Description

“Sotheby’s is like an old master painting in desperate need of restoration.” 

Dan Loeb, October, 2013

Summary:

Fast forward 16 months. Loeb now sits on the Board along with two other Third Point nominees.  Bill Ruprecht, the subject of withering criticism from Loeb during the bitter proxy fight, is leaving as CEO “by mutual agreement.”  Auction totals climbed 18% for the company in 2014 (the company reported the top-line for its main segment though full financials will not be released until later this month) and Christie’s had strong sales last year as well.  Momentum has continued into sales thus far in 2015. Importantly, Francois Pinault, the luxury goods magnate who privately owns Christie’s, also changed CEOs last year amidst declines in its profitability.  

Yet the stock is lower, even adjusting for the $4.54 special dividend paid a year ago.  Hence the opportunity in a firm that would be impossible to replicate—one poised to benefit from secular growth trends, improvement in industry structure, internal cost reduction and capital redeployment.  A double or more in 3-5 years seems readily attainable.

I would encourage those still interested to read the analysis by eal820 on VIC from October, 2011. The thesis was good and there is a lot of helpful company and industry data.  

The Activists:

The first activist public disclosure was a 13D filing by Marcato Capital on July 30, 2013.  It reported owning 4.51MM shares (6.6%), having started to accumulate its holding in late May with boilerplate language on strategy and communicating with other holders.

Third Point had initiated a passive position in the stock in Q1:13, owning 500,000 shares as of the March 31 reporting date.  Its 13F filed in mid-August showed ownership of 2.5MM shares at June 31.  On August 26, Third Point filed a 13D, mentioning “potential changes in strategy and leadership” and revealing a position of 3.925MM shares.

Five weeks later in early October, Third Point raised both its ownership (to 6.35MM shares, or just under 10%) and the stakes, announcing HSR approval to increase its stake and publishing an open letter to Ruprecht.  Loeb described a “crisis of leadership,”  savaging Sotheby’s strategy, culture, compensation, lack of shareholder alignment, expense discipline and leadership:

It is also time, Mr. Ruprecht, for you to step down from your positions as Chairman, President and Chief Executive Officer and for the role of Chairman to be separated for your successor. While you were an able caretaker of Sotheby’s during times of crisis, you have not shown the innovation or inspiration the Company sorely needs to play offense today. Sotheby’s requires a CEO with sufficient knowledge of the global art markets to make critical decisions, who can move seamlessly around the globe building the business and strengthening client relationships. Respectfully, we do not see evidence that you are the right person to repair the Company and drive its growth in today’s dynamic global art market.

Sotheby’s followed 2 days later by announcing a Shareholders’ Rights Plan.  Throughout this period, Marcato filed very modest increases in its holdings.  The next shot across the bow came on October 23, when Mick McGuire, head of Marcato, presented an analysis of Sotheby’s at a charitable investor conference in San Francisco. (Note:  this is available in a 13D dated 10/24/13). McGuire focused on the balance sheet and capital structure opportunity, opining that Sotheby’s had $1.3 billion in “trapped equity value” and calling for an accelerated share repurchase of like magnitude.  The real estate analysis of company holdings in New York and London (pp. 15-21) is especially interesting.  By pursuing his recommendations, McGuire concluded, Sotheby’s would be valued at $68/share.  

Over the next three months the stock traded in a narrow band in the high 40s and low 50s.  On January 29, management announced the findings of a Board review of capital allocation (announced in September) and the review of corporate cost structure (announced in November).  The four key points were as follows:

—a $300MM special dividend (paid in 2/14)

—debt financing of Sotheby’s finance entity to extract corporate capital

—alternatives for the York Avenue building in NY and New Bond in London

—$22MM in itemized expense savings in 2014

Third Point moved next a month later, nominating Loeb, Harry Wilson and Olivier Reza for Board seats.  Skirmishes went back and forth over the next few weeks.  On April 3, Third Point released an Investor Presentation:

http://1uyxqn3lzdsa2ytyzj1asxmmmpt.wpengine.netdna-cdn.com/wp-content/uploads/2014/04/Third-Point-Sothebys-Presentation.pdf

This is a must read, as it makes a compelling case for Sotheby’s latent opportunity and earnings power (page 25 in particular).  

Not surprisingly, Marcato announced that it would support the Third Point director slate.  Speaking at the Active-Passive Investor Summit on April 22 (the presentation is available in a 13D filed the next day), McGuire argued that management’s capital allocation changes “only begin to scratch the surface of opportunity.”  He embraces the $4 EPS potential laid out by Third Point (albeit with no detail, at least in the written presentation) and makes the case for a $99 price target (20X$4 + $19 from reallocation of trapped capital).  

Third Point won.  On May 5, the announcement came that Sotheby’s would include the three proposed directors in its slate of nominees.  It also emerged later that Third Point was reimbursed for its proxy and legal expenses.  

Marcato purchased an additional 2MM shares last summer as the stock drifted down the the $40 neighborhood but subsequently sold a portion of this:  At 9/it owned just over 5MM shares.  Third Point continues to own 6.65MM shares.

Update:

I think Christie’s CEO change in December is the most important subsequent development.  As Loeb charged, Sotheby’s lost market share to Christie’s in recent years.  But this came at a cost.  2013 profits fell 20% to $123MM and margins are significantly lower than Sotheby’s (http://on.wsj.com/1DUTjUz).

There is little doubt to me (and, I am confident, to Loeb) that the companies have been overly focused on winning high-profile mandates in recent years by granting large concessions to consignors.  I don’t think there is much doubt that  Steven Murphy’s exit at Christie’s suggests that Pinault is more focused on profitability.  

In late January, Sotheby’s announced increases in buyers’ premiums by reducing the levels at which discounts apply.  Christie’s has not followed yet but  I believe this is another sign of greater discipline in the market.  Given the price-fixing case involving the two going back to 2000, both houses need to be extremely careful.  But as one director said at the time, with a duopoly you don’t need collusion:  “It’s like two people selling tomatoes in a street.  If one person raises or lowers prices, the other one’s going to follow.”

Risks:

1. China crash:  Much of the growth in recent years for both houses has been driven by Asia in general and China in particular.

2.   Worldwide deep recession.

Catalyst

Changes in cost structure, real estate opportunities, further buybacks, potential sale of the company.