More on Sotheby's

Skate's reviewed the recent financial data released by Sotheby's and the news is not good.  The main issues appear to be that while sales increased both private sales and margins failed to grow. Keep in mind private sales of just a year or two ago were growing and becoming an important division for growth and profits within Sothebys.The Skate's article states Sotheby's is making one mistake after another and includes small tactical issues as well as larger strategic ones.

Perhaps the worst part for Sotheby's is the final sentence, which states if 2nd quarter 2015 auctions are not strong, Sotheby's may become a takeover target.

Skate's reports

While Auction Sales Surge, Private Sales and Margins Decline – So Where Do the Economic Benefits Go?

Sotheby’s is making one mistake after another. From small things like factually inaccurate statements in their financial disclosures (such as the claim that “it is the only publicly traded investment opportunity in the art market”1, while in fact there are 17 companies including their rivals Chinese Poly and British Stanley Gibbons), to big ones like announcing that it will pay no dividends until the new CEO is in place (correctly countered by a large shareholder Mercato who failed to see the connection, for more see Skate’s coverage).

Sotheby’s is part of an oligopoly-like, high-end, art market structure where together with Christie’s it controls 94% of fine art auction sales of over $1m in value (apiece). In the current low interest rate environment with the real estate and stock markets at their peak, the art asset class enjoys sustainable capital inflows from all over the world making Sotheby’s for fine art what London and New York are for real estate: it just grows. Hence it comes as no surprise that Sotheby’s auction sales volume (GMV) grew to an all time high of $5.15bn in 2014, 18.7% above the 2013 levels and a staggering 35.2% up compared to 2012. However, the way the business is run is weak from an efficiency point of view. Share price is underperforming S&P 500, both net income and EBITDA are nearly flat if compared to GMV growth numbers. Quite contrary to the oligopolistic nature of Sotheby’s market structure, its margins are in a continuous and steady decline, specifically the net auction margin which shrunk by 20% (from 18.3% to 14.7%) over the last five years declining in each of those five years.

While margins decline was the known trend, collapse in private sales came as a surprise – Sotheby’s 2014 private sales have almost halved ($0.62 billion in 2014 versus $1.18 billion in 2013) going below 2011 level. Large and growing share of private sales was always seen the reason for average margins decline given lower commission intake level for private sales than for auction sales. In 2014 auction volumes went significantly up, private sales declined (with private sales being just 11% of auction sales in 2014 versus 25% in 2013), and nevertheless margins went down again: 27.3% EBITDA margin in 2014 versus 28.7% in 2013).

With all profitability metrics heading south, no wonder Mr. Ruprecht was ousted. (Note that Mr. Murphy, his peer at Christie’s, was let go as well).

The big question is: Where does the economic benefit (from this notable surge in art trade) go if Sotheby’s is actually getting less per each million of artwork sold? The almost simultaneous departures of Sotheby’s and Christie’s CEOs are providing for circumstantial evidence that both firms’ shareholders also had this very same question to ask. So where does it go? On the surface, the answer is definitely ‘not to consumers’, as the commissions (transaction costs for Sotheby’s clients) remain notoriously high, with a recent hike in rates announced by Sotheby’s earlier this year (see Skate’s coverage for more).

Sotheby’s audit committee should take a closer look in the search for real answer, but Skate’s can offer an educated guess: the biggest beneficiaries are the auction guarantee providers (pocketing significant “overages”2) and a very small group of select consigners and frequent large bidders receiving rebates and special deals, often structured through private sales and other commercial arrangements. This ecosystem of Sotheby’s-selected, few and key counterparties have likely seen a lot of economic benefit from the surge in art trading volumes, the skyrocketing of hammer prices (well above guaranteed levels) and of the overall lack of transparency and rationality in art asset pricing. As Sotheby’s explains on page 4 of its 10K 2014 filing: “the counterparties to Sotheby’s auction guarantee risk and reward arrangements are typically major international art dealers or major art collectors”. This handpicked old boys network is where Sotheby’s and Christie’s shareholders should look for the missing margins, Skate’s is happy to help with forensic if necessary :)

While both Sotheby’s and Christie’s shareholders might have their strong reasons to replace their CEOs, they would have to either keep old boys network in the game, reinvent the business model or face the disastrous lack of a sell-through. Given the consignments lead time and the timing of leadership changes, Q4 of this year is going to bring the judgment day, however already May / June auctions should bring in some clues.

Should Q2 auctions flop, Sotheby’s share price will collapse and it will become a formidable takeover target…

Source: Skate's