

There have been strong tail winds for Hipgnosis Songs Fund since the last quarter of 2022. The Copyright Royalty Board issued a ruling at the end of last year setting out the rates of royalty payments for the next five years and came in slightly ahead of expectations, boosting the expected income streams for Hipgnosis. Furthermore, Hipgnosis had a bumper festive season with Mariah Carey’s ‘All I Want for Christmas Is You’, which is part-owned by the company, reaching the top of the Billboard Hot 100 chart for the 2022 Christmas period for the second time. The song saw total stream on Spotify surge 30% higher for the year to 196.7m with total stream of 1.43bn and setting a daily record on the 24th of December of 21.3m. Ed Sheeran’s ‘Shape Of You’, another song part-owned by Hipgnosis is the second most streamed song on Spotify with 3.332bn streams.

Hipgnosis Song Fund is an interesting alternative investment and an attractive diversifier in a balanced portfolio. The share is trading at a deep discount to net asset value and offer significant upside potential when central banks become less hawkish and interest rates start tapering off.

Local Report

By Gielie Fourie

INTRODUCTION: At its first meeting of 2023 on Thursday, 26 January, the South African Reserve Bank (SARB) lifted the repo rate by 25 basis points (bps) to 7.25%. Three members of the Monetary Policy Committee (MPC) voted for the announced increase, while two voted for a 50bps increase. It may signal that the hiking cycle is abating. The increase in the repo rate comes despite December’s surprise inflation numbers, which showed a slight cooling off to 7.2%. This latest rate hike is the eighth in the current cycle, which started in November 2021 (the total adjustments to date are 375bps). The 25bps rate hike was broadly in line with consensus expectations. In his address, SARB Governor Lesetja Kganyago, frequently underlined the importance of price stability to the greater SA economy – despite the short-term costs to local consumers. Price stability remains necessary to achieve long-term economic growth.

EFFECT ON THE MARKETS: Reaction from the market was positive – the JSE was up by more than 1% after the interest rate announcement. However, the rand weakened after the announcement, trading at R17.20/USD at 21h40. On Friday the JSE closed at another all-time high of 80,791. Intraday it hit 81,000. An analyst remarked: “The JSE is too cheap. It had to go up at some point. It can certainly pull back, but the medium term target is 89,500 to 90,000.” The current Price Earnings ratio of the JSE is 13.15x. The interest rate hike increased South Africa’s prime lending rate to 10.75%. The rate-hiking cycle is starting to slow amid the SARB’s uncertainty around economic prospects.

ECONOMIC OUTLOOK: Governor Kganyago painted a bleaker picture of South Africa’s medium-term growth prospects amid heightened global uncertainty and concerns around the impact of loadshedding and failing state-owned enterprises (SOEs) at large. This was quite an unusual move away from only monetary orientated commentary on the part of the SARB. Interestingly, the SARB nevertheless appears as uncertain as financial markets at large on the direction of both the global and local economic outlook, frequently citing uncertainty to its inflation and growth forecasts.

GROWTH FORECASTS HALVED: Governor Kganyago slashed the country’s growth forecast exactly by half for the next two years, highlighting the dire impact the worsening power supply crisis is anticipated to have on the economy. The SARB now projects that South Africa’s 2023 GDP will grow by a meagre 0.3%, half of the previous estimate of 0.6%, due to “extensive load shedding” as well as other logistical constraints. Its forecast GDP growth for 2024 is now just 0.7%, half of the previous estimate of 1.4%. It has cut its growth forecast for 2025 from 1.5% to 1%. The SARB also forecasts no growth for the fourth quarter of 2022, despite the economy growing 1.6% in quarter three. These significant downward revisions come as load shedding has escalated to unprecedented levels, with multiple power cuts taking place daily for several weeks now. Official GDP figures for the last quarter of 2022, and the year as a whole, are yet to be released. The Bank estimates that 2022’s growth will come in at 2.5%. “The forecast takes into account ongoing high levels of load shedding, and more modest household spending and investment growth than previously,” Kganyago said.

UNEMPLOYMENT: Commenting on the SARB’s sharp downward GDP revisions, chief economist at Sanlam Investments, Arthur Kamp, said the forecasts were “far below the required level to deliver a meaningful, sustained decrease in the unemployment rate”. He added: “South Africa’s paltry economic growth rate cannot be attributed to monetary policy. Rather, the lack of sufficient, reliable energy supply, infrastructure bottlenecks and a high government debt level, which crowds out private sector investment, are the main problems.”

STATE OWNED ENTERPRISES (SOEs): Kganyago painted a bleaker picture of South Africa’s medium-term growth prospects amid heightened global uncertainty and concerns around the impact of loadshedding and failing state-owned enterprises (SOEs) at large. His reference to SOEs was interesting. The SARB itself is a SOE, albeit a successful and respected SOE.

INFLATION: Kganyago added: “This marks the 8th consecutive rate hike since policy normalisation started in November 2021, to anchor inflation expectations more firmly around the mid-point of the target band of 3-6% and achieve the inflation target in 2024. The move was driven by the Bank’s assessment that risks to the inflationary outlook remain skewed to the upside. The headline Consumer Price Inflation (CPI) forecast was revised up to 6.90% in 2022 (vs. the prior estimate of 6.70%), kept unchanged at 5.40% in 2023, and raised to 4.80% in 2024 (vs. the prior estimate of 4.50%).”

BOTTOM LINE: Last night Pres. Ramaphosa announced that the ANC wants a state of national disaster to be declared around South Africa’s energy crisis, with the presidency co-ordinating an emergency programme to “ensure that the energy crisis is properly addressed”. The Loadshedding Effect: Each quarterly decline of 1% in electricity consumption equals a 0.16% decrease in GDP (Absa research). The economy is unlikely to grow by more than 0.3% quarter-on-quarter through 2023 (Bloomberg). Below is a graph displaying the movements of the prime lending rate over a period of 60 years. Over 60 years it was north of 10% for about 40 years. There may be signals that the hiking cycle is abating, but as the graph below illustrates, when interest rates go higher than 10% (we are at 10.75% now) it is difficult to bring it down. In these uncertain times you need a trusted consultant at your side. Contact one of our experienced consultants for a free consultation.

SA Prime Overdraft Rate - sine 1963

South Africa Prime Overdraft Rate % (Source: Trading Economics, SARB)

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Reference: References can be supplied on request.

The Bottom Line: Innovation and the Magic of Compounding

By Carel La Cock

The oldest investment trust listed on the London Stock Exchange can trace its beginnings back to the surging demand for rubber at the advent of the car industry. Following the Panic of 1907 when the New York Stock Exchange fell nearly 50% from its peak, credit markets dried up and realising the opportunity to lend to rubber plantations in Asia, Colonel Augustus Baillie and Carlyle Gifford established The Straits Mortgage and Trust Company Limited that would ultimately become the behemoth: Scottish Mortgage Investment Trust (SMT), a constituent of the FTSE100.

Baillie Gifford & Co, the investment management company that stewards SMT, oversee total assets in the fund of £16.67bn as at the end of February 2022. Outgoing manager, James Anderson, defined his career with early investments in Amazon and Tesla, which propelled the fund to cumulative growth of 696.8% in the last 10-years, compared to 220.4% for its benchmark, the FTSE All-World Index. Anderson’s investment philosophy has always been based on the belief that technological improvements will drive innovation and that even picking a small number of these successful future companies and holding on to them long enough to let the magic of compounding work, will lead to exceptional returns for clients. Tom Slater, co-manager since 2015, will take over the reins at the end of April and believes that it matters less failing to sell the holdings you should sell, than selling the holdings you should not sell. When they go long on investments, they remain long offering support as patient investors often nurturing private holdings until they go public.

After a stellar performance in 2020 which saw net asset value (NAV) grow by 106.5%, 2021 was more subdued by its own standards, up only 13.2%. This year the share price has come under severe pressure from rising inflation and the rising interest rate used in discounting long duration income flows on many of the growth stocks in its portfolio. Moderna, the manufacturer of Covid-19 vaccines and the largest holding in the portfolio at 8% is down nearly a third year to date, while Tencent, the Chinese e-commerce giant, at 4% of the portfolio is down nearly a fifth this year. Others in the top five holdings: ASML (-13%), Illumina (-9.6%), Tesla (-13%) and NVIDIA (-10.4%) have all been downgraded due to expectations of a steepening yield curve.

Is now the time to panic and if not now, then when? Geopolitical risk is at an all-time high, the US federal reserve has just hiked interest rates for the first time since 2018 and global inflation is running rampant while oil and gas prices have spike on supply fears. However, listening to manager, Tom Slater and deputy manager, Lawrence Burns discuss the current environment and the outlook for the portfolio in a recent investor presentation, you don’t get the sense that now is the time to panic, or indeed ever. Their strategy is long-term, and they have positioned the fund to participate in structural changes and technological advances in society. They have incredible deal flow built on decades of strong relationships and a reputation for stability and patience. Entrepreneurs are keeping companies private for longer and having early access to investment in these opportunities often leads to extraordinary returns.

As for its current top holding, asked if Moderna is a “one-trick-pony” with reference to the major windfall from the Covid19 vaccine, but recently downgraded as investors see the end of the pandemic and the Covid-19 vaccine franchise, Lawrence answered “Moderna is a one trick pony, but that one trick is a broad and important one and that trick is mRNA.” The biotechnology behind the Covid-19 vaccine is a powerful one with programmes to cure zika, HIV, cancer and a range of other ailments making the recent windfall unlikely to be a once-off.

Regarding the tightening of regulation in the Chinese technology sector and its impact on Tencent, the team thinks that the Chinese government is ahead of the curve in terms of regulation and that democratic western nations will eventually implement similar regulatory changes. They believe that companies that “go with the grain of society” and who are aware of their broader impact on society will find it easier to prosper. In this regard, Chinese tech companies are further along the route of enlightenment.

Lastly, Tom Slater does not agree that higher inflation and rising interest rates should lead to lower valuations on growth stocks. He cautions investors to also consider the impact of pricing power on some of these high growth companies as they become market leaders in their field. Therefore, with higher expected future inflation, one should also adjust the future cash flows that will yield a better current valuation. Looking past the current volatility, the fund has invested in some ground-breaking technology and the managers are excited by the intersection of computing power and biology calling the opportunity set “large and varied” They have 49 investments in private companies, and it is not difficult to imagine the next Amazon and Tesla coming from that pool.

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