Quietly, over the last three months, Sotheby’s auction house has seen its stock lose a quarter of its value.
This is, in large part, due to its high-end clients. Something is about to happen to them.
The polite way to say it is that — as Sotheby’s CEO Tad Smith put it earlier this month — they are about to get more “discerning.”
The frank way to say it is that they’re about to get walloped by this year’s choppy markets.
Sotheby’s stock price is warning of this. Yes, we’re seeing record-breaking sales for some items, like a Modigliani painting sold by rival Christie’s for $US170 million earlier this month, but if you look below that tier the picture isn’t so great.
“The Modigliani sold last week for $US170 million, but we’re seeing second-tier artists and second-tier works by the best artists starting to slide down in price,” billionaire hedge fund manager and art collector Ken Griffin said in a CNBC interview this week.
For years, some have said that we are in the midst of an asset bubble spurred on by the Federal Reserve’s low interest rate policy.
“When you keep the price of money at zero, all sorts of silly things start to happen,” said Ruchir Sharma, head of emerging markets and global macro at Morgan Stanley Investment Management at a Bloomberg conference in October.
As that policy changes, that bubble will pop. And a recession is due anyway.
“We’ve experienced a global recession once every seven to eight years over the last 50 years,” Sharma said. “The last time we had that was ’07-’08, but that was an extreme outcome. This global expansion is in its seventh year, so we have to be careful.”
Kindly see yourselves out
Sotheby’s, which reported a $US17.9 million net loss for the third-quarter, is preparing for a slump in some ways.
Last week the company said it will offer its employees “voluntary separation incentive programs” in certain regions. In other words, it will pay its employees to leave.
But, in other ways, it’s actually taking on more risk even as odds for a downturn rise.
The buyout offer above was not extended to employees in Sotheby’s financing unit. This is a part of the business that has exploded since hedge fund activist investors like Third Point’s Dan Loeb and Mercato Capital’s Mick McGuire got involved with Sotheby’s, and Smith took over as the company’s CEO.
It’s not nearly as big as the auction segment of the business, but the margins are better.
According to Moody’s, Sotheby’s has more than doubled its borrowing capacity in order to support the finance segment. This, the ratings agency says, has the potential to double Sotheby’s loan portfolio to $US1.3 billion.
“There is a risk that to drive this stronger growth for its lending portfolio, Sotheby’s could choose to increase the loan-to-value it tolerates or extend credit to individuals with a more risky credit profile,” Moody’s said. “In fact, Sotheby’s revolving credit facility now allows it to have a loan to value (LTV) of up to 60%, compared to 50% previously. This could potentially result in an erosion in the collateral value cushion during the next cyclical downturn or prompt an increase in the level of its loan losses.”
Sotheby’s said in government documents that “in rare circumstances, loans are also made at an initial LTV ratio higher than 60%.”
Moody’s also points out that since Sotheby’s is very much in the relationship building business, it’s very likely that it will continue to extend credit to people through a downturn.
That this downturn is coming is still only a possibility, not a certainty, of course. But Sotheby’s own shares are a warning sign.
Short seller Jim Chanos shared this chart proving that point with Business Insider last year.
If you buy this, you may also buy that Sotheby’s has taken on more risk just as we’re about to head into a downturn that will rough up even some of the wealthiest people on the planet.
Rough, of course, being a relative term.
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