by : Business, Featured Articles, February 2016

Bowie’s Bonds: An Appreciation

Bowie’s Bonds: An Appreciation

David Bowie is a legend in more ways than one. In the 1970s his on stage alter egos could have been shunned; instead, they shattered conventions and then they were embraced. It was Bowie’s persona, his sense of fashion, and, above all, his music, that over time elevated pop culture by making it more inclusive and, ultimately, more compassionate. Lady Gaga knew.

Interestingly, and with the help of Wall Street, Bowie found his own solution too to the financial woes that eventually caught up with him by the turn of the century. An expensive lifestyle in New York had earlier led him to migrate to Berlin in the 1980s, but cash was needed in quantity now and Berlin was no longer an option. The flotation of the Bowie Bonds, which he underwrote with his recording and publishing royalties, would later spearhead other artists to follow suit. Fundamentally, the Bowie Bonds validated the idea that an artist’s worth can be measured in future income streams of intellectual property –– for which there is an apparent cash value here today: in Bowie’s case, and given the terms of the transaction he undertook with Wall Street, that amounted to $55 million, which he duly pocketed in 1997.

Bowie revolutionized the way top artists would since think about procuring funds to develop new projects or leverage their way out of a financial strait. He broke away from the music industry mold by seeking financial autonomy outside it and succeeded. This was before the World Wide Web, well before music went digital, and long before crowdfunding was seen as possibility for milestone funding.

Background

Back in the mid 1990s, when the Bowie’s bonds were issued, about the only way artists could seek financing for their musical endeavors was to get a recording deal with a major label and have the label supply all finance. Simply put, the labels advanced the money for recording costs and sundries for an album, and the artist kept on paying back the loan from both the album and single sales until the label recouped in full the advance and sundries, as well as the marketing and publicity costs of ‘establishing’ the artist. Only after the loan was sunk, could an artist earn royalties on the sound recording that originated the advance. The Bowie Bonds put a crack on that structure.

To understand the mechanism of Bowie’s transaction some perspective is needed. Stocks and bonds are the financial pillars of a modern economy. When a company issues stock, it sells ownership shares to raise money. No fixed schedule of payment on principal or interest is expected, but this so-called equity investment depends on good profit returns for the buyer of stock. Of course, not every business wants to sell a controlling stake. In that case, debt financing is the alternative. Debt financing can be done in two ways, either by taking a loan from a bank or by issuing bonds.

Bank loans tend to be expensive and the amount of financing involved is limited. Not so bonds, which help raise cash for municipalities and cities, corporations, and the federal government (the largest borrower of all). In general, a bond is just a promissory note of payment paid to bondholders in a stipulated period of time, with periodical fixed interest rate payments and a guarantee that the full amount of the principal is going to be returned at maturity.

Individuals can exceptionally become bond issuers if they have an attractive enough pool of assets they can securitize to back up the bonds. This was the case of Bowie. Moreover, one of the reasons bonds are so attractive as a financial instrument is that they can be liquidated at any time after purchase: unless the issuer defaults, which is rare, institutions or retail investors can always recover their loan if they themselves need cash at short notice. (If the fixed interest rate of the bond is higher than the prevailing money market rates at the time of the sale, the bondholder makes a profit: conversely, he takes a loss; if the money market rates are the same as the bond rate, the bondholder recovers the exact amount of the loan).

In 1997, David Bowie met with David Pullman, a renowned Wall Street investment banker, to consider some form of debt financing. Bowie was then considered the U.K.’s wealthiest rock artist, with Rolling Stone magazine estimating his net worth at $917 million (an individual’s net worth is the difference between his assets and liabilities; Bowie, however, had a cash-flow problem). A large part of Bowie’s wealth came from his lucrative publishing catalog.

The Paper

Pullman came up with an innovative financial mechanism, the ‘celebrity bond’. This new instrument consisted in Bowie issuing paper backed up by his future royalty earnings from his pre-1990 catalog. Bowie was to forfeit his music rights from twenty-five of his albums for a period of ten years, i.e. for the maturity of the bond. The future royalties of the songs could serve as collateral for the bonds, which were issued at close to 8%, so the forfeited catalog had to raise about $5 million a year — a safe bet at the time.

In fact, at issue, the Bowie Bonds earned a triple-A bond rating from Moody’s, the highest. The economy was in overdrive, as was the music industry, and this kind of financial instrument at the time appealed to investors, many of which were apparently seeking to diversify their holdings. Other musicians would rush in after Bowie: James Brown, Ashford and Simpson, and Iron Maiden, among them, but for much smaller amounts.

The markets, though, did not predict the rise of Internet piracy and the single song format after Apple iTunes, both of which hurt album sales and sound recording royalties. By 2004, Moody’s had cut Bowie’s bond rating to BAA3, only one level above junk. Nonetheless, the original 10-year Bowie bond was paid off in full at maturity in 2007, when Bowie resumed sole ownership of his music and royalties. Luckily for Bowie, this was right before the financial crash of 2008, which pretty much ended the celebrity bond market. James Brown, for instance, fared badly with his own bond. Finding the payment of interest hard, he asked to convert his old bonds into new ones at a lower rate with no avail. Pullman, who had brokered the bonds for Brown, rejected the idea because the bonds were relatively new, the market interest rate did not support such a transaction, and also because it had to be done with the consent of the bondholders which was unlikely.

Reflections

David Bowie, together with David Pullman, first put on the table the idea of royalty-backed securitization and made an intangible asset pool of intellectual property ultimately the equivalent of a firm loan collateral, such as a house in a mortgage or a car in a car loan. This could have implications for the future of music and other forms of intellectual property. Miramax, the film studio, has securitized $250 million of 3.34% notes due 2026 against the future cash flows of its library of films. Also, Bloomberg recently indicated that according to data from Barclays, bonds that are backed up with intangible assets comprised 21% of all U.S asset-backed securitization in 2015 and that segment of the market grew faster than other more traditional sectors.

Bowie’s bonds, in short, have come a long way. But very few artists today would seem to offer the guarantees that would attract outside investors, such as Bowie did. And even if the loan collateral were expanded from publishing and recording revenue to a share in live music receipts, a bet on a celebrity artist would still be risky in a world were the value of that intangible pool of royalties is less clear when technology changes.

Finally, it is good to remember that Bowie was willing to surrender and transfer the rights of the assets that were pertinent to the deal to a separate legal entity not under his control; only under this arrangement, did lenders control the risk, for if Bowie went bankrupt, the securitized asset pool was at least under their control.

In many ways, therefore, it can be said that no artist has tested his name in the markets as amply and successfully as Bowie did – and with such courage.

 

By Eduardo Loret de Mola

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Comments

  1. Larry Corn says:

    Think you have this backward. If coupon paid is higher than market, asset is more valuable. Also money market rates not the comparison– will instead by yields on similarly rated paper. <>

    • peter alhadeff says:

      Yes, thank you, Larry, an erratum slipped through in the editing; it is now corrected. I agree as well that you compare the paper to yields of other similarly rated paper, but the statement about losses or profits on a bond sale being dependent on the average interest rate out there — we called them the money market rates — is broadly right.

  2. C Fluet says:

    The bonds were handled by David Pullman, not handled by Bill Pullman who is a Hollywood actor

    • peter alhadeff says:

      Thank you, and duly noted. Not sure how we went from David to Bill, but it’s back to David again!

  3. Nice write up.

    Will be interesting to see if such a mix between music and finance can become more mainstream – especially in a time when royalties are much lower, but easy to track and distribute.

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