Sotheby's Capital Allocation Review

Forbes is reporting that Sotheby's has announced a new capital allocation plan which will return $325 million back to investors through a special divined and share repurchase plan. As many are aware, Sotheby's management has been under fire from a group of activist investors wishing to change the structure of the international auction house. Sotheby's credit rating was downgraded due to the new and more aggressive financial plan.

Forebes reported on the new allocation plan

The onslaught of activist investing has pushed art power house Sotheby’s to take an aggressive financial step to fend of the likes of billionaire Daniel Loeb.  On Tuesday, the auction house founded in 1744 announced plans to return $325 million to investors this year through a special dividend and share repurchase program that will force Sotheby’s to repatriate foreign cash and caused its credit rating to be slashed by S&P.

For the hedge funds, though, management didn’t go far enough: Marcato’s Mick McGuire called for Sotheby’s to return $1 billion to shareholders over the next 12 months, while Third Point still has its crosshairs on CEO Bill Ruprecht’s head.

Facing up to the risks of being a publicly traded company, Sotheby’s tried to please its high-profile investors with a series of initiatives aimed to returning about $500 million to shareholders in the near-term.  The company’s policies should allow it to invest $90 million this year in growth initiatives, Sotheby’s said.

The announcement is the culmination of a review of the company’s capital allocation and financial policies after CEO Bill Ruprecht and his management team received a letter by Dan Loeb blasting the company for its inefficient use of capital.  From highlighting Ruprecht’s “generous pay package and scant stock holdings [and] a perquisite package that invokes the long-gone era of imperial CEOs: a car allowance, coverage of tax planning costs, and reimbursement for membership fees and dues to elite country clubs,” to noting hundreds and thousands of dollars were spent on “an extravagant lunch and dinner at a famous ‘farm-to-table’ New York area restaurant where Sotheby’s senior management feasted on organic delicacies and imbibed vintage wines,” Loeb hit management where it hurt.  He was seconded in his activism by Mitch McGuire of Marcato Capital Management and Nelson Peltz of Trian, who liquidated his position last November.

Sotheby’s plans to issue a $300 million special dividend and announced a $150 million share repurchase program, of which $25 million are expected to be deployed before year-end.  Management expects about $150 to $200 million to be returned to shareholders through debt-financing of their loan portfolio, and $22 million in savings.  The auction house also split its core agency business and financial services business, putting a 15% return on investment (ROI) target on the first and a 20% target on the second.

A major point in dispute for some time has been the costs of keeping Sotheby’s’ two marquee headquarters, located on York Avenue in New York and on Bond Street in London.  After concluding they don’t need all that square footage in New York’s upper east side, the company has been looking at bids, and is evaluating the sale of roughly 50% of that property, according to Stifel’s David Schick.  Sitfel’s analyst had estimated Sotheby’s could around $700 million in additional value from the sale of its New York HQ, but “now believes this may yield less value than expected by the Street.”  Sotheby’s is also analyzing what to do with its Bond Street property, but doesn’t seem to keen on getting rid of it at this juncture.

Credit rating agency Standard & Poor’s gave its verdict on the company’s plans, lowering their rating from BB+ to BB with a negative outlook.  Blaming the “more aggressive financial policy,” S&P’s research team noted Sotheby’s’ credit profile could be impaired this year.

The initial reaction to the auction house’s announcement was overwhelmingly positive, with the Stock rallying more than 6% in pre-market trading.  Indeed, shares in Sotheby’s have been flying high over the past 12 months, leaving other luxury names like Bernard Arnault’s LVMH Moet Hennessy and Coach COH -1.78%, as well as the S&P 500, in the dust.  The stock has actually been among the best in class, trading alongside names like Michael Kors and Tiffany’s.

The day’s gains were quickly reversed, though, as the stock fell even lower than the broader market.  Marcato’s McGuire’s response, which called for management to return $1 billion to shareholders this year using earnings from 2013 and 2013, capital from their financial services unit, and real estate transactions, definitely helped the bearishness.  Third Point’s Loeb, the company’s biggest shareholders, decided not to comment at the time.

Sotheby’s and its management team are liked within the industry, but have to face the realities of being a publicly traded company.  With activism on the rise, scrutiny of their business practices and decisions can result in a public battle with hedge funds, forcing companies to take aggressive steps.  Sotheby’s not only announced a financial step to return capital, it also adopted a poison pill designed to protect management from proxy fights against Loeb and McGuire.  This raises the question whether Sotheby’s wouldn’t be in a better position if it was privately owned, like rivals Christie’s currently under Francois Pinault’s control.

Source: Forbes