Who's Winning In Sotheby's Latest Drama?

Famed auction house Sotheby's (NYSE: BID  ) is no stranger to dealing with huge sums of money. The company recently enjoyed a massive sell-off of Chinese art and sculpture that brought in $540 million. The event hit such a frenzy that one dealer said "we haven't seen the room so full or so positive or so buoyant for a while ."

That quote might be more telling than the speaker realizes. Sure this sell-off was huge, but Sotheby's overall annual revenue is lagging from where it was just two years ago. Its largest shareholder, Daniel Loeb's Third Point, LLC, is hungry to fix this by overhauling Sotheby's outdated business methods, but Sotheby's isn't about to take this advice lying down. Can investors stand to profit off this mounting internal tension?

What Loeb sees
Daniel Loeb is not exactly known for his subtlety in shareholder correspondence, and with Sotheby's he's made no exception. In an Oct. 2 open letter to CEO William Ruprecht announcing Third Point's new status as Sotheby's largest shareholder, Loeb detailed a string of recent grievances he felt the auction company had committed, and dropping revenue wasn't the only fly in the ointment by a long shot.

From an annual perspective as of the fiscal year's end, the company's operating margins have also fallen by roughly eight percentage points since 2010, and net profit margins have dropped six percentage points. Market share is suffering too, with archrival (and privately held) Christie's taking the lion's share. In Loeb's opinion, Sotheby's is just making excuses by saying that its competition's deals (including a recent $3.2 million sale of post-war and contemporary art) are making more headlines than money, and that Christie's privatization is a strength in its own right.

While Christie's private status makes it convenient for the competitor to hold its cards to its chest, the success of a rival has little impact on how Sotheby's chooses to retain (or lose) its money. Besides revenue and margins, the cash on Sotheby's balance sheet is also down $122 million from 2011 . With these kinds of findings, even the least vocal investor could see that something needs to change.

Just how to change it exactly? In Third Point's view, by taking a page out of the Christie's playbook and putting more of an emphasis on selling modern art, while still paying attention to "top clients." Loeb thinks this can happen if Ruprecht steps down and Loeb himself is voted onto the Board of Directors.

In this corner, Sotheby's
Sotheby's didn't exactly accept Loeb's criticisms with a smile. Instead, two days after Loeb's open letter, the company filed a stockholder rights plan with the SEC that will punish any shareholder whose stake goes above 10% of the company.

The "poison pill" bluntly voices Sotheby's take on the matter (we think we're doing just fine, thanks but no thanks), and keeps Loeb from gaining any more of a foothold than he already has. This kind of action suggests Sotheby's is stubbornly clinging to its old ways and refusing to listen to new ideas. That kind of operational M.O., as Loeb detailed in his letter, could be what makes Sotheby's "like an old master painting in desperate need of restoration."

Still, even if Loeb can't get any more of a say in the matter, he's at least gotten shareholders' attention, and that can be very powerful. The day after the Third Point letter, Sotheby's stock jumped from $50.04 to $50.94 per share, the highest it had been all year. Enthusiasm waned slightly after Sotheby's took action, and shares have since dropped to $50.

What could happen next?
Even if Daniel Loeb never makes it to a seat at the Board, his critiques of Sotheby's could still bring about positive change for shareholders. Activist investors tend to be the squeaky wheel that gets the oil, so to speak. Carl Icahn's efforts to take over Dell, for example, may not have gone over exactly as he'd wanted (mainly, with him becoming the new owner of the company), but they still led to an eventual buyout at a higher price than investors were first promised ($13.75 per share with a $0.13 dividend, after original buyout price was just $13.65 per share). If Loeb continues squeaking loud enough, Ruprecht may get tired of the racket and start to listen, and maybe even compromise.

No Pitch


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