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Tuesday, September 15, 2009

Update - Tale of Two Auction Franchises, plus BIDZ/EBAY

On 5/11/09, we wrote about two auctioneers, both established franchises protected by meaningful barriers to entry: Sotheby's (BID, $16.94) and below-the-radar Ritchie Bros. Auctioneers (RBA, $24.50). We like the entrenched market positions for both companies and think both will likely be around for generations. We thought we'd relay some points from June quarter results (now old news) and continue our tale:
  • One reported June quarter revenue down 48% to $167 million (somewhat better than March quarter's down 58% Y/Y) and operating income of $53.1 million (excluding $5 million of restructuring costs, a massive improvement from a March quarter operating loss of $50 million).
  • The other reported revenue up 3% Y/Y to $84 million and operating income of $28 million (+19% Y/Y) for the quarter.
  • One has net debt position of $368 million and generated trailing twelve month cash flow from operations of negative $37 million and implied negative free cash flow of $50 million (assuming normalized annual capex of $12.5 million).
  • The other has a net cash position of $152 million and generated trailing twelve month cash flow from operations of $167 million and near break-even free cash flow (as a result of planned expansion capital expenditures).
Which one is which? Readers can probably guess. Let's add a little commentary from earnings releases:
  • "We are on track to achieve the $160 million in cost savings in 2009 as compared to 2008 as announced last quarter. These substantial savings, as well as a new three year $150 million revolving credit facility that we expect to close with GE Capital later this month (subject to the conditions in the GE Capital commitment letter), have us on solid ground for the future.... We adjusted quickly to the different and difficult environment that suddenly presented itself and we are very well positioned to capitalize on a market rebound and benefit from our improved margins and lower costs.”

  • "We've seen two noticeable worldwide trends recently: there's more used equipment coming to market and more people are turning to our fair, transparent unreserved public auctions to meet their equipment needs. We're selling more lots, attracting more bidders and continuing to conduct record-breaking auctions in what many people would describe as a challenging market. Buyers and sellers of used equipment are turning to [us] in increasing numbers, and the investments we've made in developing our salesforce and expanding our global network of auction sites have enabled us to handle and benefit from that growth. We're pleased with our progress and believe we are on track to meet our goals for 2009."
Not surprisingly, the first series of bullets correspond to Sotheby's while the latter relates to Ritchie Bros. Auctioneers. In May, we expressed caution surrounding Sotheby's weakening financial condition (high debt load) amidst a challenged luxury market. Since then, shares are up almost 50% on the company's ability to reduce costs and Market expectations for an economic recovery. By contrast, RBA is up only 2% and the S&P500 is up ~15% -- please see graph below from Nasdaq.com:


What's going on here? We think investors are correctly assessing normalized earnings power of both companies and, in this case, choosing BID over RBA. If we simply take the five year average of reported earnings for Sotheby's and assume this represents a full economic cycle (in truth, we should probably also include the weak 2002-03 period), average EPS equals $1.56. Applying a 20 times multiple (or 5% earnings yield, awarded for difficult-to-replicate franchise) to this figure, we arrive a fair value of $31 per share. We include results from the company's 2008 10-K below:

The following table provides selected financial data for Sotheby’s (in thousands of dollars, except per share data).

Year ended December 31

2008

2007

2006

2005

2004

Net Auction Sales (1)

$

4,189,735

$

4,625,914

$

3,234,526

$

2,361,830

$

2,334,937

Income statement data:

Auction and related revenues

$

616,625

$

833,128

$

631,344

$

496,899

$

439,526

Finance revenues

14,183

17,025

15,864

8,302

5,907

Dealer revenues

55,596

62,766

12,776

5,131

3,604

License fee revenues

3,438

2,960

2,922

1,404

45,745

Other revenues

1,717

1,843

1,903

2,117

2,274

Total revenues

$

691,559

$

917,722

$

664,809

$

513,853

$

497,056

Net interest expense

$

(28,349

)

$

(14,166

)

$

(27,148

)

$

(27,738

)

$

(30,267

)

Income from continuing operations

$

28,269

$

213,139

$

107,359

$

63,217

$

62,397

Net income

$

28,269

$

213,139

$

107,049

$

61,602

$

86,679

Basic earnings per share from continuing operations

$

0.44

$

3.34

$

1.78

$

1.04

$

1.01

Basic earnings per share

$

0.44

$

3.34

$

1.77

$

1.01

$

1.40

Diluted earnings per share from continuing operations

$

0.43

$

3.25

$

1.73

$

1.02

$

1.00

Diluted earnings per share

$

0.43

$

3.25

$

1.72

$

1.00

$

1.38

Cash dividends declared per share

$

0.60

$

0.50

$

0.20

$

$


Meanwhile, Ritchie Bros. -- which is growing through the recession and, therefore, at peak/record earnings -- is already trading at 24.5 times current year earnings. We include results from the company's 2008 annual report below:

Consolidated Statements of Operations
(Expressed in thousands of United States dollars, except share and per share amounts)
Years ended December 31, 2008 2007 2006
Auction revenues
$ 354,818 $ 311,906 $ 257,857
Direct expenses
49,750 46,481 40,457
305,068 265,425 217,400
Expenses:
Depreciation and amortization
24,764 19,417 15,017
General and administrative
164,556 144,816 117,714
189,320 164,233 132,731
Earnings from operations
115,748 101,192 84,669
Other income (expense):
Interest expense
(859 ) (1,206 ) (1,172 )
Interest income
4,994 7,393 6,664
Foreign exchange gain (loss)
11,656 2,802 (451 )
Gain on disposition of capital assets
6,370 243 1,277
Other
1,375 1,471 1,079
23,536 10,703 7,397
Earnings before income taxes
139,284 111,895 92,066
Income tax expense (recovery) (note 8):
Current
39,101 33,797 33,757
Future
(1,217 ) 2,115 1,091
37,884 35,912 34,848
Net earnings
$ 101,400 $ 75,983 $ 57,218
Net earnings per share (note 6(e)):
Basic
$ 0.97 $ 0.73 $ 0.55
Diluted
0.96 0.72 0.55
Weighted average number of shares outstanding
104,713,375 104,266,113 103,639,380


Thus, with respect to Sotheby's, we appear to have missed an excellent opportunity to pick up a premier franchise on the cheap. That said, while our above analysis points to meaningful further upside, timing is uncertain and risk remains that Sotheby's operating results will be pressured for some time to come. We generally prefer companies with more favorable near-term fundamentals and limited debt burdens. Consistently high margin, high ROE Ritchie Bros. Auctioneers fits this billing, but the stock remains too expensive for our liking. We'll continue to watch both names and remain content with our auction franchise exposure via Bidz.com (BIDZ, $3.75) and eBay (EBAY, $24.44). Please see our prior posts here and here, respectively.

We believe BIDZ offers a substantial margin of safety at current levels, even with a skeptical view of "normalized" earnings power. We still like EBAY, too, although the margin of safety is gradually being eroded as shares march upward and Wall Street embraces the name anew (please see analyst upgrades today). However, we envision cash piling up on eBay's balance sheet as the core business chugs along and PayPal keeps growing, which should propel shares into the $30s over time (e.g. 20 times current consensus 2010 EPS of $1.62 = $32 per share).

Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long BIDZ, EBAY.

© 2009 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

2 comments:

  1. JW,

    Given your proclivity for the auction business, I am curious to get your perspective on this announcement from this week from JLL:

    http://www.us.am.joneslanglasalle.com/unitedstates/en-us/pages/NewsDetail.aspx?ItemID=17742

    While the auction concept in this field is not new; migrating this concept on-line, with the strengths of these two partners, would appear to be a venture with tremendous potential.

    An on-line auction will create a virtual trading platform for sophisticated investors (REIT'S, etc.) and may bring more liquidity to this sector by opening or creating an expanded market even for those less sophisticated, but with access to capital. This may also open the door for more well capitlized financial institutions to pick off problem loan properties from those that are not as well grounded and are looking to shed non-performing loan assets at a discount, but may be loathe to do so within their own community or region.

    At the same time an on-line auction facility should wring out un-necessary and redundant costs; and dramatically reduce the market cycle for some property by broadening the audience. The one question I have however is; given their expertise, if JLL will not skim the cream that surfaces for their own benefit, while auctioning off only what has gone sour.

    I recognize this is a little far afield from Sotheby's, but I's be interested in your take.

    ReplyDelete
  2. Hello Anonymous,
    Thank you for your question. JLL's news is interesting and the JV appears to fill/address a market need -- streamlining the liquidation/sales process, potentially helping banks realize sales proceeds faster than otherwise could and, thereby, reducing "REO" expenses (which are growing rapidly at present):

    “With the default rate on commercial mortgages held by U.S. banks expected to rise to the highest level in 17 years in the fourth quarter of 2009 , the smaller regional banks will have less time and government intervention to delay and pray much longer. They need a solution to move loans and property easily off their balance sheets now,” said Bart Steinfeld, managing director of Jones Lang LaSalle’s Real Estate Investment Banking practice. “We expect the community banks to begin selling their small balance loans first, and our note auction platform will be a formidable tool for financial institutions seeking to consolidate and monetize loans of all sizes off their balance sheets.”

    AND, REDC appears to have credibility:

    “Since 2007, REDC has led the residential real estate market with more than $5 billion in real estate asset sales at auction, including more than $3.4 billion in 2008 alone,” said Jeff Frieden, CEO of REDC,...

    However, based on the press release, we don't about the JV's financial structure and how it will contribute to JLL's operating results. So, hard to say how beneficial it will be without doing more homework. Looking quickly at JLL's valuation, the stock appears fairly valued:
    http://finance.yahoo.com/q/ks?s=JLL

    -18x TTM and NTM earnings
    -9.4x TTM EBITDA
    - 0% FCF yield based on TTM FCF of only $3 million (CFO less capex)

    However, we need to acknowledge the distressed operating environment and earnings/FCF need to be normalized for a true view. Let's focus on FCF -- per recent mgmt presentation
    http://www.joneslanglasalle.com/InvestorPDFs/Investor_Presentation_Aug_2009.pdf

    full-year, 2009E capex of only $45 million, compared to $114 million in 2007 and $70 million in 2006. TTM CFO was only $121 million, compared to $409 million in 2007 and $378 million in 2006. If we assume normalized CFO of $250 million (still below prior levels) and capex of $80 million, implied FCF is $170 million, or an 8% FCF yield on JLL's current market cap. Not bad, but timing for a recovery to "normalized" CFO is uncertain and a rebound is, at least partially, already discounted in the valuation. If you believe in franchise value (JLL is well-positined in space), perhaps a 5% FCF yield could be justified.

    Bottom-line: worth keeping an eye on JLL developments and looking for more detail on how the JV might/will contribute to results.

    -JW

    ReplyDelete

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