Profit Flop at Sotheby’s: Auction Houses’ Self-Defeating Assumption of Consignors’ Risk (UPDATED)

My critical analysis at the end of last spring’s round of major New York art auctions, in which I argued that auction-house arrangements with consignors “have become too arcane, convoluted and counterproductive for the market’s (and the auction houses’) good,” has been supported by the figures in Sotheby’s earnings report issued Monday: It revealed that for the six months ended June 30, 2018, its “net income [i.e., profit] of $50.8 million, or $0.95 per diluted share,” was “a 23% and 21% decline, respectively” from the same period last year.

Here’s what’s happened to Sotheby’s stock since that Aug. 6 announcement:

The high point, on the left, is the $52.91 closing price on Friday, Aug. 3—the last trading day before the release of the disappointing results. At today’s close (Aug. 9), Sotheby’s stock (symbol: BID) was at $47.61, compared to a 52-week high of $60.16.

Below is the auction house’s explanation (from the second page of Sotheby’s announcement) of its disappointing performance in the second quarter and first half of 2018. Tad Smith, the firm’s CEO, admitted (at the start of the earnings conference call with analysts) that these numbers were “lower than we [not to mention the analysts] expected”:

Results for the second quarter and first half of 2018 were impacted by a decline in Auction Commission Margin [calculated by dividing commission revenue by hammer price] to 14.1% [from previous year’s 16.3%] and 15% [from previous years 16.7%], respectively.

In the second quarter of 2018, the art market was driven by competitive high-value consignments from fiduciary sources such as estates, foundations and charities. Accordingly, when compared to the prior year periods, our Auction Commission Margin was reduced by a higher level of auction commissions shared with consignors in these situations. [In other words, deals were struck with consignors that sacrificed a portion of Sotheby’s profits, in order to snare desirable “high-value consignments.”]

The comparison of Auction Commission Margin to the prior year periods was also negatively impacted by buyer’s premium used to offset auction guarantee shortfalls and fees incurred in respect of auction guarantee risk-sharing arrangements. In particular, the current year periods were negatively impacted by the sale of two guaranteed paintings, which collectively reduced our Auction Commission Margin by 1.4% and 1.1% during the three and six month periods, respectively. [Emphases added.]

While Sotheby’s didn’t name the two under-performing headliners, art-market reporters easily outed them—Modigliani‘s “Nu Couché (sur le côté gauche),” 1917, which hammered in New York at $139 million ($157.2-million with buyers premium), against its presale estimate “in excess of $150 million”…

…and Picasso‘s “Buste de Femme de Profil,” 1932, which brought $36.1 million in London, against a $45-million presale estimate:

Both works appeared to have sold on one prearranged bid (without competition), according to reports by those attending the sales. Below is how Sotheby’s latest 10-Q report to the SEC (p. 16 of the pdf) explains the negative effect that such one-bid wonders—backed by third-party guarantors or partners (as described below)—can have on the auction house’s take from the buyers premium. This is the clearest, most detailed explanation that I’ve seen of the arcane (sometimes self-defeating) side-deals that auction houses cut with third-party guarantors, irrevocable bidders and outside partners (emphases added):

We may reduce our financial exposure under auction guarantees through contractual risk-sharing arrangements. Such auction guarantee risk-sharing arrangements include irrevocable bid arrangements and, from time-to-time, partner sharing arrangements.

An irrevocable bid is an arrangement under which a counterparty irrevocably commits to bid a predetermined price on the guaranteed property. If the irrevocable bid is not the winning bid, the counterparty is generally entitled to receive, as their fee, a share of the buyer’s premium earned on the sale and/or a share of any auction guarantee overage….

If the irrevocable bid is the winning bid, the counterparty may sometimes receive a fee as compensation for providing the irrevocable bid. This fee is netted against the counterparty’s obligation to pay the full purchase price (i.e., the hammer price plus buyer’s premium) and is recorded as a reduction to our auction commission revenue in the period of the sale.

In a partner sharing arrangement, a counterparty commits to fund: (i) a share of the difference between the sale price at auction and the amount of the auction guarantee, if the property sells for less than the minimum guaranteed price, or (ii) a share of the minimum guaranteed price if the property does not sell, while taking ownership of a proportionate share of the unsold property. In exchange for accepting a share of the financial exposure under the auction guarantee, if the property sells, the counterparty in a partner sharing arrangement is generally entitled to receive, as their fee, a share of the buyer’s premium earned on the sale and/or a share of any auction guarantee overage.

Christie’s reported its sales total for the first half of 2018 as “almost $4 billion,” compared to Sotheby’s $3.45 billion. (My request for an exact figure, rather than an “almost” figure, was received but unanswered by Christie’s, at this writing.) 

UPDATE: A Christie’s spokesperson said that the “almost” referred to the total in British pounds. The dollar total was $4.04 billion. 

Because Christie’s, as a private company, doesn’t have the same reporting requirements as publicly traded Sotheby’s, we don’t know if its big numbers yielded big profits.

Like Sotheby’s, Christie’s had a high-priced underachiever: Although the $102-million hammer price ($115 million with buyer’s premium) for Picasso‘s “Young Girl with a Flower Basket,” 1905, met its presale estimate of about $100 million, the price was widely perceived as a disappointment for Christie’s, as evidenced by the auctioneer’s prolonged, futile attempts to eke out another bid, and by the dead silence in the room after the hammer came down.

What’s more, we don’t know whether Christie’s series of David Rockefeller estate sales (which included Picasso’s “Young Girl”) turned a profit commensurate with its megabucks total. What we do know is that its $835.11-million total (including buyer’s premium) fell short of the $1 billion that some observers had giddily forecast. The Rockefeller sales were 100% sold. But we don’t know (as I previously observed) whether this was the result of setting a collection-wide “global reserve,” allowing the auctioneer considerable flexibility on individual lots, provided that the overall result was acceptable. Since the Rockefeller series was an estate sale, with all proceeds going to charity, the heirs might have preferred a clean sweep, rather than having to seek other means of disposal later.

Robin Pogrebin had reported in the NY Times that “Christie’s defeated its rival Sotheby’s by guaranteeing the Rockefellers’ estate a minimum total price of $650 million, according to a person familiar with the deal. That is a large gamble for an auction house.” Sotheby’s had decided that it couldn’t take the risk, as Hugh Hildesley, Sotheby’s executive vice president and vice chairman, Americas, told me.

When I started covering the art market in the 1970s, sending art to auction involved more risk to the seller than to the auction house: Until the hammer fell, a consignor didn’t know what his work would sell for, or whether it would sell at all. The moment of truth occurred publicly, for everyone to see. It made for suspenseful theater, which was part of the thrill of attending and participating in those sales.

Now the thrill is gone: Auctions of many big-ticket works are pre-orchestrated charades, with “success” predetermined. There still are occasional bidding wars. But too many top works, which ought to attract genuine competition, are one-bid wonders, selling at a pre-arranged price. Everyone who can decipher the symbols in the catalogue knows which works have essentially been pre-sold. But auction-house guarantees, sometimes assumed in partnership with major dealers or collectors, can backfire, as seen in the Taubman sales at Sotheby’s.

Notwithstanding his comment during the earnings conference call that “the market is clearly healthy,” CEO Smith revealed that Sotheby’s is planning some belt-tightening, to the tune of $20 million. About half that amount is to be achieved through staff reductions, in part by not filling vacant positions. (Maybe these two were harbingers of things to come.)

When will the auction houses realize that reverting to healthier practices of yesteryear would be in their mutual self-interest? Clean auctions, without convoluted side deals concocted to win property by eliminating consignor risk, would be in the best interests of the auction houses and the public. Government regulation may be the only way to stop the erosion of what auctions used to represent—fair, open competition on a level playing field.

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