Intellectual property ABS, though often talked up, has never really lived up to the hype, especially as investors became hesitant to venture into the esoteric in recent years. And now the infamous "Bowie Bonds" that got the ball rolling in 1997 are under threat of a downgrade.
David Pullman, founder and chief executive of the New York-based Pullman Group, said the Bowie bonds were designed to give British pop star David Bowie instant access to future royalties from copyrights on a catalog of his songs, while investors would pocket a 7.9% coupon payment over the 10-year average life of the bonds. The predictability of the revenue stream scored a single-A rating.
But the decline in retail sales across the music entertainment industry led Moody's Investors Service to put the securitization on review for a possible downgrade from its current A3 level. The move, said a nonchalant Pullman, was linked to the agency's March 2003 downgrade of EMI Group Plc, which provided a $30 million 15-year guarantee for the catalog license the deal is based on.
Pullman claims that the EMI credit enhancement is not essential to the continued performance of the bonds, and that a one-notch downgrade would still qualify the issue as investment-grade. "The guarantee is so favorable to the trust that if, for whatever reason, EMI didn't pay, we could go out and relicense the catalog for another huge amount up front and that doesn't include the publishing income itself," he says.
But the plummeting music sales that prompted the EMI downgrade are still a concern for this deal and the handful of music-related securitizations that followed it. Record manufacturers have seen their primary distribution platform change overnight from mom-and-pop stores to retail empires like Wal-Mart Stores and Target Corp.
"Like in every other industry, those major retailers significantly reduce the margin for the manufacturer, causing a major change in mechanical revenues," said Bob D'Loren, president & CEO of UCC Capital Corp., which has structured several intellectual property deals in the entertainment sector. But to say the Bowie bond deal is doomed because of the ramifications of EMI's rating downgrade is a sweeping generalization, said D'Loren.
Entertainment industry analysts concur, especially as an investment in something like music royalties can be a diversification opportunity for investors looking for unique exposures. The deal was structured so that they would be able to sell the underlying assets if the bonds defaulted. And since most major music catalogs currently trade at around 20 times net publisher share, said the analyst, Bowie bondholders have little to worry about.
"Wall Street has never been terribly receptive to the entertainment space, especially music," said Michael Elkin, chairman of the entertainment and media group at New York law firm Thelen Reid & Priest. "There've been charges of Hollywood accounting and fictitious net profits but in the wake of Enron and the utility industry, and WordCom and the telecom industry, entertainment is not looking so bad."
Like any other, the industry has its fair share of hurdles to overcome. In addition to waning retail sales and consumer confidence, the music industry is battling rampant online piracy and uncertainties about its future.
The good news is that such periods of transition have historically given rise to more opportunities. The shift from vinyl to cassette and from cassette to compact disk revitalized the recording industry and its ancillary businesses. And the Internet has opened up a whole new area of opportunity, as exemplified by recent ventures into online music distribution by RealNetworks Inc. and Apple Computer Inc.
And such opportunities aren't limited to the music industry. The patents and copyrights on computer software could easily lend themselves to securitization, as could book and television syndication rights. Pullman and his group are currently working on a transaction that he claims will be the first-ever securitization of a pool of different music, TV and film assets. They hope to launch the deal, which mixes different genres of music from different decades, sometime this summer.
"The size of pool will be a function of where spreads and interest rates are and how much we can handle in terms of the amount of due diligence we need to do, which is enormous on these deals - it's about a hundred times the amount of work we do on a single artist/songwriter deal," Pullman said.
Other IP securitization players say there is renewed interest in the asset class among individual music artists, too. But these deals will probably be pitched in a different way than they were in the 1990s when they were presented as an arbitrage opportunity. Musicians and companies were encouraged to borrow money against future revenue streams at an attractively low fixed interest rate, and to invest the proceeds in the financial markets.
That sort of opportunistic arbitrage play doesn't really make sense any more, said Thelen Reid's Elkin. But for artists, composers, writers or producers that have an actual need for the money, this is as good a way as any to raise money for business or personal use.
"As long as there's a need, there will be a market for these transactions, and the rating agencies will not stop underwriting, they'll just be more careful," said Elkin.