The below graph reflects the performance of Sotheby’s (BID) versus the Russell 2000 and Morningstar small cap growth index. Not only has growth been lagging value over the long run, which is normal, but Sotheby’s in particular has also been lagging in its small cap growth sector. From this perspective it might appear that—in terms of equity returns—Sotheby’s has been in the worst of the worst investment category. This makes the firm vulnerable to activist shareholders who believe that the company is not achieving its full earning potential. This article considers the upside prospects for Sotheby’s in light of both the Fed’s recent dovish announcement and Third Point’s Dan Loeb’s shareholder activism.
This article considers the upside prospects for Sotheby’s in light of both the Fed’s recent dovish announcement and Third Point’s Dan Loeb’s shareholder activism.
Hedge fund activist target
Unlike their large cap and mid cap counterparts, small cap companies have some unique risk factors. Sotheby’s is no exception. Small cap growth companies, like Sotheby’s (BID) can be vulnerable to activist investors. Hedge fund activist Dan Loeb of Third Point holds a 9.2% stake in Sotheby’s, which as a total market cap of approximately $3.09 billion. In the case of Sotheby’s, perhaps this activism will increase the share price. Given Loeb’s ~$300 million investment in Sotheby’s, it’s no wonder that he has been (so far, unsuccessfully) seeking to install his own Board nominees. However, hedge fund managers who do not like what they see or get, can just as quickly turn on their investments, and short them with equal vigor and conviction.
Sharks eat the sick, weak, old, and slow
As Sotheby’s has declined nearly 17% so far this year, despite a strong 2013 performance, with quarterly earnings growth up 37.30% year over year, one has to wonder what is taking the wind out of this stock. This looks like a textbook activist opportunity, and if Dan Loeb’s instincts are right, Sotheby’s has a long way to go in terms of improved performance. With a forward 2015 of 14.29 (Capital IQ), this is a growth stock that is priced like a value stock. Yet, Morningstar small cap growth index holds Sotheby’s in its top 25 holdings. Given the price earnings ratio, it is hard to see why they consider it a growth stock, but given the activism brewing, it might be priced like a growth stock in due course.
Sotheby’s
Sotheby’s has a $3.09 billion market cap with EBITDA, of $242 million on $518 million debt, although it holds $721 million in cash. Sotheby’s does not have a high level of debt, and with a profit margin of 15.23% it would seem to be in a position to finance growth. Such a company might be vulnerable to activist shareholders who would like to utilize Sotheby’s cash position and fairly strong earnings stream to borrow more money, add to debt, in order to finance growth. While Sotheby’s management is likely to be cautious on taking on more debt to finance growth, as the ability to service debt could be weak in a soft economic environment, activist investors are often interested in taking the risk that comes with higher levels of debt.
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