I’ve never actually bid on a live auction. I want to. I want to be the guy who spends a million bucks on a painting. Until then, the best I can do is troll the used crap over at eBay (NASDAQ:EBAY) — and live vicariously by purchasing Sotheby’s (NYSE:BID
) stock.
The venerable auction house survived its price-fixing scandal of many years ago and, along with the rich opening their wallets again, is seeing a sizable burst in business. The financial crisis proved to be a double-edged sword for Sotheby’s — as I’m sure people tried to sell off their prized widget collection but also found buyers to be scarce. Now, however, rich folks are enjoying their snifters of brandy while bidding on the aforementioned widgets.
(Oh, by the way, Sotheby’s also will loan you money secured by that genuine Dali painting hanging in your living room at about 45% of assessed value. Or it’ll broker a private sale for you.)
Sotheby’s is not necessarily a growth business that you can tack a typical P/E ratio onto. That’s because the prices of what it sells (and collects commissions on) can vary wildly from week to week. The company also is, as mentioned, economically sensitive. It also depends on who chooses to sell that painting of “The Scream” that fetches a zillion dollars. So one quarter might be great and another might not be.
In essence, then, you are buying the Sotheby’s brand and Sotheby’s cash flow — and that cash flow is gigantic. Because the company has very little in the way of capex, operating cash flow is reduced very little before getting to that free cash flow number. In FY2010, Sotheby’s generated $324 million in FCF, and $385 million in FY 2011. That’s impressive. The company also sits on almost a billion dollars in cash and half that in debt.
There are, however, two things I don’t understand. First, the debt appears to be expensive — costing about 10% in annual interest. This would make sense if Sotheby’s was playing the arbitrage of financing loans against art for a higher rate, but it isn’t. So why is BID throwing away some $40 million in interest payments each year when the company has great cash flow and plenty of cash on hand? In fact, 2011 was Sotheby’s second-most profitable year in history!
Also, with such strong cash flow, I’d like to see a higher dividend than the current 8 cents per share (good for a 1% yield). I understand that Sotheby’s has some exposure in its auction business — namely, that it will sometimes guarantee a certain minimum sale price for a piece, and if that isn’t met, the company has to eat the difference. Still, BID seems to be hoarding a lot of cash.
Sotheby’s trades at 13 times this year’s earnings, but when you back out the $7 in net cash on the books, it’s closer to 10 times earnings. Given that BID generates $5 per share annually in free cash flow, I see this as a great deal. Throw in amazing net margins of 21%, and you’ve got an undervalued winner.
I’d put in a bid on the stock right away.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Capital, Inc., which brokers secure high-yield investments to the general public and private equity. You can read his stock market commentary at SeekingAlpha.com. He also has written two books and blogs about public policy, journalistic integrity, popular culture and world affairs.
