If you enjoy the finer things in life, then you'll love the
action taking place in the specialty retail market. Great
paintings, sculptures and fine jewelry are not only to be
appreciated, but they can make for great investments as well.
We've already seen one shake-up in the specialty retail
industry this year. Billionaire John Paulson is taking famous
piano maker Steinway Musical Instruments private for $512
million. The bidding war between Paulson, private equity firm
Kohlberg & Co. and Samick Musical Instruments has driven
Steinway's stock up 90% this year.
While Paulson is a fan of pianos, it's no secret that
billionaire and activist investor Daniel Loeb loves art. He is
said to have various pieces of art hanging in his Park Avenue
office and enjoys going to art shows.
Loeb and his Third Point hedge fund are coming off one of
their biggest wins after helping turn around
Yahoo (Nasdaq: YHOO)
. Loeb sold two-thirds of his position back in July when the
stock was trading around $25, locking in a cool half-billion
dollars in profits.
Now Loeb's looking to put that capital to work in other
markets, with the art market being a perfect candidate. Loeb and
his Third Point hedge fund have started their latest activist
campaign with leading auction house
. Loeb joins fellow activist investor Marcato Capital in the
Marcato now owns 6.6% of the company, and Third Point owns
5.7%. Third Point and Marcato join billionaire and notable
activist investor Nelson Peltz's Trian Fund Management, which
owned 3% of Sotheby's as of the end of the second quarter.
||Sotheby's headquarters in New York City.
So what are these billionaires and activists expecting to get
out of Sotheby's? Are they after the real estate value? Is the
company grossly undervalued? Are they playing the expected
rebound in art sales? Will they push the company to boost
The hedge funds involved have kept their public statements
vague, and while none of the activists involved has outlined his
plans for the stock, it's safe to say there is value in the
company that needs unlocking.
Part of Sotheby's moat is its unrivaled name recognition. For
those who don't know, Sotheby's is an auctioneer of specialty
retail items, which includes fine art, antiques, jewelry and
other collectible items. Its roots date to 1744, when it was
founded in London.
With the industry being niche, and the fact that Sotheby's is
the only major publicly traded auction house, relative valuation
is next to impossible. However, from a historical valuation
perspective, Sotheby's does not look all that appealing. The
stock is trading at near-decade highs on price-to-earnings (P/E),
price-to-sales and price-to-book bases.
Thus, there will need to be a catalyst to drive the stock
higher. Here are a few possibilities these activist investors
could be looking at to unlock value.
Sothebys took quite a nasty spill along with the broader economy
back in 2008, trading below $9 per share before rebounding to the
over $45 it trades at today. As income levels rise and the
broader economy strengthens, the demand for the finer things in
life, such as art, should also rebound. The company's underlying
reliance on the economy is exhibited by the stock's 2.7 beta.
Although the expected boost in sales and earnings, due to a
rebounding economy, will likely boost the share price, that's not
the sole reason for the activists' investing. Activists generally
get involved for something more than market-moving events. They
look to generate their own alpha through management shakeups,
strategy realignment, balance sheet restructuring, and so on.
The big news of late, in addition to the activist campaigns, is
that Sotheby's is planning to sell its New York headquarters.
Stifel Nicolaus has said that those real estate properties could
hold unrealized value for Sotheby's, noting that the New York and
London properties might be worth $300 million more than is
carried on the balance sheet.
It's no secret that one of the activists involved in
Sotheby's, Marcato Capital, specializes in real estate
investments. That firm may be looking to get its hands on any
profits from Sotheby's real estate and return them to
Loeb and his activist buddies may believe Sotheby's can expand
its margins to historic levels. The company's trailing 12-month
margin on earnings before taxes (EBT) is 18.4%, while in previous
years it has had margins between 27% and 30%. If we think about
where earnings would be if the EBT margin were 27%, there is
definitely upside here. With a 27% EBT margin, earnings could
easily be nearly 50% higher than current levels; assuming
Sotheby's keeps its premium 31 P/E multiple, the price target
would be $68.
Boosting Shareholder Value
The activists could also be looking at Sotheby's cash on hand.
The company has more than $10 in cash per share and could
increase its modest 0.8% dividend yield or boost share
repurchases. Its debt-to-equity ratio is down to 0.5 as of last
quarter, compared with 0.9 in 2009. Sotheby's recently said it
was exploring new ways to boost shareholder value, which could
include a higher dividend or share buybacks.
Whatever the reasoning behind Loeb's investment, you'd better
believe the upside will be realized in a short period. Loeb isn't
necessary a long-term investor, rather an opportunist. So the
question remains whether he'll treat this like a short-term
investment, as was the case with Yahoo, or an ultra-short-term
investment, like his stake in
Sotheby's has only five analysts following it -- compared with
the 48 following
Apple (Nasdaq: AAPL)
-- so it can be tough to get information on the company. But
investors can use this to their advantage: Despite the fact that
Sotheby's has three activist investors collectively owning 15% of
the company, the stock is flat since Loeb's
Sotheby's also offers investors downside protection given its
inherent moat as the only major publicly traded auction house.
The other major player in the $8 billion art dealership industry,
Christie's International, is private. Sotheby's other moatlike
characteristics include its cash-generating capabilities and
strong liquidity. Over the trailing 12 months, Sotheby's managed
to generate $237 million in free cash flow. That's $6.50 a share,
or an 8.7% free cash flow yield.
Risks to consider:
The biggest risk is another pullback in the economy.
Investors should also consider the risk that the activist
investors announce a sound strategy for unlocking value, sending
the stock surging, but ultimately their plans fail, sending the
Action to take -->
Get into Sotheby's before the real bidding process begins. If the
activists get their way, there could easily be more than 50%
upside to the stock over the next couple of years. The stock has
a solid moat and business model that makes the downside limited.
The company's balance sheet and free cash flow are both
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