Review of Sotheby's Earnings Call

The NY Times is reporting on the recent Sotheby's earnings call and SEC filing where additional information on the auction houses financials were discussed and released.  The report shows first half 2016 sales were down by 21% yet net income increased. Sotheby's also reported increased auction commission margins and noted the increase came through discipline and "lower priced bands".

The NY Times reports

LONDON — The art auction business has been a challenging one over the past decade or so. As art prices soared, the big international houses gambled with guarantees and sacrificed commissions to attract the most valuable lots, squeezing their own margins.

Now that the market has cooled considerably, Sotheby’s, at least, may have found a path to greater profitability.

On Monday the publicly traded company announced in a Securities and Exchange Commission filing that it sold a total of $2.45 billion of art and collectibles in the first half of 2016, a decline of 21 percent on the $3.1 billion with fees it reported in the equivalent period the year before. The contraction was actually even more severe given that the 2016 figures included Sotheby’s June sales of contemporary art in London, which last year were held in July, in the third quarter.

But despite the downturn, Sotheby’s net income increased to $89 million, or $1.52 a share, during the past three months, improving on the $67.6 million, or 96 cents, it made in the second quarter of 2015. (The company lost $22.3 million in the first quarter of 2016.)

Sotheby’s rival, the privately owned Christie’s, said auction sales were $2.5 billion over the equivalent six months, a drop of 37.5 percent.

Mike Goss, Sotheby’s chief financial officer, said at the earnings call for investors and analysts that the company’s auction commission margin had increased to 16.4 percent in the second quarter, up from 15.5 percent in the equivalent period last year.

Mr. Goss attributed the improvement to “a shift in mix toward lower price bands” and to a lesser extent “greater pricing discipline.”

He alluded to the loss incurred from Sotheby’s $509 million company-financed guarantee to secure the collection of its former owner and chairman, J. Alfred Taubman, whose final auctions occurred in the first quarter. As of the end of March, the collection had brought in a total of $473 million. (Sotheby’s now owns the unsold lots, which it could sell later.)

“Guarantees on masterworks have generally proven to be attritional to earnings, but in the past they did buy market share,” said Neal Meltzer, an art adviser in New York. “Winning the sale of the Taubman collection was vital to maintaining respect for the Sotheby’s brand.”

Sotheby’s has also cut costs. The company’s salary-related expenses fell 30 percent, to $75.2 million, in the second quarter, following the shedding of 80 staff members through buyouts, the departure of several highly paid senior directors, and a reduction of incentive and share-based compensation plans.

“Sotheby’s has held the line,” said Guy Jennings, managing director of the Fine Art Fund Group in London. “They haven’t allowed consignors to eat into their margins.”

“Pictures at $70 million are good P.R., but the revenues are in the middle market,” he said, where sellers tend to pay full commissions and guarantees are nearly unheard of. “That’s the most lucrative way to do business.”

So far in 2016, Sotheby’s best-performing auction lot has been a 1909 early Cubist Picasso, “Femme assise,” which sold in London on June 21 for 43.3 million pounds, about $63.6 million at the time, just two days before Britain voted in a referendum to leave the European Union. The painting had been consigned, without a guarantee, by the New York collector Sheldon Solow, according to the Baer Faxt newsletter.

Sotheby’s results cheered investors. In after-hours trading Thursday, it was at $40 a share, up from its Aug. 5 price of $32.28. Back in February, it had sunk as low as $19.13.

Shares were given a boost by an enhanced $325 million stock repurchase program announced in January, and by the news on July 28 that the Taikang Life Insurance Company of China had become Sotheby’s largest shareholder by raising its stake to 13.5 percent.

A report published last month by the French database Artprice.com said that China was the world’s largest auction market in the first half of 2016, with $2.3 billion in sales. Sotheby’s auctions in Hong Kong reached $461.5 million in the first six months, up 22 percent from 2015. Sales of Western art to Asian clients increased 12 percent over the same period.

“Despite the overall drop in auction sales last year, the Asian market remains the biggest in the world,” said Wendy Cromwell, an art adviser in New York. “This investment can potentially open new avenues for profitability for Sotheby’s.”

Sotheby’s stock buyback, its shedding of employees and its growing presence in Asia have clearly benefited its financial performance. But any transformative effects from its acquisition in January of the New York advisory firm Art Agency, Partners have been harder to quantify. Sotheby’s paid as much as $85 million for the expertise of the agency’s three principals, Amy Cappellazzo, Allan Schwartzman and Adam Chinn.

In announcing the acquisition, Tad Smith, Sotheby’s president and chief executive, said it would help improve the company’s “leadership position at the high end of the fine art market, bolstering our private sales capability, giving us new growth opportunities in advisory services and reinforcing the client-first culture in all we do.”

In the first half of 2016, year-on-year private sales declined 33 percent to $249.6 million. But Sotheby’s S.E.C. filing does register $3.4 million of income from advisory fees — though the company did have to pay Art Agency, Partners $4.4 million in compensation for the privilege. Still, since the merger, Sotheby’s has managed to secure the prime consignment of an otherwise thin-looking November auction season in New York — the collection of paintings owned by the New York collector and philanthropist Steven Ames, who died in March, and his wife, Ann.

To do so, Sotheby’s offered a guarantee, and has estimated the collection at around $100 million. It includes two 1980s Gerhard Richter abstracts, each expected to sell for at least $20 million, and a 1976-77 Willem de Kooning painting, which has yet to be formally estimated. Mr. Smith said in the Monday earnings call that Sotheby’s intended to hedge some of the Ames guarantees with third-party investors.

So, Sotheby’s would appear to be shipshape, ready for whatever geopolitical storms blow at the art market.

“I wonder how much of this was fortuitous,” said Steven Blitz, the chief economist at ITG Investment Research, a brokerage firm in New York. “They’ve kind of fallen into a situation where the average hammer prices were lower and the commissions were higher. It’s not a strong market.”

Mr. Blitz said he remained concerned about the growth of art-based lending in Sotheby’s revenues, which was up 20 percent in the first half of 2016, to $29.5 million. Such financial vehicles, he said, have yet to be tested in an economic downturn.

“Sotheby’s stock is a macro trade,” he said. “If the global economy goes into recession, it will lose money.”

“But it will survive and come back, if it’s not overloaded with debt,” he added. “They have kept control of costs. There’s nothing magical about it.”

Source: The NY Times