Sotheby's Embraces Criticism

Under fire from investor juggernauts such as Daniel Loeb, legendary auction house Sotheby's (NYSE: BID  ) came out with better-than-expected earnings results on Tuesday based on higher commissions in private sales and improved auction revenue. The embattled company has recently faced calls for management to step down due to lavish corporate expenses and a failure to embrace newly established art markets such as Asia and the Internet. In the meantime, the art market was growing faster than most other asset classes, as ultra-wealthy investors found it less volatile and an attractive substitute for cash. The questions now are whether Sotheby's has righted the alleged wrongs and if investors can expect a higher bid on the stock price.

Earnings recap
As is typical for the third quarter of the highly cyclical auction house business, Sotheby's posted a net loss of $30.1 million, or $0.44 per share. In the year-ago quarter, the company lost nearly $33 million. Revenue posted a much more attractive 29% gain to $107.9 million.

As mentioned above, the company saw gains come from private sales commissions, up 77% year over year, and a 16% bump in auction revenue. Costs remained high -- this is one of Loeb's big complaints -- but they appeared to be centered on the areas where the hedge fund manager had sought improvement. The company revamped its website substantially and dedicated more funding to its Asian offices.

Loeb was highly critical of the company's management team, citing country club bills, private cars, and fancy wines essentially being billed to shareholders even as the company was losing precious market share to its peer in the industry duopoly, Christie's. Complaints and suggestions from other activist funds, including Mick McGuire's Marcato Capital Management, include selling the company's highly valuable offices in New York and possibly London -- together worth well more than $1 billion.

William Ruprecht, the CEO of Sotheby's and the man who Loeb has demanded resign, was extremely positive in the earnings report and suggested the company was looking closely at its capital allocation practices and cost structure. Given that the financial results supported Ruprecht's comments, Sotheby's retail investors may be less likely to rally behind Loeb's continued pressure for a management shakeup.

Addressing concerns
Christie's may have gained a short-term edge in market share -- especially in the Asian market -- but Sotheby's recent performance in the region deserves commendation. Earlier this fall, the company's Contemporary Art Night in Shanghai saw the sale of a Chinese oil painting for a record $23.1 million. So far in the fourth quarter, Hong Kong revenue doubled to $538 million.

Investors will have to see more evidence of the company's investment in the Web arena. Christie's has found success in its website by reaching out to first-time buyers and would-be customers.

Sotheby's efforts indicate a management that is willing to hear investors and adjust its strategy accordingly. Then again, there has been evidence for roughly a year now that the market at large underestimated the resilience of the art market, even in the face of global economic uncertainty and a slowing Chinese economy. Sotheby's management may have the luck of macro-level winds in its sails.

Loeb and other activist investors may have been too eager to berate the company and demand substantial reorganization, but there's no doubt that their presence has created a sense of urgency in Sotheby's C-suite. Going forward, look for a strong fourth quarter and further signs of commitment to smarter capital allocation.

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