Skate's Art Investment Review

On May 5, Abbey House, a Polish firm that combines all known art business models, including a local arts & crafts auction, a local art magazine, a Polish market price database and a quasi-dealer business that promotes contemporary local artists, became the 12^th company to join Skate’s Art Stocks Index after its successful share flotation on the Warsaw Stock Exchange.

Abbey House (WSE:DAH) shares were trading at $1.37 as of publication on May 16, 2011.

On May 9, Sotheby’s also announced their quarterly results, reporting a 17% increase in revenues to $119.6 million and, perhaps most notably, an unusual first quarter profit of $2.4 million. Due to low auction-related revenues, the first quarter is traditionally a loss-making period for the firm.

Auction and related revenues, as well as dealer revenues, were the biggest winners, growing by 15.4% and 83.1% over the first quarter of 2010, respectively. Yet, increasing dealer revenues has come at a cost for Sotheby’s; dealer cost of sales skyrocketed from $1.8 million in the first quarter of 2010 to $5.9 million for 1Q 2011, or, as Sotheby’s calculates, an unfavorable change of -232%. Excluding the large increase in dealer cost of sales expenses, total operating expenses were up 11% over the same period of 2010, which is mainly due to significant increases in direct costs of services, marketing expenses and salaries and related costs.

Sotheby (NYSE:BID) shares are down -6.89% YTD as of May 16, 2011.

On May 9, Collectors Universe, a provider of authentication and grading services to dealers and collectors of high-value collectibles, released its third quarter results ending March 31, 2011. Among the highlights of the release were record revenues of nearly $12.82 million, up from $10.79 million for the same period last year. Likewise, the firm’s operating income increased to a record $3.31 million from $2.57 million in the third quarter of last year.

In his commentary and outlook, Collectors Universe CEO Michael McConnell expressed great satisfaction with the company’s results, stating, “Both industry fundamentals and internal efficiencies contributed to the strong performance.”

Judging by Collectors Universe quarterly release, the company’s efficiencies are indeed strong with selling and marketing expenses, as well as general and administrative expenses, under tight control at $1.58 million and $3.01 million, respectively. This is in stark contrast to many of the other firms in Skate’s Art Stocks Index where high operating expenses have served to hold down profitability or, in some cases, have resulted in losses.

Collectors Universe (NASDAQ:CLCT) shares are up 8.13% YTD as of May 16, 2011.

Sticking to its traditional reporting schedule, Artnet released its 1Q 2011 management report on April 29. While the company’s total revenue increased by 10% in euro terms (up to EUR 3,491,591 from EUR 3,178,513 in the first quarter of 2010), this increase was not enough to offset increasing costs, which meant that Artnet realized a EUR 70,733 net loss against a EUR 77,318 net profit for the same period last year.

Artnet’s loss for the quarter comes following the company’s report of a net profit of EUR 153,000 for all of 2010 (see Skate’s Market Notes #36, April 6, 2011). In its opening analysis to the 1Q 2011 report, the company states that its increased revenue in the first quarter was “offset by additional costs incurred by the Group for product development, consulting and payroll increases.” Furthermore, Artnet notes, “The Group continues to work with Simon-Kuchner & Partners to review pricing of its products and services.”

Looking at Artnet’s segment reporting, revenue from artnet Galleries was essentially flat at EUR 1,242,866 for 1Q 2011 vs. EUR 1,242,890 for the same period of 2010, although increased costs brought profit for this segment down significantly from EUR 73,103 to EUR 50,230. The artnet Price Database performed similarly with a slight growth in revenue hit by increased costs, thus resulting in a segment profit of EUR 194,350 that was down substantially from the EUR 360,581 profit for 1Q 2010. Such was also the case with the artnet Advertising segment, which saw profits shrink to just EUR 12,036 from EUR 69,741 in the same period last year, despite the hefty increase in revenue from EUR 315,955 to EUR 398,200.

artnet Auctions posted a modest EUR 85,602 loss for the first quarter, although revenue was up significantly from EUR 413,293 in 1Q 2010 to EUR 614,663 for the first quarter of this year, which indicates that the company is well on its way to making Auctions a profitable segment. artnet Magazine was listed as a new segment for the first quarter after previously being “considered primarily a marketing tool supporting the Group’s business activities”; it posted a EUR 224,925 loss on revenue of EUR 18,273, although Artnet states that artnet Magazine “will be developed into a full-fledged business.”

As the overall economy and the art market both continue their recovery, Artnet will need to be vigilant about redefining its business model and dealing with stagnant or loss-making segments. While we repeat our belief from last month that the artnet Auctions segment will begin to make money in the next couple of years, we remain concerned that artnet Galleries and to a lesser extent Advertising could pose challenges to the company’s finances. Though the economy has made a considerable recovery, the effects of the financial crisis and recession have made business owners much more conscious of costs, which will increasingly put the Galleries segment at risk given other platforms through which galleries can communicate with each other and their customers.

To their credit, Artnet does recognize the need to bring fresh life to the Galleries segment, stating, “The Group projects to offer a new plan to the gallery members in 2011, which is anticipated to increase revenue for this product in the coming year.” On May 16, Artnet also announced a new lower-priced subscription plan for its Database products, which it claims was made possible by reduced production costs associated with the segment. As the Price Database is traditionally a high-revenue segment for Artnet, more attractive pricing could bring additional subscribers and revive the company’s profitability in this segment.

Artnet (FRA:AYD) shares are up 0.94% YTD as of May 16, 2011.

On May 5, 2011, the Warsaw-based art auction Abbey House will float its shares on the Warsaw Stock Exchange.

With the firm’s pre-IPO pricing range suggesting a pre-money valuation of PLN 36 million (approximately $13 million) and a tiny capital increase of just 153,697 Series B shares at PLN 3.6 or USD 1.3 per share, the deal is small. Abbey House is a start up, having commenced operations in October 2010 and grossed only USD 0.5 million in sales for 2010. Its business model combines all known art business models, including a local arts & crafts auction, a local art magazine, a Polish market price database and a quasi-dealer business that promotes contemporary local artists. In a nutshell, Abbey House is telling potential investors that it will be a proxy for the Polish art market and thus be able to capture any growth experienced by this market in the foreseeable future.

Jakub Kokoszka, Vice President of Abbey House, estimates that the current size of the Polish art market is USD 100 million and could potentially increase 20-fold to USD 2 billion by 2021. This projection is based on a report by KPMG – The Luxury Goods Market in Poland – that places the overall value of the luxury goods market in Poland at approximately PLN 27 billion in 2009. Furthermore, Abbey House bases its estimates on a combined 100,000 high net worth individuals (HNWI – more than EUR 1 million in liquid assets), premium affluent citizens (EUR 500,000 or more in liquid assets) and core affluent citizens (EUR 2,000 or more in gross income per month). Based on the assumption that 20% of these 100,000 individuals can afford and will choose to purchase at least one work of art per year, Abbey House estimates that the total annual turnover in the Polish market will grow by a factor of more than 6.5 – from the current level of 3,000 artworks sold at auction to 20,000 works sold per year.

While Skate’s takes those projections with a large grain of salt and notes that Abbey’s business model thus far lacks focus and maturity, we are very happy to report on the upcoming IPO and will be delighted to follow Abbey House once it is successfully listed (i.e., once the IPO is underwritten). This is the first art industry IPO since Skate’s began publishing Skate’s Art Stock Index on September 1, 2005. Since then, most of the changes to the index have involved delisting firms as they went private or defunct (e.g., Italy’s Finarte Casa d’Aste or the Toronto-based Art-in-Motion Income Fund).

Developing the local auction business is perhaps the best thing that Abbey House can do in the next few years. The company’s listed peers in South Korea and Japan (Seoul Auctions, Shinwa Art Auctions and Art Vivant) have all managed to grow solid and profitable businesses locally (see Skate’s Art Stocks & Funds section). In addition, there are also excellent privately owned firms that have become notable operators (e.g., Polly in China, Safron in India and Russian-art focused MacDougall’s in London).

We have scheduled our due diligence visit to Abbey House on May 6 in Warsaw, and if all goes well, we will include the Polish firm in Skate’s Art Stocks Index as of May 10, 2011. This will expand the number of constituent stocks to 12 in the index. Abbey House will likely be the smallest firm in the index in terms of market capitalization and the only one to represent eastern Europe.