Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

Hedge fund rips into this swanky auction house

Marcato pressures Sotheby's
Marcato pressures Sotheby's

In a strongly worded letter issued to Sotheby's lead director Friday, the activist hedge fund Marcato Capital Management accused the auction house's board and management of "willful neglect" and demanded both an immediate $500 million share repurchase and the replacement of the company's chief financial officer.

The letter cited poor or nonexistent returns on capital.

"Despite our dialogue with you and other members of the board, a substantial portion of Sotheby's invested capital continues to earn a poor return or worse yet, earns no return at all," wrote Mick McGuire, founder of the $3 billion San Francisco fund company, in his Feb. 20 letter to lead independent director Dominico De Sole. "This willful neglect on the part of both management and the Finance Committee of the board must end urgently."

In a written statement issued Friday evening, Sotheby's responded to the Marcato letter. "The Board welcomes shareholder views and suggestions," said De Sole, "but our immediate priority is selecting a new CEO and determining a strategy to increase shareholder value. We will address capital allocation based on our strategy and the resulting capital needs."

Patrick McClymont, Sotheby's CFO, had no immediate comment on demands for his replacement.

Marcato's broadside is only the latest in a string of activist critiques to be levied upon Sotheby's. The company's shares were up 1.3 percent in afternoon trade after the hedge funds demands were first revealed on CNBC, suggesting that some investors might consider them an overreach—at least for now. 

Charles Elson, the University of Delaware finance professor who specializes in corporate governance, said in an interview that De Sole's rationale made sense. 

"The key in an organization is the leadership, the CEO, and once a new CEO comes in, you typically see a change in the leadership team," Elson said. "And I think you have to be a little patient until they find someone."

McGuire, however, who with 7.4 percent of Sotheby's shares is its second-largest stakeholder, according to FactSet, disagrees. (Accounting for options he holds that amount swells to 9.5 percent.)

"Shareholders deserve leadership that combines sound business strategy with skilled financial management," he wrote. "For the duration of Marcato's investment, we have enjoyed neither." (With 9.6 percent of the shares, Third Point, the large New York hedge fund, is Sotheby's single-largest shareholder, FactSet reports.)\

Mario Tama | Getty Images

Marcato first invested in Sotheby's in 2013, as did the funds Third Point and Trian Fund Management. But unlike Third Point founder Dan Loeb, who quickly began urging that the auction house's CEO, Ruprecht, be replaced, Marcato has largely been focused on issues of financial stewardship, like returning more capital to shareholders. (Still, when Loeb decided to wage a proxy fight last spring, McGuire backed him.)

In 2014, Loeb, whose fund was demanding from Sotheby's multiple board seats and the ability to amass additional shares in the company, launched a proxy war ahead of the company's annual meeting. Late that April, court documents from a lawsuit Third Point had filed against the auction house revealed excerpts from internal Sotheby's e-mails that showed the nasty, personal nature the proxy battle had taken on. 

Shortly before Loeb's public call for the replacement of Ruprecht the prior fall, the CEO described his own view of both Loeb and McGuire in an e-mail: "We are going to be the target of a proxy fight with activist shareholders. The motivation for that fight is only peripherally about returning capital. It is about being on Sotheby's Board. Mick McGuire needs that as validation, and Loeb wants that for ego." (Ruprecht also called Loeb a "scumbag" in a separate exchange.)

Loeb's court efforts eventually failed, but he won a board seat for himself, as well as two additional seats for directors that received his blessing— moves that appeared to soften his stance toward the company.

The e-mail exchanges, however, were not forgotten by McGuire, who highlighted them in his own letter to Sotheby's on Friday. 

Citing Ruprecht's statement that he needed a Sotheby's board seat for reasons of "validation," McGuire wrote that "I was offered a board seat and I declined because I would only serve on the condition that Sotheby's commit to certain capital allocation targets; a condition the company resisted." Shareholder promises since then, he added, have gone unfulfilled.

McGuire's own analysis suggests that by combining its cash stores with an undrawn credit facility and leveraging certain real estate assets in to cash, among other things, Sotheby's has access to at least $1.3 billion in unused capital, leaving it with more than $850 million it could theoretically return to shareholders without depriving it of an emergency cushion.

Loeb, who was sent a copy of Friday's letter, declined to comment.