Sotheby's: Worth A Bid

The auction house Sotheby's, synonymous with fine art, traveled to Ferrari's proving grounds in Maranello, Italy, on June 28 to take bids on vintage cars -- a fun diversion in an excellent season. "The demand side of our business is robust, strong, and feels very reassuring," Chief Executive William Ruprecht told me.

Cool. Yet in that other noted auction market, the New York Stock Exchange, things are not going so swimmingly for the 261-year-old auctioneer's parent, Sotheby's Holdings (BID ). The previous week its shares scraped $13.47, a 52-week low and 30% off their November high. Sotheby's, investors know, also has been another word for trouble. In 2000 it pled guilty to fixing prices after the other half of a global duopoly, Christie's International, turned state's evidence. Sotheby's agreed to pay a $45 million fine, while its ex-chairman and controlling shareholder, real estate mogul A. Alfred Taubman, wound up behind bars. Is more trouble with the law ahead?

UNLIKELY. ALTHOUGH DENYSE MACKENZIE, senior deputy commissioner in Canada's Competition Bureau, told me her office still is probing Sotheby's, other jurisdictions are done, and the worst of the penalties likely have been assessed. For its part, Sotheby's says it doesn't expect another serious hit. Chances are, what lately has been hurting the stock is a combination of scant coverage of the company by Wall Street analysts, recent tough earnings comparisons, and the inherent difficulty of valuing such a rare object.

Few on the Street pay Sotheby's much mind. Just two firms issue profit estimates. That's no small job, since the chief determinant of Sotheby's earnings is revenue, and that in turn is largely set by how much stuff is put up for auction, which can be swollen year to year by estate or distress sales. Any one unusual event, such as 2004's private sale of the Forbes Fabergé collection, can make the next year's revenue look disappointing.

To some eyes, that's how 2005 is shaping up. It will be tough to beat last year's growth, when revenue jumped 57%, to $497 million, and income from continuing operations swung up to $62 million from a $26 million loss. Just the same, revenues in this year's first quarter rose better than 22% from last year, not counting a one-time $45 million fee Sotheby's got in 2004 for selling most of its realty unit. The deal helped Sotheby's repair its balance sheet, which had been dented badly by the fines and settlements after its price-fixing case. Shareholders' equity as of Mar. 31 had grown to $227 million from $164 million 12 months earlier. Operating cash flow in that time rose sharply, as the operating margin widened to 19.1% from 15.7% in the comparable earlier period.

If Sotheby's has put most of its legal woes behind it, is fixing its balance sheet, and has operations in trim, how should it be valued? That's tricky, in part because chief rival Christie's is private. Ariel Capital Management (ARGFX ), the Chicago parent of two high-performing mutual funds, is a longtime shareholder. Tim Fidler, Ariel's research director, puts Sotheby's intrinsic value at perhaps $22 a share, based both on a 1998 sale of Christie's and on a stable art market, with revenue growth averaging, say, 6% a year.

At that, Sotheby's would have an enterprise value (stock market capitalization plus net debt) of $1.5 billion, or 3.3 times the last four quarters' revenue and almost 14 times EBITDA (earnings before interest, taxes, depreciation, and amortization). Assuming Sotheby's doesn't fix prices in the future, using past multiples is hazardous. Yet Sotheby's rarely has traded below today's multiples (2.2 times sales and 9.1 times EBITDA at $14 a share) and often far above those implied by Ariel's research. In this auction, it's the buyer who stands to win.

By Robert Barker

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