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EX-99.5 3 d875183dex995.htm EX-99.5

Exhibit5

February20,2015
DomenicoDeSole
LeadIndependentDirector
Sothebys
1334YorkAvenue
NewYork,NewYork10021
Domenico,
IamwritinginresponsetoSothebysannouncementonFebruary13ththattherewillbenoreturnofcapitaltoshareholdersat
thistime.1
Inthe18monthssinceMarcatosinitialinvestmentinSothebys,wehaveoutlinednumerousopportunitiesbothpubliclyand
privatelyforSothebystouseitscapitalmoreintelligentlytocreateshareholdervalue.Despiteourdialoguewithyouandother
membersoftheboard,asubstantialportionofSothebysinvestedcapitalcontinuestoearnapoorreturnorworseyet,earnsno
returnatall.ThiswillfulneglectonthepartofbothmanagementandtheFinanceCommitteeoftheboardmustendurgently.
Shareholdersdeserveleadershipthatcombinessoundbusinessstrategywithskilledfinancialmanagement.Forthedurationof
Marcatosinvestment,wehaveenjoyedneither.Wefeelaresponsibilitytoothershareholderstoexpressourdeepconcern
withthegovernanceandexecutivejudgmentonmattersofcapitalallocationandholdthisboardandmanagementaccountable.
WesubmitthatanynewCEOsfirstorderofbusinessmayneedtoincludetherecruitmentofanewCFOwhowillservethe
interestsofshareholdersratherthandefendmisguidedpoliciesofthepast.
Bywayofbackground,sellsideanalystscoveringSothebysvaluethecompanybyapplyingaP/Emultipletotheirestimateof
earningspershare.ThismethodologyproducesaresultthatignoresanypartofSothebysbusinessthathasvaluebutdoesnot
contributetoitsearningsthemostobviousexampleofwhichisthecompanysunusuallylargecashbalance,butthesamecan
besaidforartandjewelryinventory,excessequityintheloanportfolio,andrealestateassets.Noneofthissignificantvalueis
beingaccountedforinSothebyscurrentmarketvalue.
Today,wepresentaspecificandstraightforwardroadmapthatwebelievecanimmediatelyrelease$12.33pershare(28%of
currentmarketvalue)withoutmateriallyaffectingthecompanyscontinuedearningspower.Withthisincreasedflexibility,we
recommendtheimmediaterepurchaseof$500millionofSothebysshares.
1

ExhibittoSothebysForm8KfiledFebruary13,2015

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Howdidwegethere?
AsimpleGooglesearchforDelawareChanceryCourtMemorandumOpinionSothebysproducesacourtdocumentthat
offersrareinsightintotherationalebehindSothebyscurrentcapitalallocationstrategy.Theemailexcerptsinthecourt
opinionexposethatcapitalallocationdecisionsinthepasthadnotbeengovernedbythoughtfulconsiderationforliquidity
needs,returnthresholds,andcostsofcapitalbutratherbytacticalconsiderationstoforestallalongoverdueproxycontest.
Amongnumerousotherexamples,thepassagebelowbetweenCEOBillRuprechtandRobertTaubman,amemberofthe
FinanceCommittee,wasparticularlydisappointing:
Wearegoingtobethetargetofaproxyfightwithactivistshareholders.Themotivationforthatfightisonly
peripherallyaboutreturningcapital.ItisaboutbeingonSothebysBoard.MickMcGuireneedsthatasvalidation,
andLoebwantsthatforego
Myreviewofthesituationhoweveristhis:ifwemakeagesture,thatwecanafford,ofacoupleofhundredmillion
returnedquicklytoshareholders,wegainenormoustacticalleverageintheprocessofpersuadingthe85%of
shareholderswhowerenotactivists,thatweareresponsiblestewardsfortheirinvestment
Sothisisaboutpower,andpoliticalgamesmanshipwithshareholders,notaboutcapitalstructure[emphasis
added]
Ifyoudoamodestbuyback,andstillfeellikeyouaregoingtoloseaproxycontest,thenyouwouldofferactivists
oneortwoseatsandstillbeincontrol.2
Atthetimeofthiscorrespondence,SothebyscurrentCFO,PatrickMcClymont,wasemployedbyGoldmanSachsandserving
asmanagementsfinancialadvisor.InanemailexchangewithBillRuprecht,PatrickMcClymontagreedwithBills
argumentthatthedecisiontomakeaprudentdistributionnowallowsusthegreatestcontroloverboardcompositionand
collegialitygoingforward.Tobunkerinensuresboarddisruptionnextspring.Thisisntandneverwasaboutcapital
markets[forMcGuireandLoeb].ItsaboutgettingintoaleadershippositiononSothebysboard.[emphasisadded]
Asyourecall,thisreasoningprovedtobewrongasIwasofferedaboardseatandIdeclinedbecauseIwouldonlyserveonthe
conditionthatSothebyscommittocertaincapitalallocationtargetsaconditionthecompanyresisted.
Againstthisbackdrop,shouldshareholdersbesurprisedthataCFOwhowasoriginallyhiredastheCEOsactivistdefense
bankerwouldbereluctanttoupdateacapitalallocationstrategythatwasconceivedwithulteriormotives?Shouldshareholders
besurprisedthatpromisestoreturncapitalhavegoneunfulfilledaftertheillconceivedplanfailedtoaccomplishitsgoalof
preventingaproxychallenge?Shouldshareholdersbesurprisedthataboardandmanagementwithverylittleoftheirown
moneyinvestedinSothebysstockareunconcernedwiththeopportunitycostoflazycapitalallocationpolicies?
2

Source:http://courts.delaware.gov/opinions/download.aspx?ID=205180
2

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Whatshouldwedonow?
Theexerciseisasimpleone:
1)

Answerthequestion:Howmuchcapitalflexibilitydoesthecompanyrequireinordertopursueitsbusinessstrategyand
beconfidentthatitcanwithstandanunexpecteddownturninitsbusiness?

2)

CalculatesourcesofcapitalthatSothebyshasatitsdisposal.

3)

If#2isgreaterthan#1,thecompanyisovercapitalized.Thecostofthisovercapitalizationcanbemeasuredby
comparingthecompanyscostofcapitaltothereturnbeingearnedontheseassets.

Managementhasprovidedaframeworkto#1inapresentationdatedJanuary29,2014whereSothebysdetailedtheresultsof
itscapitalallocationandfinancialpolicyreview3(thispresentationmysteriouslycannolongerbefoundonSothebyswebsite).
Theanswerto#1is$495millionwhichisbrokendownasfollows:

$300millioninstandbyliquidityincasethecompanyexperiencesaworstcasescenarioofhavingtofundauction
guarantees.Thecompanydefinedworstcasescenarioas50%ofoutstandingguarantees(netofanypurchase
commitments)andanoveralllimitof$600millioninguarantees(net).(Intruth,theJanuarypresentationdetaileda
liquidityreserveof$150millionagainstanetguaranteelimitof$300million,butmanagementveryquicklyblew
throughitsownselfimposedlimitjustafewmonthslaterandrevisedtheirmaxguaranteetargetto$600million,but
thelackofdisciplinearoundtargetsisthetopicofadifferentconversation.)

$100millionofavailablecapitaltofunddealsthatoffercertainbuyersextendedpaymenttermsonpurchases.This
representsloansthatareoutsidetheactivitiesofSothebysFinancialsServices(SFS)queryastowhyextended
paymenttermsarenotfundedoutofSFS?

$90millionasacushiontoworkingcapitalinthescenariowhereasuddenandseveredownturnreducescashflow
fasterthanthecompanycanresetitscostbase.

$5millioninworkingcapitalforSFS.

Toreiterate,inJanuary2014,aspartofanefforttoundermineaproxycontestthroughagesturewecanafford,
managementsframeworkimplies$495millionofworstcasescenarioliquidityrequirements.Itisdifficulttoimaginewhy
managementwouldhaveanyreasontounderestimatethisnumber,butquiteeasytoimaginewhytheymighthavewantedto
overestimatethenumberforpurposesofjustifyingasmallergesture.
3

ExhibittoSothebysForm8KfiledJanuary29,2014
3

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CalculatingthesourcesofcapitalatSothebysdisposalisalsonotdifficult.However,wedobelievethattherearestepsthat
Sothebyscanandshouldtaketoincreasethetotalliquidityavailabletothecompany.Wedetailthisbelow:
CurrentReadyLiquidity:

$484millioninCashat9/30(definedascashonhand,plus$450millionreceivablefrombuyersless$386million
duetoconsignors)

$192+millionofestimatedFreeCashFlowgeneratedinQ420144

$300millionrevolvingcreditfacilitythatiscurrentlyundrawn

Subtotal:$976million
Wecontinuetorecommendthatthecompanytakethefollowingeasystepstocreateadditionalsourcesofliquidity:

AppraiseLondonrealestateassetsanduseasasourceoffundingthrougheither:1)mortgagefinancingor2)adding
appraisedrealestatevaluetothecollateralbasketofthecreditfacility.$162.5million.Usingestimateof$250
millionappraisalvalueand65%advancerate.

Employconservativeleverageagainstauctionsegmentthroughfixedratetermfinancing.Managementrecommends
3.5x4.0xAdjustedDebt/throughthecycleEBITDA,inclusiveofmortgagerelateddebt,andhasbeenunwilling
todisclosetheirdefinitionofthroughthecycleEBITDA.Wewouldadvocatefor2xDebt/throughthecycle
EBITDA,butweexcludemortgagedebtfromthiscalculation.Wecomputethetrailing7yearaverageauction
segmentEBITDAtobe$206millionimplyingincrementalborrowingcapacityof$112million.

IncreaseSFSloantovaluetostatedtargetlevelof85%ofoutstandingloanbalances.$54million.

AppraiseNewYorkrealestateandcontributeresidualequityvalueofNewYorkpropertytothecollateralbasketof
thecreditfacility.$41million.Usingestimateof$400millionappraisalvalue,65%advancerateoftotalproperty
valueless$219millionmortgageloan.ThecompanyhastheabilitytoprepaythemortgageonJuly1andthisisan
opportunetimetoimprovethetermsofthemortgage.

Subtotal:$370million
#2:Totalsourcesofcapital:$1,346million
#2minus#1=$851millionofexcesscapital!
CalculatingtheCost:
$851millionofexcesscapitalrepresents$12.33pershare,or28%ofthecurrentstockprice.Webelievethecompanycan
immediatelyreleasethisexcesscapitalwithoutmateriallychangingtheearningspowerofthebusiness.
4

AssumesQ22014adjustedcashflowfromoperations(excludingchangesinaccountsreceivable,duetoconsignors,and
unusualinventoryinvestment)lesscapitalexpenditures
4

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Thisdegreeoffinancialmismanagementisunacceptableparticularlygiventhepersistenceofexcesscapitaloverthetenureof
Marcatosinvestment.Theboardandmanagementmusttakethenecessarystepstocurethisdynamic.Werecommendthe
immediaterepurchaseof$500millionofSothebysshares.Thisamountrepresentsthecurrentcashandrevolvercapacity
lesstheentirereserveforworstcasescenarioliquidityrequirements.Sharerepurchasesaremuchmoretaxefficientthana
specialdividendandwebelievethatSothebyssharesareacompellinglongterminvestment.Theremainingexcesscapital
canbeaccessedinshortorderandredeployedintoactivitiesthatclearthecompanys15%ROIChurdleorcanbereturnedto
shareholdersthroughadditionalsharerepurchases.Futurefreecashflowgeneratedbythebusinesswillalsobeavailableto
fundgrowthinvestments.
Weexpectthatwiththisanalysis,theFinanceCommitteeoftheboardwillbeequippedtofulfillitsdutyasfiduciariesto
shareholders.Whilethesenumbersappearlarge,theirmagnitudeonlyservestohighlightthederelictionofresponsibilityof
Sothebysboardandmanagement.AsoneofSothebyslargestshareholders,wealsolookforwardtoathoroughdiscussion
withitsnewCEOregardingtheimportanceofintelligentcapitalallocationincreatingvalueforshareholders.
Sincerely,

MickMcGuire
cc:
JohnAngeloFinanceCommittee
JessicaBibliowicz
KevinConroy
TheDukeofDevonshire
DanielLoeb
DanielMeyer
OlivierRezaFinanceCommittee
MarshaSimms
RobertTaubmanFinanceCommittee
DianaTaylorFinanceCommittee
DennisWeiblingFinanceCommittee,Chairman
HarryWilsonFinanceCommittee
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