As revealed in its 2014 Annual Report, released on Monday, Sotheby’s sustained a 9% drop in its net income (profits), compared to 2013. Its profitability has been under close scrutiny ever since activist investor Dan Loeb launched his attack on management.
But this drop in profitability seems less significant after analyzing what caused it: Last year’s $12 million decline in net income (from $130 million in 2013 to $118 million in 2014) wouldn’t have happened were it not for the $20 million in expenses directly related to shareholder activism, the resulting proxy contest with Loeb’s Third Point and related shareholder litigation.
On top of that, there was a cost of $14.2 million related to the restructuring plan intended to boost future profits, and another $7.6 million in costs related to the activist investor-driven resignation of Sotheby’s CEO Bill Ruprecht (still serving until his replacement is found). All of these anomalous one-offs have nothing to do with the core business.
“Adjusted net income,” adding back those one-off expenses, was actually up 9% (not down 9%) from the previous year.
Completely under the radar, buried deep in the annual report, were the revelations regarding “auction guarantees”—the negotiated minimum sale prices guaranteed to consignors for certain properties. The cap for “net outstanding auction guarantees” (the value of the guarantees after deducting the impact of related risk- and reward-sharing arrangements, such as third-party guarantees) was doubled—raised from $300 million in May to $600 million, according to the latest annual report.
The actual amount of outstanding guarantees as of Feb. 25, 2015 was only $79.5 million, partly offset by irrevocable bids from third parties totaling $28.2 million. Guarantees tend to ramp up in advance of major evening sales of Impressionist, modern and contemporary works.
Guarantees help the auction houses to snare desirable artworks, but they can prove costly if bidding fails to reach the level of the guaranteed price. This is what some observers believed may have happened with major lots at both Sotheby’s and Christie’s last fall. (The auction houses don’t disclose the details of their individual guarantees, nor how they fared. Christie’s, unlike Sotheby’s, is not publicly traded and provides little transparency about its finances.)
Ruprecht had told stock analysts in last November’s conference call that guarantees in that month’s Impressionist sales had been “meaningfully profitable.” The annual report now provides more details on what “meaningfully” may mean:
In 2014, the net loss from Sotheby’s auction guarantee and inventory activities increased by $13.3 million [from $2.17 million in 2013 to $15.46 million in $2014], principally due to losses incurred on certain guaranteed property [emphasis added] offered at auction during the current year.
When evaluating the performance of Sotheby’s portfolio of auction guarantees, management takes into consideration the total net revenue earned on guaranteed property offered at auction, which includes any auction commission revenues earned, as well as any guarantee overage or shortfall. On this basis, in 2014, Sotheby’s portfolio of auction guarantees was profitable.
Sotheby’s has rebuffed activist investors’ calls for a major return of capital to shareholders, saying that it wants to involve its as-yet-unnamed new CEO in making such decisions.
Whoever takes that job will have his work cut out for him (or her) in steering this storm-tossed boat into calmer waters.