What’s Happening to Artprice’s Stock?

April 18, 2011

Artprice, the Paris-listed art market data provider that is best known for its price database, flamboyant headquarters near Lyon named House of Chaos, and secretive financial reporting (the firm publishes only revenue values without disclosing either proper financial statements or any significant operational data), came on our radar last week due to the inexplicable surge in its share price. Artprice’s share price tripled over the course of last week, which now makes the firm valued at $142 million. This is four times above its major rival Artnet’s market capitalization and about 20 (sic!) times its annual revenues (Artprice made EUR 5.4 million in sales in 2010, a modest increase of 11% over 2009). Artprice’s business model is not nearly as well understood as Artnet’s, and we can see no basis for either this share price rally or Artprice’s valuation in general. The rally appears to have been triggered by an article in the local media (La Tribune newspaper) implying certain forward-looking statements such as an anticipated rapid increase in Artprice’s sales. Skate’s remains very suspicious of Artprice, as we do not like the lack of transparency in its accounting and are troubled by these rapid share price movements.

Artprice’s Share Price Performance in the First Half of April versus Skate’s Art Stocks Index and Artnet

Some Musings about the Future of the Chinese Art Market

April 18, 2011

Earlier this month, Artprice, a company led by its principal shareholder, an eccentric Frenchman by the name of Thierry Ehrmann, released its annual report on the outcome of the art market in 2010, using the Chinese flag as its cover page. The key conclusion of the report was that China has become a leader in the auction segment of the global art market (“electric shock to the world history of the art market,” commented Artprice). Almost simultaneously, London-based ArtTactic published a report titled “China Art Market Confidence Reaches New High,” which states that the company’s measurements for the investment quality of different art market segments show that “the Chinese contemporary art market has moved into first place in terms of Market Confidence and is currently 21% above the U.S. & European market Confidence Indicator” (although what exactly “confidence” means remains unclear). Finally, the first week of April, traditionally the “Chinese Week” in the global auction market, once again proved the favorable situation for this segment by bringing 22 entries to Skate’s Top 5000 (our ranking of the 5,000 most expensive works of art on the basis of auction prices). Of these 22 sales, three were repeat sales with annualized investment returns ranging from 19.7-93.8% (on a USD basis). In addition to all the market buzz in April, the arrest of one of the most recognized (though by no means the most valuable) modern Chinese artists, Ai Weiwei, only served to further emphasize the impetuous nature of the Chinese art market.

In our opinion, the Chinese art market is definitely seeing some turbulence, although it is still too early for it to be given the status of “global art leader.” Going forward it seems that China has become the main center for speculation on the art market and perhaps the riskiest segment of the global art market. When it comes to the premium (investment) segment of the global art market monitored by Skate’s Art Market Research, China is far from dominance by every indicator. The most valuable Chinese artist (Zhang Daqian) occupies the #62 spot in the ranking of global artists by market capitalization (the total auction value of works sold in the price range of Skate’s Top 5000). Although the largest Chinese auction house (Poly International Auction) has challenged the world’s third largest, Phillips, it still remains only the fourth largest auction house in terms of premium (investment) quality art sales. Finally, the total value of artworks by Chinese artists in Skate’s Top 5000 is less than $800 mln, which is far behind the market value of European and American artists, although it does exceed the aggregate market value of works by Russian artists by a factor of 2.5.

The main driving force behind the boom in the Chinese art market is a simultaneous increase in the number of wealthy people in China and their income growth, which is superimposed on the consequences brought on by the recent global financial crisis, especially the deep skepticism of many investors concerning the possibility of protecting and increasing their capital through traditional investment tools. The practice of art investment, which has deep historical and cultural roots, is widely recognized in China as a reasonable strategy for alternative investment. China’s economic prosperity on the one hand (earlier this year, China officially became the second largest economy in the world after the United States) and an age-old proven global formula of value creation on the art market through a constant and significant source of demand (from medieval royal courts up to today’s private museums) have indeed made China one of the world’s most important art market centers. Yet, from an investment point of view, China is the global leader of venture capital and highly risky investment in “new art,” but it is not a global center for art investment that aims for capital protection, something New York and London can more reasonably lay claim to.

When observing the enchanting variety of names, periods, themes and styles created by contemporary Chinese artists and consumed by the local art market (with a less significant share of foreign capital in the total volume of transactions), one of the most interesting things seems to be the swift creation of “new brands” on the Chinese art scene. Thus, in 2010 Zhang Daqian became one of the world’s most frequently traded artists in the price segment above $1.8 mln (i.e., the threshold of Skate’s Top 5000). At the beginning of 2010, Zhang Daqian was represented by only two works in Skate’s Top 5000 and statistically was barely different from several dozen other 20th century Chinese artists who were selling at similar prices. In a bit more than a year, the speculative Chinese market catapulted Zhang Daqian, making him the undisputed leader in this segment with a nominal market capitalization of $97 mln and an average annual rate of return of 23.7% for repeat auction sales. During the “Chinese” auction week in early April, every fifth work sold above $1.8 mln was created by Zhang Daqian.

Zhang Daqian’s striking rise compared to his peer group of artists is very similar to the rapid growth in the markets for Andy Warhol, Jean-Michel Basquiat and Gerhard Richter. Does this mean that a Chinese art investment object comparable to Coca-Cola, General Electric and Siemens in terms of liquidity and investment potential has appeared? Probably not yet. Unlike China’s CNPC oil monopoly and the world’s largest mobile operator, China Mobile, Zhang Daqian and other most Chinese artists of his era lack an export component of ideas and images that would make it universally appealing to investors and collectors all over the world. The time test for the art market is the ability of art objects to occupy a permanent place in the pantheon of artistic heritage of world civilization, to become a part of the universal system of cultural and historical values of humanity. It remains to be seen whether Chinese artists will pass this time test.

Yet, the art market recognizes the importance of Chinese capital, and the most experienced dealers and gallery owners are trying to play a well-tested game of involving the “new bourgeoisie” (New Chinese) in the building of their own names and social roles through the patronage of the arts. But this does not mean that the global museums are willing to transfer substantial resources to Chinese contemporary art exhibitions or that international private collectors are ready to invest more time and money in the development of the Chinese cultural idea. Rather, a more natural strategy for the global establishment would be to export Western art and art market methods to China, obtaining significant income in exchange for recognition of China’s economic power.

History is repeating itself, moving into a new geographic territory. Like China today, during the postwar years new industrial and financial elites in the United States attracted Europe’s art elite and was the largest source of demand on the art market. Demand dominance gradually transferred into supply dominance as an American cultural environment and art market infrastructure produced and “sold to the world” names that symbolized the economic and intellectual leadership of the United States.

Today China is not the world’s main art market; rather, it is the most rapidly growing source of demand standing at the T-intersection of the “Japanese” and “American” ways. If it turns to the right, strengthening its role in global politics and economics, China will be able to integrate its national culture into the modern global context for several decades, erecting its own Pollocks, Lichtensteins and Warhols (both in terms of fame and value). If it turns left, it will fall into the Japanese impasse, where artificial self-isolation, a society closed to foreigners and infantilism on the world stage have turned the Japanese miracle of the 1980s into the Japanese economic nightmare of today. This is manifested by Murakami’s role as the most valuable Japanese artist of all time (only 128th in Skate’s ranking) and Japanese art greatly trailing that of China, with Murakami separate from his countrymen of different ages, forgotten and out of demand.

To read the full article, including data charts, please click here.

Artnet Returns to Profitability (But to What Extent?) and Refines Strategic Focus

April 6, 2011

Modest Top Line Growth and Risk Profile Remain Areas of Concern

Artnet has reported its 2010 financial results, and they are in line with our prediction of the firm’s steady return to profitability. The company had been incurring losses in the last two years after shifting its strategic focus to an online auction business model in late 2007.

The biggest positive for 2010 is that Artnet is finally profitable again with a net profit of EUR 153,000 versus a loss of EUR 467,000 in 2009, although it should be noted that this profit comes with the help of historical tax liability release (see detailed discussion further in this report). Cash flow from operations also swung from a negative EUR 180,000 in 2009 to a positive EUR 651,000 in 2010. The cash position has grown nicely by 23% and, with the exception of a EUR 249,000 finance lease liability, the firm remains effectively unleveraged.

On the negative side, this lack of leverage actually translates into a lack of growth. Artnet has clearly identified a new business model centered on online art trading, and while the artworks that are being sold are small-ticket items for the art industry (below $10,000 in value), the average transaction sizes are wonderful in terms of online commerce in general. So far Artnet seems to be doing much better than eBay, Artfacts or any other rival in the online art trading space. In 2010, it achieved a volume of $13 mln, and, very importantly, the company has managed to avoid any public scandal surrounding the sale of fakes or inappropriately authenticated items through the system.

Despite the potential, Artnet’s management appears to have shied away from investing in faster growth and adopting the product more vigorously. As a result, top line growth was a disappointing 12%, and the firm continues to lose money in two out of its four business segments. Our updated financial model for Artnet suggests that the firm needs to achieve at least $35 mln in turnover for online sales art before it can break even (We discussed this number with Artnet, and the company’s management is convinced that they can break even with $27 mln in volume, i.e., double what they achieved in 2010. Our estimate is larger, as we expect Artnet’s costs to grow as it starts taking more consignments from outside its dealer network and its commission structure can also come under pressure once potential rivals like VIP Art Fair get their act together).

Instead of vigorous investment in the online auction platform, Artnet actually cut back on its capital expenditures by a factor of three in 2010, with overall investment in product development at just EUR 103,000 in 2010 versus EUR 328,000 in 2009. To be fair, however, Artnet’s investment levels were higher in 2009 due to the development of the Decorative Arts Price Database, which is now complete. Artnet’s management told us that the current system in place could easily handle the volume increase necessary for Artnet to operate a profitable online auction business. Yet, it remains to be seen whether current capabilities are enough to support the increased volume necessary to achieve sustainable profitability. Selling and marketing expenses remained effectively unchanged in 2010, going from EUR 2.97 mln in 2009 to EUR 3.07 mln in 2010. We believe that Artnet’s online model does work and that the firm should put significant capital into growing it even faster than it did in 2010 to retain its leadership position in online art trading space.

Artnet’s Business Model: From Art Industry Portal to Mass Consumer Art Retail Play

While Artnet’s management may still be pondering the revenue potential of its auction business, it appears to have made up its mind about the fundamental change to its business model. The firm is clearly migrating away from its traditional B2B focus on galleries, artist offices and art market intermediaries toward a model that focuses more on retail business. This decision seems evident in Artnet’s 2010 annual report and finds further support by the lack of growth in the company’s legacy business segments (see section “Core Statement”; the full annual report can be downloaded from the Artnet profile in the Skate’s Art Stocks & Funds section at www.skatepress.com).

Indeed, as Skate’s predicted a year ago, Artnet’s core B2B offering – “artnet Galleries Network” – produced virtually no top line growth in 2010 (0.4% growth in EUR terms to be precise) and plunged into losses, swinging from EUR 103,000 in earnings before taxes for the segment in 2009 to exactly the same EUR 103,000 in losses before taxes in 2010. While the segment remains the largest contributor to Artnet’s revenue mix and did better than we expected in 2010, it holds little growth potential given its current format and is being challenged by various other platforms through which galleries can communicate with each other and their customers. Artnet clearly recognizes this, and the company will need to review its gallery strategy in order to reverse loss-making trends for the segment.

The firm is responding by repositioning its primary moneymaker, the Price Database segment, to service both the business and retail market. It is also now presenting the Auction segment as a C2C model similar to eBay but with specialist market knowledge, data support and a product category focus in price levels (under $10,000 per work) that fall below the radar of Sotheby’s and Christie’s. All of these elements of Artnet’s retail strategy are clearly designed to pursue the objective of attracting more registered members and a greater level of site usage, which would make its marketplace more liquid and thus bring a second life to another struggling business segment at Artnet, namely Advertising, where profitability collapsed by 77% in 2010 due to stagnating revenues.

One striking takeaway from our analysis of Artnet’s 2010 financial results is that the company is actually not making money on EBT by segment basis. The EUR 739,000 provided by the Price Database cash cow, which is supplemented by a token EUR 61,000 EBT from Advertising, is still less than the losses before taxes generated by the Auctions segment and the losses from the Galleries segment. This all serves to put Artnet in the red by EUR 61,000 on an EBT basis. Apparently, the release from Artnet’s historical tax liabilities (EUR 335,000 in release of German tax liability for prior years (including related penalties)) enabled the firm to claim in its annual report that it “ultimately returned to profitability in 2010.”

That said, Artnet is now clearly on the path to profitability, and we expect the firm to return to positive EBT in 2011, especially given the EUR 700,000 cash flow that was generated in 2010, which was a EUR 800,000 improvement over the previous year. We expect that the still bleeding Auctions segment will begin to make money in 2013 (and possibly in 2012 if Artnet increases its sales and marketing expenses by at least 50% in 2011). It also seems as if Artnet has become even more attractive to its largest outside shareholder (i.e., not controlled by Mr. Neuendorf), as Artis Capital Management of San Francisco has apparently increased its stake in the company to 10.39%.

Risks of the C2C Model

Artnet is now betting that a C2C auction model will serve as a locomotive for growth and enjoy synergy with its Price Database and Advertising segments through more retail purchases and greater revenues from a growing audience base. This strategy creates a strong opportunity for growth. At the same time, it also opens up a Pandora’s Box of new risks, such as vendors using Artnet’s system to deal in fakes and wrongly attributed artworks. This would result in an increased percentage of charge backs and payment defaults. Certain worrisome signs are already there, as the firm’s trade receivable (accounts receivable net) grew by 20% to EUR 1.13 million in 2010 and its doubtful accounts increased by 26% in 2010.

These new risk areas can be mitigated, but they require adequate controls, and we are worried that Artnet may not have those in place. The firm is run by a three-member supervisory board (the German equivalent of a board of directors) but has no audit committee customary for US/UK public companies. In addition, Hans Neuendorf’s charisma as CEO and the fact that he remains the firm’s largest shareholder make for a powerful force that could cause Artnet to overlook red flags under certain circumstances. Although the small Hamburg-based firm that audits Artnet is part of Nexia International, a large and well-respected network of accounting and consulting firms, the absence of a Big 4 auditor does raise questions as to whether sufficient controls are in place to minimize exposure to payment, counterparty and fraud risk on Artnet’s growing C2C auction system. Under no circumstance are we implying that Artnet is experiencing any problems of this nature already or that the German audit firm has any conflicts or qualification handicaps that prevent it from doing a good job; rather, we are simply pointing out that the C2C model naturally increases Artnet’s risk exposure, which may require further implementation of best practice corporate governance at the firm including introduction of the audit committee chaired by an independent director.

These concerns aside, corporate governance at Artnet is rock solid in comparison to the less-than-impressive governance and reporting track record at Artnet’s listed art industry European peers. Artprice continues to produce quarterly reports without disclosing financial statements, instead publishing merely revenue and profit numbers. Camerawork has stopped making any public disclosure whatsoever. So if Artnet improves its corporate governance and reporting standards even further to match that of Sotheby’s and Collectors Universe, it will stand even higher above its European peers and go unchallenged as the only public investable company in the art market data world, for while we maintain coverage of Artprice, we do not view Artprice as an investable firm due to the poor quality of its reporting and governance.

To read the full article with data, please click here.

Monthly Art Investment Ideas from Skate’s Art Market Research: April 2011

April 1, 2011

Welcome to the April issue of Skate’s Art Investment Review. As always, our coverage is focused on the universe of 635 global artists whose artworks are represented in Skate’s Top 5000 database, which is comprised of the world’s most valuable art according to auction prices. To learn more about Skate’s Top 5000 and the artworks and artists represented, please visit http://www.skatepress.com.

In this issue:

  • Skate’s Top 5000 Entries in March
  • Overview of the Chinese Market in 2010
  • Overview of Chinese Artists in 2010
  • Top 5 Investment Ideas in April
  • Skate’s Art Stocks Index

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