Skate's Art Investment Review

artnet delayed publication of its 2012 financial results by over four weeks and finally released the results on Monday, April 29. Hardly a surprise, artnet’s annual report now evidences what Skate’s and other industry analysts suspected long ago—that artnet is heading toward a liquidity crunch and is hugely underperforming in its auction segment (proclaimed by artnet as its area of focus) when compared to its pure-play rivals like auctionata in Berlin, artspace, art.sy and paddle8 in New York and Saatchi Online in the UK.

All the artnet performance metrics in 2012 worsened on a y-t-y basis. Revenues are down by 6% in USD terms (flat in EUR terms due to the favorable USD/EUR exchange rate), and the firm went from an operating profit of EUR 0.9 million in 2011 to an operating loss of EUR 0.7 million in 2012. Furthermore, artnet’s operating cash flow went from positive to negative, its headcount increased and its cash position has been depleted to the level of 4-5 months at the burn rate artnet currently generates.

In Q3 2012, Hans Neuendorf successfully campaigned against Redline’s hostile takeover attempt when the Luxembourg regulated and based, Russian-funded investment manager offered EUR 6.4 per share of artnet stock (Skate’s advised on this transaction). The stock is currently trading at the EUR 2.8 per share level, living evidence of a bad decision made by Mr. Neuendorf and those shareholders that supported him last year.

artnet’s shareholders can find little comfort in the company’s 2012 disclosure – the auction segment that was supposed to drive the firm’s topline has stalled and produced just EUR 2.3 million in sales and EUR 0.18 million in gross profit for the year. This is less than 15% in revenue growth compared to 2011 and more than a 50% decline in gross profit compared to 2011.

This profitability decline is no wonder, as by now artnet has lost its first-mover advantage in the online art trading space completely. Much better capitalized, legacy and Neuendorf-leadership free, pure-play online art trading companies are grabbing market share and addressing the economics of the online art trade much faster. According to Skate’s estimates, the median growth of the six strong private peer group (Liveauctioneers, Saatchi Online, paddle8, artspace, auctionata and art.sy) was just below 40% in online art trading revenue for 2012, and these six companies raised over $50 million in fresh capital in the first four months of 2013. The online art trading market that artnet had for itself just three years ago is now an ultra-competitive space where artnet is no longer in the top three in terms of volume, has no capital with which to compete and possesses no remaining competitive advantages apart from its brand and price database. Those strengths are still important, but, based on the firm’s 2012 results, clearly not enough to ensure a viable business model under current artnet leadership.

Likely to avoid a going concern qualification, Mr. Neuendorf had to provide the auditors and shareholders with comfort that he would personally finance artnet through shareholder loans and deferrals of his compensation when the firm runs out of cash (and there is no if here – artnet will run out of cash this year).

In the global arms race for dominance in the online art trade, artnet has completely transformed itself from incumbent leader to an obvious victim. This only brings to mind a vivid image from a Jurassic Park movie: a white goat expecting T-Rex in the rain in the middle of a dinosaur theme park yet to be opened.

At below EUR 3 per share, and with no debt, no poison pills—thanks to the minority shareholders campaigning and litigation from last year—and some remaining prize assets, such as its price database and brand, artnet seems to be screaming for a new takeover suitor. Skate’s can bet we will hear about one shortly.

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On February 7, 2013, Collectors Universe filed second quarter and half year performance results that reflect a troubled position for the company. Although the three months ended December 2012 are usually the weakest period of the fiscal year, this time the decline was even more significant due to an overall downturn plaguing the company’s core market.

With its involvement in the narrow sector of collectible coins and stamps, the only way Collectors Universe will be able to achieve success is to hold a leadership position in this market. Securing this position involves maintaining the highest level of expertise, continuous development of services, as well as growth of market share domestically and through conquering new markets. The company’s management has been active on all of these fronts; to date, Collectors Universe has pursued two main business development priorities—its online presence and its overseas operations.

The online services of Collectors Universe include a large, subscription-based database dedicated to certified coins, sports memorabilia and autographs. The company also offers online collection management that allows for monitoring of the latest market trends, current prices and supply. As for the growth in market share, Collectors Universe is investing heavily in its Hong Kong and Paris operations, which is translating into an increased volume of coins submitted.

Nevertheless, the current situation in which Collectors Universe finds itself is less than perfect. Exhibit 1 in the full Market Note shows that the company’s published performance results are universally negative in comparison to the previous year. Net revenues dropped by 16% to USD 9.6 million during the three months from USD 11.5 million in the same quarter of the prior year. Exhibit 2 reveals that this performance decline was caused by a 26% reduction in coin service revenues. Operating expenses decreased by 4%, while operating income dropped by 50% due to the decline in service revenues. Net income also fell, declining by 48% in the second quarter to USD 0.5 million.

Yet, despite the company’s difficulties, there was a silver lining in the second quarter performance; revenues generated by trading cards and autographs gained 10%, partially offsetting the overall dip. We should also note that not all external factors acted against the company. During a recent auction, a very rare first strike silver dollar from 1794 brought USD 10 million. In 2003, this coin was graded by Collectors Universe, which serves as evidence of the company’s expertise and reputation.

If Collectors Universe is to successfully overcome its present difficulties, the company’s newly appointed CEO, Robert Deuster, must further strengthen management and find a way to confront the challenges brought on by external factors.

To read the full Market Note with data, please click here.

This week, Noble Investments (UK) plc—a London-based international rare coin, banknote, medal and stamp dealer, as well as auctioneer (and a constituent company of Skate’s Art Stocks Index)—made an offer to acquire The Fine Art Auction Group (“TFAAG”). TFAAG was formed in 2011 through the acquisition of Bloomsbury’s rare books & manuscripts auction by Dreweatts, a small art auction business of Sotheby’s/Christie’s vintage established in 1759. TFAAG was built on the idea of exploring the synergetic effect of two auctions operating in different product categories but sharing a single management, marketing budget and sales strategy.

TFAAG operated as a consolidated entity for about a year and a half, and the strategy has clearly worked. According to a filing made by Noble with the UK regulator, TFAAG’s 2011 accounts looked solid with the firm reporting sales of £6,800,690, EBITDA of £1,006,495 and profit before tax of £525,772. Net assets were £1,128,358 as of December 31, 2011. While the accounts for 2012 have not yet been reported, TFAAG seems to be operating with a smaller operating profit margin than its larger listed auction house peers. Nevertheless, the firm’s business model appears to be robust enough to preserve its niche in the highly competitive UK art and collectibles market.

TFAAG is now moving up in the food chain, becoming an acquisition target itself. Noble is one of three international publicly traded collectibles firms (the second largest after Santa Ana-based Collectors Universe in terms of sales); the company’s primary strength is in servicing the numismatics market. Noble’s acquisition would be a repetition of the TFAAG story—another consolidation play with the new Noble Group spanning its auction and dealing activities across the broadest possible collectibles segment, from coins and stamps to fine art and memorabilia.

Buying TFAAG is a “transformative acquisition” deal for Noble. Valued at around £30 million, with sales of about £13 million and a net profit margin of an enviable 18%, Noble is unlevered and has been struggling to find ways to grow in recent years. Stanley Gibbons, its stamps-market rival, has produced a far superior growth rate due to its more aggressive and generally more successful push into Asia. Collectors Universe, while plagued with management changes and a lack of leadership, has nevertheless managed to grow topline and made an important acquisition in the online space. So Noble has responded; the purchase of TFAAG is a major bet for the firm in that Noble is not only trying to move into more valuable auction categories, but it is also paying a significant price for a target equal to approximately 15% of Noble’s own enterprise value. TFAAG is valued at up to £5.48 million (with some variable component in the deal structure), comprising an initial consideration of up to approximately £2.75 million and deferred consideration of up to approximately £2.73 million.

While significant for Noble, the valuation is actually very reasonable with TFAAG being acquired at a sales multiple of 0.8 and an EBITDA multiple of 5.5. Noble’s respective multiples are 2.3x sales and over 6.0x EBITDA; the weighted average multiples for Skate’s Art Stock Index are about 2 and 8, respectively. Not only is Noble paying a good price for a profitable firm, which, once consolidated, would boost Noble’s revenues by 50%, it is also using a clever structuring for the deal, deferring almost 50% of the payment and using its own stock as acquisition currency. Noble has also brought two senior executives from TFAAG into its management board, which shows that the integration strategy was clearly thought through as well.

Skate’s welcomes the move and considers it to be perhaps the best acquisition among Skate’s Art Stock Index listed companies this year. We are therefore increasing our target price for Noble from £1.8 to £2.3 per share with immediate effect.

For more details about Noble’s acquisition, please visit www.skatepress.com/?cat=137.

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