Dan Loeb is Nuts Going After Sothebys (BID)

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Fine Art – Girl with a Pearl Earring

I’m not an art fan. I lack taste.

However, I did visit the High Museum of Art in Atlanta a couple of months back. I came away impressed with the collection of fine Dutch art and the painting of the Girl with a Pearl Earring.

Looking and learning about art for the first time was a great experience. It gave me a chance to stop thinking about investments for a day and let the other side of my brain get some needed exercise.

On the other hand, it seems like Dan Loeb enjoys mixing art with investing. He personally is a fierce collector of art and has highly prized pieces in his Third Point office.

And now, he has added another piece of art to his collection at Third Point.

Sothebys (NYSE:BID).

Loeb recently filed a 13D showing a 5.7% ownership of Sothebys (NYSE:BID) and is planning to go activist on the company.

Dan Loeb Buying Activity of Sothebys

Enter the World of Fine Art

In case you are not familiar with Sothebys (NYSE:BID), the company is an auctioneer of fine art, decorative art and jewelry.

Think of ebay but only stuff you can’t afford.

It’s an easy to understand business with a huge moat. In 2012, it held 46% of the global market with Christie’s (a private French company) being its only major competitor. There are small auction houses here and there, but nothing that can take market share from the two big players.

The majority of revenue comes from the Auction segment where Sothebys (NYSE:BID) collects commissions on the items sold at its auctions. While this has translated to gross margins in the mid 80% range, it has not trickled down to net margins very well.

Sotheby’s Gross, Net Margin – 10 Years

The company has a history of lumpy operations making it difficult to gauge and predict.

What I See in Sothebys (NYSE:BID)

Business and Intrinsic Value Estimate

Dan Loeb obviously chose to target Sotheby’s because he sees potential in an area he is familiar with. I’m sure he sees upside despite the current consensus that Sotheby’s is overvalued.

At the moment, the most I see is the following:

1). An inconsistent company due to the items it auctions
2). Regularly dilutes shares
3). Lots of cash and assets on the balance sheet
4). Manageable debt
5). Lots of working capital

Art is not a high turnover item, especially those that go for millions of dollars. But there is an interesting sign that I see from the inventory numbers.

It shows that art is high in demand at the moment.

If you take a look at the Days Inventory Outstanding (TTM), it shows 364 days. A full turn of inventory is taking just one year to clear compared to a peak of 760 days back in 2009. You can see from the numbers below that the inventory days has declined every year since 2009.

Sotheby’s Cash Conversion Cycle | Click to Enlarge

Additionally, Sotheby’s business model also shows that they pay the sellers of the art, at a very slow rate. This puts them in a very healthy cash surplus position. It’s why you see such a high cash balance on the balance sheet. In the latest quarter, cash made up 25% of total assets.

What is Dan Loeb Thinking?

Sotheby’s owns real estate in New York and London and in May 2013, the company went out to get the NY property assessed. Unless the real estate is on the books at zero, I don’t think Loeb’s purpose is to monetize real estate. It wouldn’t move the profit needle far enough.

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