Despite Hype, Royalty-Backed Bonds Haven’t Gone Platinum

Investment company parties seldom boast more pizazz than the one Japan’s Nomura Securities threw in 1997 to introduce its bond-market spinoff.

The venue was Hollywood’s House of Blues, the crowd was studded with enough rock and film stars to adorn a studio premiere and the climax featured Nomura’s top bond executive, the flamboyant Ethan Penner, leaping on stage to perform his own rendition of “Born to Be Wild.”

Penner’s enthusiasm certainly seemed warranted. Hollywood and Wall Street were both abuzz about a new frontier in entertainment finance, a way of turning stars into marketable investments by offering a stake in their royalties.

The benchmark deal was a $55-million bond backed by song royalties belonging to rock star David Bowie--and that seemed like small change as long as the rights to hits by the Rolling Stones, Crosby, Stills & Nash and dozens of other top rock and pop names remained unharvested. Nomura hinted it might be willing to assemble deals worth $1 billion or more.

But today, barely two years later, the enthusiasm and hype have largely subsided.

Nomura, which originally planned to mine not only songwriting royalties but also such assets as classic movies and sitcom syndications, recently closed Penner’s division, which completed only one small entertainment deal in its short life. Penner himself was fired in September, and his partner in the venture, record producer Irving Azoff, is suing the firm on the grounds that it misled him.

The quantity of asset-backed securities collateralized by intellectual property such as music rights or film revenues remains a tiny fraction of the $200-billion-a-year total, according to Wall Street surveys. None of the biggest stars who were initially cited by promoters as likely clients for Bowie-type deals have publicly signed up.

The reason may be a very fundamental one: The deals may only make sense for artists in exceptional cases.

“At the end of the day, it all amounts to borrowing money,” said Cliff Burnstein, a principal in the management firm Q Prime, which represents Madonna, Metallica and other leading acts. “There were reasons for David Bowie to do it that don’t apply to anyone else, and I’ve never been able to figure out why it would be worthwhile for anyone else.”

Indeed, Bowie’s deal remains the largest music-rights securitization ever done, the king of a very small hill. The most recent to be announced involved the husband-and-wife singing and songwriting team Nickolas Ashford and Valerie Simpson, who in November borrowed $30 million against the royalties of such 1980s standards as “Ain’t No Mountain High Enough.” (Rumors that Michael Jackson was contemplating the securitization of his part-ownership of publishing rights to the John Lennon-Paul McCartney songwriting oeuvre have yet to pan out.)

David Pullman, the New York investment dealer who arranged the Bowie and Ashford & Simpson loans, has himself completed only one other deal in the intervening two years: a $30-million transaction, involving three separate but related deals, for the Motown songwriting trio of Brian Holland, Lamont Dozier and Eddie Holland.

“I consider this a more-talk-than-action asset class,” said Wendy Geneen Cohn, director and co-manager of the commercial asset-backed group at Fitch Investors Service, a bond-rating agency.

That is surprising, given that the possibilities seemed endless after Bowie, the hugely popular glam-rock icon of the ‘80s, took out a 10-year, $55-million loan collateralized by his future earnings from the songs on such hit albums as “Changes” and “Ziggy Stardust.” The original loan was packaged as a security and sold privately to Prudential Insurance Co., which today collects regular interest payments on it.

As conventional as it was in form, the transaction was a novel one under the surface. While most bonds and other fixed-income securities are backed by assets with a predictable earnings stream such as mortgages, office leases, credit card payments or auto loans, it was unusual to securitize an asset as beholden to the whims and eddies of popular taste as rock songs. To make the risk more palatable, Bowie’s record company, EMI, guaranteed a portion of the bond.

The transaction catapulted Pullman, then an obscure but publicity-savvy broker for the New York firm of Fahnestock & Co., to household-name status in the entertainment industry. It also made him the most determined evangelist of the new financial engineering. Any artist with a sizable catalog, he suggested, could be turned into a marketable security.

Predictions that songwriters, filmmakers and situation-comedy writers would soon be as hot on Wall Street as securitized mortgages and high-tech stocks filled not only Forbes and Fortune magazines but also Variety and Entertainment Weekly.

That reaction has proved overblown. One reason is that the value of pop songwriting royalties, while huge in the aggregate, comprises thousands of small properties owned by individual songwriters or performers. Big investment firms such as Nomura quickly became disenchanted with the labor-intensive chore of agglomerating dozens of small deals into packages large enough to interest institutional investors.

Add to that the unique difficulty of crunching the numbers on entertainment properties.

Before an asset can be pledged as collateral on a security, its value must be carefully appraised. Experts typically measure it against dozens of comparable properties and “stress test” it by positing a range of worst-case financial scenarios. Even mortgage-backed securities, in which each loan is carefully documented and can be measured against thousands of comparable transactions, required years of such testing before investor doubts were eased enough to create today’s multibillion-dollar market.

For entertainment assets, which are often subject to years of conflicting ownership claims, every deal involves navigating through a maze of ancient documents.

“These are complicated assets,” Pullman said. “[They] are never going to be cookie-cutter. They’re not for the faint of heart.”

Bond analysts say some proposed deals fail because the underlying properties are simply too encumbered with cross-claims or other problems.

“We’ve seen deals that have presented us with challenges we could not overcome,” said Ken Linsk of Duff & Phelps Credit Rating Co. “Intellectual property as a whole is just not standardized. It’s not like a credit-card deal, which is relatively standardized and has industry acceptance.”

Then there is the questionable rationale for many artists to get involved. As Burnstein observed, few have David Bowie’s unique needs for a transaction that would convert a steady stream of royalty income into a massive lump-sum payout. Bowie had a compelling use for the cash: A former manager who owned a share of the rights to many of his old songs was willing to be bought out, giving Bowie the opportunity to acquire exclusive ownership of the properties.

Sources say Bowie also was planning a change of residence that threatened to subject him to higher taxes in the future, warranting the acceleration of income into the 1997 tax year.

For the artist-borrowers, the pitfalls of engaging in these deals without having a clear purpose are enormous. Fees amounting to hundreds of thousands of dollars and high interest payments cut into the available capital from the start.

If the pledged properties do not produce enough revenue to cover the required interest and principal payments, the artists could be declared in default and lose their royalty rights forever--much as a delinquent mortgage holder can lose his or her house to the bank. (However, such deals are relatively new and none has gone into default, industry analysts say.)

Moreover, placing windfalls in the hands of clients inexperienced with handling big sums of money could lead them to squander a fortune.

“The largest concern many business managers have, particularly those with people who are prone to spending every penny, is that they’ll be left without a nest egg,” said one investment banker.

Some entertainment and investment professionals still believe that many artists could benefit from using the investment markets to diversify their nest eggs.

“Going out and selling bonds to invest in something other than your own career is good advice,” said Azoff, a onetime partner in Nomura’s ill-starred venture.

Others believe the deal flow has been small because the market for entertainment assets is still in its infancy. “The argument that it hasn’t happened yet is similar to predictions about the Internet,” said Pullman. “Perceptions sometimes take years to catch up to reality.”