Lending in tune

What’s fashionable in the music industry can turn on a dime. Genres come and go, and few artists achieve true longevity.

Unless, of course, you are the walking economy that is Taylor Swift. Roughly 20 years into her career, she is one of the music industry’s superstars. She seems unstoppable — you can’t shift the Swift. 

Musicians, and the music industry, have increasingly become financially savvy in recent decades. David Bowie’s royalty bonds were just the start: in the last few years, some of the most famous names, from Bob Dylan to Shakira, have raised millions in sales of their music rights to investors who forecast reliable future revenue based on the stickiness of their fandom.

Private credit is now getting in on the act. Last week, 9fin reported on the race to acquire BMI, the owner of many music back catalogs that belong to Swift, Rihanna and Ed Sheeran. New Mountain is currently in pole position to snap up the company.

At $1.7bn in enterprise value, it’s a workable opportunity for private credit. So it’s not surprising that Oak Hill, JP Morgan and Blue Owl have been involved in discussions to provide financing. According to our reporting, the deal is likely to price in the 550bps-600bps range.

It’s a departure from the usual healthcare and technology LBO financings that private credit firms have a penchant for, but the investment case is relatively simple — and tracking the quality of the musical assets is easier today than ever before. 

The way we consume music today is counted by a growing number of streaming services. Taylor Swift is close to a 100m monthly listeners on Spotify, and as rights holder, BMI is racking up the plays. As for the profitability of the much vaunted vinyl revival…we’ll defer to Pizza Express on that one.

Reason to dwell

The US private credit market is the deepest and most sophisticated globally, so of course many foreign investors want in. But investing in it obviously has to make sense economically — and for that reason the ‘season and sell’ structure is a popular strategy for funds with foreign LPs. 

Season and sell is when a private credit firm originates a loan in one fund and then sells it to a separate offshore vehicle six months later. Under the legalese of US tax law, the offshore vehicle is not technically engaged in trade or business, and is simply investing in a financial instrument like stocks or bonds. As such, it is exempt from federal income tax.

But if the IRS gets it way, season and sell could turn into…season and hell. 

As we detailed this week, a case involving now defunct hedge fund YA Global has potentially huge implications for this strategy. If the IRS wins its lawsuit against YA, season and sell could become untenable — and this could stretch the already yawning competitive gap between smaller direct lenders and bigger players. 

Season and sell is especially favored by smaller funds, because setting up a business development company — which achieves some comparable tax efficiencies by different means — is considerably more expensive and logistically challenging.

It’s the latest example of how regulation may stifle smaller lenders while the big incumbents take the extra costs in their stride. It’s also another argument for why it’s a lot easier to buy an existing private credit fund rather than start one from scratch.

Stranger than friction

In today’s society, we are overwhelmed by choice. But when it comes down to selecting your legal representation, that’s not always a bad thing — it’s generally preferable to choose your own, especially when you are investing your own money.

In Europe and the US it, is now a relatively familiar practice (at least in the syndicated markets) for private equity firms to choose the law firms that provide legal representation for their lenders. 

The practice is now facing the scrutiny of the International Organization of Securities Commissions (IOSCO), as 9fin reported recently.

Over the years lenders have found workarounds: proposing a list of three law firms to the sponsor to choose from, or appointing their own shadow counsel to assess documentation alongside the official designated counsel. But neither of these is a full solution.

In the broader sense, there is simply no circumventing the natural friction that exists between lenders and borrowers. The practice of lender-counsel designation was already losing ground in the private credit markets, but many in the sector will be cheering IOSCO on here.