Struggling To Return Capital | UMG Acquires Downtown Music Holdings
Here are two stories that caught our eye this week:
1) Private Firms Struggling To Return Money
Private equity are struggling to return money to their limited partners (LPs). Hedge funds, too.
Last year, private equity funds returned the lowest amount of cash to their investors since the financial crisis 15 years ago). That’s according to Raymond James Financial Inc.
Distributions to so-called limited partners totaled 11.2% of funds’ net asset value, the lowest since 2009 and well below the 25% median figure across the last 25 years, according to the investment bank.
Hedge funds and private equity depend on returning capital to their investors. That’s what allows them to launch new funds. And get their LPs to recycle that cash back into their new funds.
Clients of Armistice Capital are finding out the hard way… that positive returns don’t equal returns coming back to them.
From the Wall Street Journal (emphasis added):
“Armistice Capital delivered the goods to investors for over a dozen years. The hedge fund outperformed rivals in 2024, and its record since inception trounces the broader stock market.
What the firm hasn’t delivered is much cash to investors who wanted out late last year. It mostly gave them the equivalent of IOUs instead, according to an investor letter viewed by The Wall Street Journal.
That usually happens at hedge funds that repeatedly lose money. At Armistice, it happened because the firm loaded up on thinly traded assets and sparked an outflow of investors after it announced new terms that would have made it harder for them to exit, people familiar with the firm said.
Now, some clients are waking up to the risks the firm was taking. The value of Armistice’s holdings of those illiquid assets was disclosed once a year, and with a lag. The firm told clients who got the IOUs that it would likely take at least a year before they are fully cashed out…
Monthly disclosures to investors said Armistice could liquidate nearly all of its stock portfolio in 30 days or less. That assurance came with some notable fine print: Its analysis didn’t factor in its warrants.
The firm gave investors a glimpse into the size of its warrant book in audited financial statements. Armistice estimated their value as of year-end, but those statements were typically released a few months later.
Investors who redeemed from Armistice in late 2023 received about half of their money back in cash. The rest was paid out in shares of a separate investment vehicle, known in the industry as a side pocket, consisting of illiquid assets including warrants…
On Jan. 17, Boyd wrote to investors that the firm would pay about two-thirds of redemptions requested at the end of 2024 with shares in another side pocket. He said certain positions either couldn’t be realized or if realized at the time, would be at values the firm determined were “at a discount to their true value.” The firm subsequently predicted it would take 12 to 18 months before departing investors were fully cashed out.
For January, Armistice’s main fund gained about 3%. The side pocket into which departing investors were diverted weeks earlier lost more than more than 10%.”
It’s not just illiquidity. There’s little to no capital to distribute back to LPs because of high interest rates, a closed IPO window, and acquisitions all drying up.
That’s why Mike and I believe “cash is king.” And a primary reason why we launched The Partners Fund.
The Partners Fund is primarily an income-first fund — focused on cash flow generating assets. Our goal is to distribute 10% APY per year by the end of 2025. We’re at just under 8% gross annualized distributions today.
The Partners Fund pays out quarterly distributions… with the goal to never miss a distribution payment. So far, we’ve done just that.
That’s what makes us different from the standard hedge fund or private equity firm.
Our LPs know a distribution is coming.
There’s the glamor of making 10-50 times your money.
It’s every investor’s dream. Whether it be in the public or private markets.
Hedge funds and private equity firms have that goal. But if you can’t sell or return capital, is the return real?
2) Universal Music Group Buys Downtown Music Holdings
The mergers and acquisitions (M&A) in the music publishing industry is heating up.
Universal Music Group (UMG) bought Downtown Music Holdings (DMH) — the parent company to music distribution platforms CD Baby and FUGA — for $775 million at the end of 2024.
UMG continues to try and roll up the music industry to remain the dominant player.
UMG is trying to own the “full-stack” of the music industry… So it bought DMH for a couple of reasons.
First, it believes DMH will help it expand into independent (indie) and international markets.
Indie artists and labels own a 36.7% global distribution share as of 2023. DMH owns CD Baby — with over 20 million tracks from 2 million creators. So UMG immediately gets access to indie artists.
Meanwhile, UMG CEO Lucian Grainge has been critical of AI music platforms like TuneCore and DistroKid. Grainge has been at the forefront of litigation against AI platforms.
He knows the industry is evolving quickly. Grainge calls it the “Streaming 2.0” era.
So UMG is trying to protect both flanks. One from independent artists who don’t want to sign with the major labels. The other from AI platforms taking artists’ music and repurposing it without paying a royalty.
DMH helps it at least gain a foothold into the indie market.
Second, DMH’s portfolio includes digital and physical distribution, publishing administration, royalty processing, and marketing services.
These tools create a one-stop shop for independent artists and labels. UMG brings that all in-house now.
The $775 million price tag is estimated to have a multiple 6x net revenue and 19x earnings before interest, tax, depreciation, and amortization (EBITDA) multiple.
A 6x revenue and 19x EBITDA multiple is high for any industry acquisition. And tells you all you need to know about the music industry.
It’s not slowing down anytime soon.
Good investing,
Lance
DISCLAIMER: This is solely our opinion based on our observations and interpretations of events. This should not be construed as personal investment advice.