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Gain Exposure to the Growing Art Market With This Stock

By Mark Lin - Mar 5, 2014 at 1:56PM

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If you have ever wished to make money from art, you aren’t restricted to either being an artist or bidding for art at an auction. Sotheby’s represents one of the few, if not the only, publicly-traded investment opportunities in the art market.

Source: Sotheby's

According to the annual TEFAF Art Market Report published by consultancy Arts Economics, the global art market has increased by 61% from $36 billion in 2001 to $58 billion in 2012. This growth is largely driven by the increase in new millionaires and billionaires outside of America and Europe. While buyers in these developing markets used to account for only 5%-10% of global art buying two decades ago, they're now responsible for close to 30% of this market. Sotheby's ( BID ), a leading art auction house, is the best proxy for this growth. It was the first Western company to hold an auction in China, and the only auction house that holds sales in Qatar.

More importantly, the art auction market is essentially a duopoly between Sotheby's and Christie's. In the past two decades, neither company has gained a significant lead in market share over the other party, with the widest difference between the companies' market share reaching 12% (Sotheby's -- 44%, Christie's -- 56%) in 2009. Since then, Sotheby's and Christie's respective market shares have been more or less at parity with each other. This suggests that Sotheby's faces minimal threats from new entrants and it isn't likely to fall far behind rival Christie's in the battle for art dollars in the future. Sotheby's benefits from two key competitive forces discussed below.

Not all brands are created equal. A brand creates value for the owner only if it enables the brand owner to either attract more customers or charge higher prices. Sotheby's high margins are the best indication of its pricing power. Except for 2008 when the global financial crisis affected the company, Sotheby's has delivered an EBITDA margin in excess of 30% in every year since 2006.

Sotheby's strong branding also helps keep its customer relationships sticky because of the inherent nature of art. Firstly, the difficulty of authenticating and valuing works of art means that Sotheby's three centuries of experience and expertise make the company an authority on the subject matter. Secondly, its customers are price insensitive as commissions are small in relation to the values of the items at auction and the potential gains or losses associated with sales or purchases.

It is also possible to draw similarities between Sotheby's and luxury-jewelry retailer Tiffany ( TIF ) here. While the '4 Cs', in which buyers assess diamonds through attributes such as carat, cut, clarity, and color, make for good conversation topics at cocktail parties, most consumers don't apply these attributes when they make purchases. Instead, buyers rely on branding as a quality indicator. As a result, Tiffany can charge customers more for the diamonds it puts in its distinctive blue boxes because of the assurance it provides to customers. This is evidenced by Tiffany's financial track record, as it has consistently achieved a gross margin of between 56% and 59% for the past decade.

Source: Sotheby's

The strong gets stronger
Sotheby's branding advantages are further reinforced by network effects. For example, Sotheby's had the honors of auctioning the most expensive painting (Edvard Munch's The Scream -- $120 million) and sculpture (Alberto Giacometti's L'homme qui marche I -- $104 million) in the world. Therefore, owners of works of art are drawn to Sotheby's when they want to sell off their prized collections at good prices. This in turn attracts buyers to Sotheby's, as they know that Sotheby's will always have the greatest works of art on sale.

Besides collecting art, golfing is also a favorite hobby of the rich. ClubCorp Holdings ( MYCC ), the largest owner-operator of private golf and country clubs which has about 148,000 members, also benefits from the network effect. Golf clubs aren't just places to keep fit, they also serve as avenues for keeping in touch with old contacts and making new friends.

As a result, ClubCorp's market leadership means that more people will join it as members. This further increases the number of existing members for ClubCorp, which makes ClubCorp even more attractive to potential members because of its larger network. The numbers speak for themselves: ClubCorp's membership retention rate for its golf and country clubs has remained above 82% from 2003 to 2012, notwithstanding the global financial crisis.

Foolish final thoughts
It is an open secret that the rich are getting richer, and one of the growth areas that will see increased spending from the affluent is art. While there are other companies that serve different luxury markets, they aren't as dominant in their industry as Sotheby's is in its industry. Sotheby's has maintained a minimum 44% share of the global art market since 1989. Its dominance is unlikely to be challenged anytime in the near future, given its strong brand and the associated network effects. As a result, Sotheby's is the best and probably the only publicly traded vehicle available for investors to gain access to growth opportunities in the art market.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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