Skate’s Semiannual Art Industry Forecast

Parallel Reality for Global Art Market Emerges in China, Art Dealing Starts to Migrate Online
Artnet Downgraded, MCH Group (Art Basel Operator) Upgraded

In January, we published our customary outlook for the year and made seven predictions for 2011. Following Skate’s art industry workshop held in Venice on June 4 and on the eve of Art Basel we are reviewing our forecasts and introducing several important new trends to watch.

New trend: China’s art market increasingly a speculative playground for locals

Eagle Standing on Pine Tree by Qi BaishiThe painting at the right, Eagle Standing on Pine Tree by Qi Baishi, is now the most valuable Chinese painting and world’s 15th most valuable work of art following its sale on May 22 for $65.5 million. Continuing this year’s new tradition of price records being set at second tier auctions (see Skate’s reports on MacDougall’s results from earlier this year), this top lot from the May auction sales was offered at the China Guardian Auction, the second largest local auction in China, which has been in operation since 1993. As a sign of the auction house’s quality, it was unable to attribute the year of creation to this artwork and did not publish pre-auction estimates.

A prolific artist who passed away in 1957 at the age of 80, Qi Baishi has emerged as China’s 47th most valuable artist in recent years and was the 10th most actively traded artist globally based on the data in Skate’s Top 5000. Baishi saw 11 sales exceeding $1.87 million per artwork in 2010.

The sale was the part of Chinese art market’s May extravaganza that saw 10 auction sales priced over $7 million per work and further established Zhang Daqian among the world’s most actively traded artists in the higher price category (half of the sales were his artworks). He was also the only Chinese name to be traded at major global auctions in this price range in May.

The Chinese art market is clearly living in a parallel reality at this point. Local auction houses trade local art that generally lacks a wide international ownership base and relies largely on domestic demand and art market infrastructure. The writing is on the wall: high-end Chinese art has virtually no repeat sales records to speak of, and not a single Chinese artwork was present in the Top 10 repeat sales in May. Investors entering the Chinese art market at current valuation levels are taking very significant liquidity and value destruction risks.

There are certain markets, such as those for works of Zhang Daqian, which are definitely worth following more closely. These works, which offer a must-have Chinese component for any global collection of 20th century art, are increasingly building international exposure and have Warhol-like elements in terms of liquidity.

New trend: art dealing starts to migrate online

Skate’s recently conducted extensive research on online art trading platforms for one of its clients, and the conclusions reveal a massive surge in both private equity investment in online art trading solutions and quick adoption of online marketing tools by the world’s most established galleries. Specifically, we estimate that the amount of private equity investment in global online trading platforms will grow from a mere $5 million in 2009 to over $30 million in 2011. At least 100 established global galleries will offer new online memberships in addition to the incumbent services of Artnet and Artprice. Acquiring and managing customers online is already becoming the #1 CRM (customer relationship management) channel for all artwork sales below $1 million as traditional location-based marketing aimed at cultivating a customer base around physical galleries is exhausting its growth potential in an over-saturated market. More importantly, investing in online marketing and CRM is increasingly a substitute to spending money on traditional art fairs – galleries and dealers apparently prefer to attend fewer fairs and focus their marketing efforts on more efficient online platforms.

It is still too early to tell which online art marketplace will emerge as the leader. At the moment, we are watching the beta launch of Art.sy at Art Basel this summer, anticipating second edition of VIP Art Fair in January and reviewing new product offerings and business plans from five other operators (in addition to existing players like Artfact, Artprice and Artnet).

Skate’s will publish an extensive review of the online art dealing platforms in February 2012, but we have already identified this segment as the quickest growing in the global art industry.

Art securitization: funds’ actual performance emerges as concern

We predicted that art securitization would be the most important trend to watch in 2011, and this has turned out to be true already. Our January forecast suggested that the total assets under management in art funds open to outside investors would grow from $300-400 million at the end of 2010 to over $1 billion in 2011. As of June 1, 2011, we estimate that the global art fund industry has at least $850 million in at least 15 art investment funds tracked by Skate’s. The inception of the FotoEffect fund, managed by Russia’s Agana, makes the largest contribution to this growth, but there are also new funds popping up in Brazil, Poland, Switzerland and Luxembourg, to name a few.

While we expect more art funds to arrive on the art market later this year (albeit none coming close to the size of Agana’s Fotoeffect), Skate’s believes that investors will become increasingly concerned about the new collective art investment vehicles’ ability to deliver satisfactory returns. The actual performance of art funds, liquidity of their ownership units (ease of redemption) and reliability of art funds’ performance data will take center stage, and fund managers might have a hard time addressing those issues in a convincing manner.

Underwhelming performance is already appearing at the capital raising stage. Brazil’s recently launched BGA Fund (Brazil Golden Art: BGA Private Equity Investment Fund is part of the Rio de Janeiro- and Sao Paulo-based firm Plural Capital and will invest largely in local contemporary art) raised BRL 40 million Brazilian (around $24 million), falling short of the initial target size of $50 million. The Art Collection Fund launched in Luxembourg this month by the duo of Stanislas Gokelaere, financier and collector, and the former head of Christie’s Europe, Bernard Steyaert, had given itself ample time until the year end to raise a mere EUR 20 million. Their fund also focuses on contemporary art as well as more exotic tribal art.

The first performance data that trickle in from the recently launched funds will not be helpful in the capital raising process either. The NAV (net asset value) of Agana’s FotoEffect shrank by RUB 33.5 million ($1.2 million or roughly 1% on an annualized basis) in 1Q 2011, which was largely due to partial management fee charges but also to the absence of reporting on notable sales that would allow marking up the fund’s NAV from what Skate’s saw as an already fully-priced valuation at launch. Russia’s other art fund, Atlanta, also reported an NAV decline of 2.11% in RUB terms for the first quarter, which translates into a 2.4% negative performance for the quarter in USD terms due to ruble appreciation for the same period.

While Russia’s regulated funds are listed on the local stock exchange and are naturally transparent with their performance data, the other global art funds are neither listed nor have any consistently transparent way of publishing performance data. The only exceptions are the Austrian and Swiss funds (for coverage of their ongoing performance, please visit the Art Stocks & Funds section). Complicating the interpretation of performance data even more is the fact that the art funds industry does not have a set of agreed-upon rules for data calculation and reporting. A few art industry trade bodies are only now beginning to develop international conventions for how art funds’ performance data should be calculated and published. As the number of art funds grows, their existing and potential investors struggle to obtain consistent and reliable performance data on those funds. The performance records that are available present a picture that is not altogether appealing.

We expect the inflow into art funds to slow and the industry to stagnate at around $1 billion in funds under management until it achieves a breakthrough with increasing credibility and consistency of performance data. Skate’s remains committed to the cause and continues to publish art fund profiles along with their performance data for all management companies that are willing to report their NAV and share their investment prospectuses with Skate’s.

Christie’s to go public barring sale to new owners, at least one new art industry IPO to take place

Our prediction of one new IPO came true; on May 5 we profiled the debut of Abbey House on the Warsaw Stock Exchange. Today Abbey is the smallest of the 12 constituent companies that make up Skate’s Art Stocks Index. Abbey House made its IPO just as Skate’s Art Stock Index peaked at 227 points at the end of April; since then, the index has retreated by more than 10%, closing below 200 points on June 1.

As of yet there is no credible news from Christie’s on a potential liquidity event for its existing owner, Francois Pinot’s Artemis group. If Christie’s really is considering an IPO, then it has clearly missed out on an extraordinary favorable spring window, which luxury goods peers like Prada went after and Sotheby’s insiders used extensively to sell down their stock.

Should Christie’s decide to go public, it will likely have a strong market ready for it this fall. A partial exit through an IPO might actually be a far better strategy for Artemis than selling to cash-rich owners whose art market agendas are unclear or questionable and who could make Christie’s business model vulnerable following an ownership change. In such a situation, Artemis could face claims under Representations & Warranties that Monsieur Pinot would be forced to provide as the seller in such a major transaction.

At this point Christie’s sale or IPO remains purely theoretical, as the firm itself has provided no credible signal that it is indeed working on exit options for its current owners.

Artnet as top performing stock in 2011

At the end of last year we banked on Artnet and suggested that it would be the best performing art stock for 2011. Accordingly, we raised our target price to $12 per share. With Skate’s Art Stocks Index at its peak in late April, we were almost there – the stock hovered around $11 per share and was among the best performers for the index at that time. When the art stocks market went down in May, Artnet was by far the worst performer of the month, losing a third of its market value. Unfortunately for Artnet’s management, the reasons are very straightforward. Following the release of very encouraging 2010 financial results and contrary to the firm’s guidance and to Skate’s expectations, Artnet’s disappointing 1Q 2011 financials show losses with online auctions and a failure to grow the business as quickly as the firm had anticipated. This is a very real concern given that Artnet no longer has the pioneer advantage in the field of online art dealing. VIP Art Fair is working on its second online edition for January 2012 and is expected to resolve its technical glitches from last January’s launch. The deep-pocketed Art.sy will unveil its pilot product at Art Basel next week. Finally, there are at least five online trading initiatives from less well-known players in the making.

Artnet’s ability to produce strong growth in the online auction market for the first six months of 2011, which can only be achieved through 2Q performance, will be decisive for the company’s outlook going forward. We have decided to put our $12 target price for Artnet under review for the time being, and we will publish a revised outlook for the firm once it releases its 1H results later this summer.

In all fairness, while we are disappointed with Artnet this year so far, we are truly bedeviled by Artprice. The Lyon-based art market data provider’s shares are up 245% (sic!) on a year-to-date basis. We see no rational reason behind this increase, especially since Artprice itself has not shared any news to warrant it. This marginally profitable company makes less than $10 million in annual sales, but today its valuation is virtually on par with Switzerland’s MCH Group, the Art Basel and Hong Kong International Art Fair owner that made a CHF 37 million (approximately $40 million) net profit in 2010. Our word of wisdom to all art stocks investors is to take current Artprice’s valuation with a massive grain of salt and prepare for a likely crashing nosedive of Artprice shares that would be triggered should anyone attempt to sell the stock in this illiquid and clearly inflated market environment.

MCH Group to be pressed to launch online strategy

At the end of last year we correctly sensed that MCH Group would need a new acquisition in the art industry to make a good use of the cash generated by its very successful Art Basel franchise. We were wrong on the company’s choice of priorities, however. The firm purchased the Hong Kong International Art Fair in May, yet its online strategy remains a mystery to this day.

We applaud to Hong Kong acquisition. Given the rise of China it was perfectly timed and focuses on a clear regional market leader. Skate’s is convinced that the deal will create significant value for MCH shareholders. While we look forward to MCH Group’s six months financials to ascertain the impact of the Chinese acquisition, we are already comfortable increasing our target price for MCH Group to $65 per share, which would imply a market capitalization of $300 million. Such a valuation would position MCH second behind Sotheby’s within Skate’s Art Stocks Index in terms of enterprise value.

That said, the time has come for MCH Group to think online. As the firm begins its incredibly successful offline Art Basel later this month, it will see the ambitious Art.sy start-up launch its beta online art-dealing product on MCH Group’s own territory. In parallel, VIP Art Fair will soon be closing acceptance to galleries for its second edition online fair this coming January with over 50 galleries now participating. We believe that MCH Group has another 12 months to decide its online strategy, which would involve either the development of an in-house product or an acquisition. The Chinese deal will definitely help to grow shareholder value between now and Art Basel 2012, but if MCH still has no credible online strategy at that point, the situation will start to look reminiscent of Borders doing battle with the Amazons of the world.

We know for a fact that there are more than a few stellar minds among MCH Group’s management who have always been able to get it right when it comes to art-related decisions. Skate’s looks forward to hearing more on MCH’s online move within the next nine months or so.

Value of Skate’s Top 5000 to exceed $30 billion, threshold price to reach $2 million

The June auctions have yet to take place, and the apparently strong fall 2011 auction season is still ahead, but we are already close to achieving these predictions. The combined market value of Skate’s Top 5000 stands at $28.9 billion as of May 31, 2011; the ranking’s threshold price (the auction price for the 5000th most valuable artwork) stands at $1.98 million. Both of our targets stand a very good chance of being reached already in June.

Warhol to overtake Monet

Andy Warhol is already there in terms of the number of works within Skate’s Top 5000 (213), but he has $360 million to go to catch up in market value and replace Claude Monet as Skate’s second most valuable artist after Pablo Picasso (Monet’s current market capitalization in Skate’s Top 5000 stands at $1.75 billion, Warhol’s is $1.39 billion). This value gap might take a bit more time to bridge than we originally anticipated, as Monet’s market is exceptionally strong. Art investors have realized that Monet’s premium market liquidity is second only to Picasso. The steady inflow of new funds into Monet’s high value art over the last six months has lifted the average ERR (effective rate of return) on repeat sales from practically negative values to a solid 9-10% (see page 3 of Skate’s Art Investment Report for June 2011).

More attention paid to photography

This prediction was largely based on Skate’s awareness of several new art funds scheduled to enter the art photography market in 2011, including Agana’s FotoEffect, which is dedicated entirely to photographic assets and is now the global art market leader in terms of NAV. Austria’s Photography Fund also reported fairly strong performance in 2011 and gained credibility as a clear benchmark for the art fund market segment.

Going forward, Skate’s does not expect any further allocation of investors’ funds to photography. We are revising our forecast and predicting that photography will remain at current levels as a visible but still fairly marginal area for art investment funds.

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