Following the 2008-2009 Global Financial Crisis, the ultra-rich have diversified further into alternative investments after getting their fingers burnt by the stock market. At the same time, the sphere of alternative investments has further widened to include non-financial assets like rare coins and art, apart from the usual candidates such as private equity and hedge funds. Collectors Universe (NASDAQ:CLCT), a provider of authentication and grading services for high-value collectibles, and Sotheby's (NYSE:BID), an art auction house, are two companies poised to benefit from this trend.
A Barclays wealth survey found that millionaires globally allocated close to 10% of their wealth to non-financial assets in 2012. More specifically, the proportion of millionaires who collected coins rose approximately 2% year-on-year in 2012. Unlike stocks, rare coins don't have exchanges for the purpose of qualification, or well-established valuation methods like trading multiples or discounted cash flow.
This drives the demand for the services of Collectors Universe, which has a track record of certifying and grading 50 million items since its inception in 1986. In the past year, Collectors Universe graded 3.3 million items. Its coin authentication and grading fees ranged from $5 to $600, earning an average of $16.29 per coin in 2013.
An uncertified collectible carries a lower value in the marketplace because of doubts over its authenticity and the upward bias in value assessment by dealers (commissions are calculated as a percentage of the sale price). As a result, most people choose to bring their uncertified collectibles to Collectors Universe, which is perceived as an independent third party that acts as the single, definitive source for collectible information. Following Collectors Universe's certification, the collectible is certified as "genuine" and graded on a scale, allowing it to fetch a higher value.
Collectors Universe generates more than two-thirds of its revenue from coin grading services, with the remaining sales contributed by the certification of other items such as trading cards, memorabilia, and autographs. Having graded 27.5 million coins to-date with an estimated $30 billion market value, Collectors Universe claims to have more than half of global market share.
It has enhanced the value of its certified coins by a great deal. For example, a 1928 $20 gold piece (ungraded) was quoted at $1,450 in January 2014. In contrast, the same coin graded by Collectors Universe was auctioned off at $10,575 in August 2013.
Collectors Universe's market dominance and brand equity is reflected in its financial numbers. For the past four years, it boasted high gross margins and free cash flow margins in excess of 60% and 15% respectively. Collectors Universe shouldn't have problems maintaining these high margins in the future, given the low capital intensity and high entry barriers of the business. It also delivered record quarterly revenue of $16.3 million in the third quarter of fiscal 2014.
Going forward, Collectors Universe has good long-term growth potential because of increased wealth allocation to non-financial assets by U.S. millionaires and international growth opportunities following its entry into the China market in July 2013. As an illustration of the huge demand from the Chinese market, thousands of coins were submitted by collectors and dealers for Collectors Universe's grading at the Shanghai Coin Expo in July last year alone.
While Collectors Universe is reasonably valued at 26 times trailing P/E and 13 times EV/EBITDA, it sports an attractive forward dividend yield of 6.3%. It deserves such premium valuations because of its attractive business model and Chinese growth opportunities.
Collecting art has long been a hobby for the rich and powerful. The value of the world's art market has grown from $36 billion in 2001 to $58 billion in 2012, according to the TEFAF Art Market Report. Given that the art auction market is essentially a duopoly between Sotheby's and Christie's, Sotheby's has been a clear beneficiary of the growth in the global art market. Over the past decade from 2004 to 2013, Sotheby's has increased its revenue and operating income by 10-year compound annual growth rates of 10% and 6% respectively.
There are two key reasons why Sotheby's has performed so well for the past decade.
Firstly, the financial loss associated with buying fake coins or fake paintings is much more significant than the fees paid to Sotheby's. As a result, Sotheby's customers are less price-sensitive, which grants Sotheby's strong pricing power. Secondly, Sotheby's brand name is synonymous with quality and trust as it has been responsible for auctioning works like Edvard Munch's The Scream, the world's most expensive painting at $120 million.
In 2013, Sotheby's has performed well, growing its top and bottom lines by 11% and 20% respectively. Going into 2014, the numbers remain strong, with Sotheby's year-to-date auction sales up by 42% over 2013.
Looking ahead, Sotheby's plans to continue capitalizing on global wealth opportunities and protecting its brand. It is gaining traction in Hong Kong, and became the highest-grossing global auction house in Asia during the fall.Sotheby's generated 18%of its 2013 revenues from China and its Asian art sales as a whole also increased 50% year-on-year in 2013. With Knight Frank forecasting a 43%growth in Asia's ultra high net worth population from 2013 to 2023, the Asian art market seems poised for big growth. Being the first international auction house to establish a presence in Beijing, Sotheby's is poised to capitalize on the first mover advantage to grab more market share.
Sotheby's also hired brand expert Alfredo Gangotena as Chief Marketing Officer this year. During Mr. Gangotena's previous tenure as MasterCard Worldwide's Chief Marketing Officer from 2009 to 2013, MasterCard was the number one ranked global brand in terms of ranking growth.
Trading at 1.0 times PEG, this implies Sotheby's growth prospects are fully factored into its share price. It will be a much more appealing investment candidate at below 1.0 times PEG.
Foolish final thoughts
As more people appreciate the diversification benefits of owning non-financial assets in their portfolios, companies like Collectors Universe and Sotheby's should benefit. More importantly, these two companies represent good proxies for the growing wealth of high net-worth individuals globally, as they are undisputed market leaders in their individual markets. In contrast, other proxies such as luxury retailers tend to face stiff competition and own less market share in their respective businesses.