Sotheby’s nine-month CEO, Tad Smith, has been throwing tons of money at the problem of his firm’s disappointing net income—the aggressive $515-million guarantee (without outside party backing) for the underperforming Taubman consignment, staff buyouts (expected to cost $40 million), the high-cost severance of CFO Patrick McClymont and hiring of Christie’s chairman Marc Porter.
The unanswered question raised during Smith’s brief tenure is whether his extraordinary outlays will prove to be reckless or prudent: Will these short-term hits to Sotheby’s profitability have the desired effect of stimulating future growth, and will that happen in time to reenergize the confidence of its artworld clients and stock investors?
The latest major expenditure of money, with the goal of eventually enhancing profitability, is Sotheby’s purchase of Art Agency, Partners (AAP), a two-year-old art-advisory firm serving collectors (and occasionally artists). Sotheby’s is paying $50 million, with a pledge to make additional “earn-out payments” of up to $35 million “over the next four to five years, …contingent on the achievement of a minimum level of financial performance [emphasis added],” according to the Form 8-K filed with the SEC on Monday.
Details of the “Earn-Out Calculation” are said to be contained in “Exhibit C” of the agreement between the parties. As far as I can tell, that exhibit is not included in what has been posted online by Sotheby’s (linked above) or by the SEC. In a conference call with stock analysts on Monday, Sotheby’s refused to provide information about how the earn-out will be calculated, other than to say that it is “based on strong revenue and increased profitability, on an incremental basis, to Sotheby’s and a positive return on investment above our normal capital rate,” in the murky words of Dennis Weibling, the firm’s interim CFO. No details have been given about the size of AAP’s client base or its income stream.
AAP is managed by: Amy Cappellazzo, former co-head of Post-War & Contemporary Art and chairman of Post-War & Contemporary development at Sotheby’s arch-rival, Christie’s; Allan Schwartzman, a respected veteran art adviser; Adam Chinn, co-founder of Centerview Partners LLC, a the boutique investment bank, and former partner at the law firm of Wachtell, Lipton, Rosen & Katz. Chinn “will assume the role of executive vice president of worldwide transaction support, succeeding Mitchell Zuckerman, who plans to retire from Sotheby’s after a 37-year career,” according to Smith’s opening statement during Sotheby’s Monday conference call for securities analysts, during which he announced these changes.
A troubling question is raised by this acquisition: By ingesting AAP, will the “big-box store” (as Cappellazzo once famously described the major auction houses) destroy what gave her boutique firm its primary value—its independence in providing disinterested advice for its clients, uninfluenced by other market players?
According to its own (now outdated) mission statement, AAP “advocates for individual and family collections in ways that galleries, auction houses, and dealers cannot by virtue of its principals’ independence.” [Emphasis added.]
Independent no more, AAP has sacrificed the appearance, if not the reality, of having only its clients’ best interests at heart. As a creature of Sotheby’s, how can it not have a bias for that firm’s offerings when it recommends purchases? How can it not lean towards recommending Sotheby’s as the best venue for clients wishing to sell?
The $35 million in financial-performance incentives from Sotheby’s suggest that it will be in AAP’s best interests to maximize the financial benefits to the parent firm. As of now, AAP clients “pay us a monthly retainer for a holistic approach to their collecting,” AAP’s Chinn said on the conference call. “We also transact for those clients, and the ways we make money on those transactions are in some cases part of our retainer relationship and in other cases on a more ad hoc basis [meaning what?]….We sign people up for a one-year period and it’s on the basis of a monthly retainer.”
Depending on how the earn-out is calculated, AAP could now be incentivized to steer business to Sotheby’s auctions and de-incentivized to negotiate the best deals for its clients. Getting the best deals, instead, for their employer would help trigger the additional $35-million performance bonus.
Whether or not there is an actual conflict of interest, the appearance of conflict could give pause to AAP’s current and potential clients.
It also remains to be seen how well the seasoned specialists already on Sotheby’s staff will take to having AAP’s art experts overseeing them. (It’s possible that some of the veterans took the buyout bait. No announcement about who’s leaving has been made.)
In their capacity as chairmen of a new Fine Art Division, Cappellazzo and Schwartzman will direct the Impressionist, Modern and Contemporary art departments. Linguistic confusion ensues: Shouldn’t American art, old masters, etc. be included under the rubric of “Fine Art,” even if they’re not major revenue-drivers?
Having already instituted a staff buyout, Sotheby’s is now poised to continue its stock buybacks. Smith gave the securities analysts this heads-up:
At current share prices [$23.75 at this writing, about half of the $46.93 closing price on June 23] and in light of our current liquidity, a clear priority for management and our Board is to repurchase our shares. Due to the ongoing deal negotiation, we were unable to do that in December when the trading window was open. As a consequence, we plan to pre-announce our fourth quarter results in the coming weeks in order to allow us to make share repurchases.
Smith’s remarks were notable for his sudden shift away from repeated emphasis on being “good for shareholders.” His new mantra is that Sotheby’s has a “client-first mentality”—a welcome change in rhetoric.
Perhaps he took my Dec. 7 post to heart:
To my ears, Smith has been tone-deaf when it comes to articulating Sotheby’s appropriate mission and vision: The emphasis should be placed squarely on service to clients, not satisfying shareholders. The former is a prerequisite for the latter.