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#DigitalSkeptic: Digital Royalties Will Stay a Royal Investor Pain

NEW YORK (TheStreet) -- Pay Mike Huppe his due, he's got a pretty good line on the music business. "The music business is complicated. I tell my students, you're lucky this is law school and not business school," joked Huppe, whose day job is president of SoundExchange, the Washington, D.C., automated music royalties collection organization, but who also teaches a class or two at the Georgetown University Law Center. "Because if this was business school and you presented a business model that was anything like the music industry, you would fail," he said. Huppe ("Like 'puppy,'" he said) is an investor hero only the Digital Age could create. For the past three years, this Harvard Law-trained attorney has directed one of the music industry's last and best shots at digging whatever gold is left from the ash and ruin of the Information Age music business: the 140-person SoundExchange, which conducts the insanely complex process of collecting so-called statutory licenses that more than 2,000 digital music services pay to play recordings of the commercially released music from 28,000 rights owners and 90,000 artists. SoundExchange has a rare ear for hearing the money in the music. Over the past decade, its annual statements say it has collected $1.5 billion in royalties, with about $507 million in royalty receipts last year alone. "The example I use is the R&B hit Respect," Huppe said. The song was written by Otis Redding. And he, and his estate, continue to collect royalties on the pure notes and lyrics of the song. "That's called 'the publishing' in the music biz," Huppe said. "Then, a few years later, Aretha Franklin recorded that same song, made it a huge hit. But she and her label only control the recording rights. SoundExchange focuses on those recording rights, and more specifically the exploding market for the rights due from digital streaming music services like Pandora iHeartRadio, Sirius XM Apple And what are Huppe's main words of investor wisdom? "Too many people oversimplify this," Huppe said. "For better or worse, it is a very complex part of the music industry." Also see: #DigitalSkeptic: A Model for Breaking the Rules and Making Money in Music>> Not different rates: Different rate models The discord, Huppe said, starts right in digital music's bass line: the core rates different outlets pay for the rights to play recorded commercial music legally over a digital network. "Pandora pays rates set under a fair market standard, while Sirius XM pays rates set under a below-market standard. And AM/FM radio pays nothing at all," he said. "Those rates may change in the future, but unless you spend real time understanding the nuance of how this unlevel playing field works, it's easy to get lost in how those rates will evolve." Take, for example, how regulator-dependent these rates are. In early October, Mel Watt, a Democratic U.S. senator from North Carolina, introduced the Free Market Royalty Act. "Under this bill, artists may negotiate any rates they can," said Watt in his statement to Congress when the bill was introduced. "The value of music will be determined by the market." Huppe points out that it is not merely the timing of the passage of the bill that matters, it's how free market economics will ultimately affect the costs of streaming music. "The ability to withhold," Huppe explained, "may or may not, depending on market conditions, have a dramatic effect on the cost to do business." "I am very bullish about this business, but to predict two years ahead on what the profit and loss will be for a streaming music business is not the kind of prediction I can see anybody making," he said. Also see: #Digitalskpetic: No One Knows How to Make Money in Local Online Radio>> Collecting static What makes SoundExchange worthy of an investor love song is that its status as a 501c3 nonprofit means it must disclose pretty much how it spends every single of its pennies. That makes it a fantastic listening tube into the inner workings of digitized music market. Certainly, SoundExchange is far from an industry masterpiece. In 2011 (oddly, the latest year reported) its $20.9 million in revenue was eaten up by $21 million in costs, resulting in a $51,194 loss. SoundExchange can also struggle to collect its fees. It is suing Sirius XM on underpaid royalties. And there can be startling jumps in accounts receivables: I saw a 35 or so-percent spike over just last year. And of course, just like everything else in the Digital Age, the big numbers hide the big hardship. Yes, SoundExchange collected $507 million in royalties last year, but that was for the work of more than 100,000 artists, which means the average annual payment per artist was about $5.07. So most still starve. Even given these limits, SoundExchange deserves real credit for doing what Google , Facebook , Twitter and all the digital rest tacitly imply is impossible: protect the value of music on an in-the-wild, digital network. As of now, friends, that song of freedom, may be all we'll ever have.