Should You Bid for Sothebys's Shares?
The Poison Pill Issue and Investors' Demands
In Carl Icahn's words, “Poison pills, euphemistically called shareholder rights plans, allow boards to issue a flood of new securities when a potential acquirer buys a large stake and seeks changes. While rarely if ever exercised, the simple right of a company to adopt a pill is a potent threat to any entity deemed hostile by the incumbent board and CEO.” Clearly, the poison pill will limit investors's strength at the time of demanding for changes. Hedge funds can finally succeed if a fair amount of strong shareholders agree on the changes to be made.
To start with, Loeb and McGuire agree on the need to free up capital from selling assets such as real estate. According to McGuire the company could free-up more than $1.3 billion (roughly 40% of the company's total market capitalization) from selling real estate holdings such as Sothebys's New York and London properties. Those proceeds could be used for both Sothebys's financing business (making loans to collectors backed by high quality art works) and to give back cash to shareholders.
Loeb has been far more aggressive than McGuire. He thinks the company's CEO (William Ruprecht) should go, and he wants to include himself into Sotheby's board of directors. According to Third Point's founder, Sotheby's is losing ground against its centenary privately owned rival, Christie's. The billionaire investor has facts in his favor. In 2012, Christie's sold almost $1 billion worth of artwork more than its competitor. This year the leading position was kept, once more, by Christie's. The company sold $3.6 billion worth of art while Sotheby's was able sell art for just $3.1 billion. Loeb also claims that Sotheby's should be far more aggressive in China and online, where Christie's was able to build a successful business.
To defend itself, Sotheby's has made a few changes. The company brought in a new chief financial officer, declared that it would review the way it allocates its capital and would consider using debt in order to free up cash for shareholders. It looks like management is ready to go for some changes but not as fast and as aggressively as Loeb seems to want.
Should You Buy?
As I always say, “Price is what you pay and value is what you get.” When you buy Sotheby's you buy a great business. It has a great international reputation that can only be matched by Christie's. Building a great reputation in estimating value for high-quality art and antiquities takes a huge amount of time and investment. Hence, it looks like it's a business with great barriers to entry and, as a result, good sustainable margins.
Now, what's the price you have to pay in order to own a great business that seems to be about to increase its margins and its pay-out to shareholders? Being up by 56% year-to-date, Sotheby's now sells for 25 times 2014 earnings. Even when the stock doesn't look cheap, I believe it's worth a bet.
Earnings per share could grow by as much as 10% year over year for the next couple of years. and a big pay-out in the form of one special cash dividend or a share buyback could be on the cards. After all, Loeb has been able to fight and win harder fights than this one.