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EX-99.5 3 d875183dex995.htm EX-99.5Exhibit5

February20,2015

DomenicoDeSoleLeadIndependentDirectorSothebys1334YorkAvenueNewYork,NewYork10021

Domenico,

IamwritinginresponsetoSothebysannouncementonFebruary13ththattherewillbenoreturnofcapitaltoshareholdersatthistime.1

Inthe18monthssinceMarcatosinitialinvestmentinSothebys,wehaveoutlinednumerousopportunitiesbothpubliclyandprivatelyforSothebystouseitscapitalmoreintelligentlytocreateshareholdervalue.Despiteourdialoguewithyouandothermembersoftheboard,asubstantialportionofSothebysinvestedcapitalcontinuestoearnapoorreturnorworseyet,earnsnoreturnatall.ThiswillfulneglectonthepartofbothmanagementandtheFinanceCommitteeoftheboardmustendurgently.Shareholdersdeserveleadershipthatcombinessoundbusinessstrategywithskilledfinancialmanagement.ForthedurationofMarcatosinvestment,wehaveenjoyedneither.Wefeelaresponsibilitytoothershareholderstoexpressourdeepconcernwiththegovernanceandexecutivejudgmentonmattersofcapitalallocationandholdthisboardandmanagementaccountable.WesubmitthatanynewCEOsfirstorderofbusinessmayneedtoincludetherecruitmentofanewCFOwhowillservetheinterestsofshareholdersratherthandefendmisguidedpoliciesofthepast.

Bywayofbackground,sellsideanalystscoveringSothebysvaluethecompanybyapplyingaP/Emultipletotheirestimateofearningspershare.ThismethodologyproducesaresultthatignoresanypartofSothebysbusinessthathasvaluebutdoesnotcontributetoitsearningsthemostobviousexampleofwhichisthecompanysunusuallylargecashbalance,butthesamecanbesaidforartandjewelryinventory,excessequityintheloanportfolio,andrealestateassets.NoneofthissignificantvalueisbeingaccountedforinSothebyscurrentmarketvalue.

Today,wepresentaspecificandstraightforwardroadmapthatwebelievecanimmediatelyrelease$12.33pershare(28%ofcurrentmarketvalue)withoutmateriallyaffectingthecompanyscontinuedearningspower.Withthisincreasedflexibility,werecommendtheimmediaterepurchaseof$500millionofSothebysshares. 1 ExhibittoSothebysForm8KfiledFebruary13,2015

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Howdidwegethere?

AsimpleGooglesearchforDelawareChanceryCourtMemorandumOpinionSothebysproducesacourtdocumentthatoffersrareinsightintotherationalebehindSothebyscurrentcapitalallocationstrategy.Theemailexcerptsinthecourtopinionexposethatcapitalallocationdecisionsinthepasthadnotbeengovernedbythoughtfulconsiderationforliquidityneeds,returnthresholds,andcostsofcapitalbutratherbytacticalconsiderationstoforestallalongoverdueproxycontest.

Amongnumerousotherexamples,thepassagebelowbetweenCEOBillRuprechtandRobertTaubman,amemberoftheFinanceCommittee,wasparticularlydisappointing:

Wearegoingtobethetargetofaproxyfightwithactivistshareholders.Themotivationforthatfightisonlyperipherallyaboutreturningcapital.ItisaboutbeingonSothebysBoard.MickMcGuireneedsthatasvalidation,andLoebwantsthatforego

Myreviewofthesituationhoweveristhis:ifwemakeagesture,thatwecanafford,ofacoupleofhundredmillionreturnedquicklytoshareholders,wegainenormoustacticalleverageintheprocessofpersuadingthe85%ofshareholderswhowerenotactivists,thatweareresponsiblestewardsfortheirinvestment

Sothisisaboutpower,andpoliticalgamesmanshipwithshareholders,notaboutcapitalstructure[emphasisadded]

Ifyoudoamodestbuyback,andstillfeellikeyouaregoingtoloseaproxycontest,thenyouwouldofferactivistsoneortwoseatsandstillbeincontrol.2

Atthetimeofthiscorrespondence,SothebyscurrentCFO,PatrickMcClymont,wasemployedbyGoldmanSachsandservingasmanagementsfinancialadvisor.InanemailexchangewithBillRuprecht,PatrickMcClymontagreedwithBillsargumentthatthedecisiontomakeaprudentdistributionnowallowsusthegreatestcontroloverboardcompositionandcollegialitygoingforward.Tobunkerinensuresboarddisruptionnextspring.Thisisntandneverwasaboutcapitalmarkets[forMcGuireandLoeb].ItsaboutgettingintoaleadershippositiononSothebysboard.[emphasisadded]

Asyourecall,thisreasoningprovedtobewrongasIwasofferedaboardseatandIdeclinedbecauseIwouldonlyserveontheconditionthatSothebyscommittocertaincapitalallocationtargetsaconditionthecompanyresisted.

Againstthisbackdrop,shouldshareholdersbesurprisedthataCFOwhowasoriginallyhiredastheCEOsactivistdefensebankerwouldbereluctanttoupdateacapitalallocationstrategythatwasconceivedwithulteriormotives?Shouldshareholdersbesurprisedthatpromisestoreturncapitalhavegoneunfulfilledaftertheillconceivedplanfailedtoaccomplishitsgoalofpreventingaproxychallenge?ShouldshareholdersbesurprisedthataboardandmanagementwithverylittleoftheirownmoneyinvestedinSothebysstockareunconcernedwiththeopportunitycostoflazycapitalallocationpolicies? 2 Source:http://courts.delaware.gov/opinions/download.aspx?ID=205180

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Whatshouldwedonow?

Theexerciseisasimpleone:

1) Answerthequestion:Howmuchcapitalflexibilitydoesthecompanyrequireinordertopursueitsbusinessstrategyandbeconfidentthatitcanwithstandanunexpecteddownturninitsbusiness?

2) CalculatesourcesofcapitalthatSothebyshasatitsdisposal.

3) If#2isgreaterthan#1,thecompanyisovercapitalized.Thecostofthisovercapitalizationcanbemeasuredbycomparingthecompanyscostofcapitaltothereturnbeingearnedontheseassets.

Managementhasprovidedaframeworkto#1inapresentationdatedJanuary29,2014whereSothebysdetailedtheresultsofitscapitalallocationandfinancialpolicyreview3(thispresentationmysteriouslycannolongerbefoundonSothebyswebsite).

Theanswerto#1is$495millionwhichisbrokendownasfollows:

$300millioninstandbyliquidityincasethecompanyexperiencesaworstcasescenarioofhavingtofundauctionguarantees.Thecompanydefinedworstcasescenarioas50%ofoutstandingguarantees(netofanypurchasecommitments)andanoveralllimitof$600millioninguarantees(net).(Intruth,theJanuarypresentationdetailedaliquidityreserveof$150millionagainstanetguaranteelimitof$300million,butmanagementveryquicklyblewthroughitsownselfimposedlimitjustafewmonthslaterandrevisedtheirmaxguaranteetargetto$600million,butthelackofdisciplinearoundtargetsisthetopicofadifferentconversation.)

$100millionofavailablecapitaltofunddealsthatoffercertainbuyersextendedpaymenttermsonpurchases.This

representsloansthatareoutsidetheactivitiesofSothebysFinancialsServices(SFS)queryastowhyextendedpaymenttermsarenotfundedoutofSFS?

$90millionasacushiontoworkingcapitalinthescenariowhereasuddenandseveredownturnreducescashflowfasterthanthecompanycanresetitscostbase.

$5millioninworkingcapitalforSFS.

Toreiterate,inJanuary2014,aspartofanefforttoundermineaproxycontestthroughagesturewecanafford,managementsframeworkimplies$495millionofworstcasescenarioliquidityrequirements.Itisdifficulttoimaginewhymanagementwouldhaveanyreasontounderestimatethisnumber,butquiteeasytoimaginewhytheymighthavewantedtooverestimatethenumberforpurposesofjustifyingasmallergesture. 3 ExhibittoSothebysForm8KfiledJanuary29,2014

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CalculatingthesourcesofcapitalatSothebysdisposalisalsonotdifficult.However,wedobelievethattherearestepsthatSothebyscanandshouldtaketoincreasethetotalliquidityavailabletothecompany.Wedetailthisbelow:

CurrentReadyLiquidity:

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

$192+millionofestimatedFreeCashFlowgeneratedinQ420144

$300millionrevolvingcreditfacilitythatiscurrentlyundrawn

Subtotal:$976million

Wecontinuetorecommendthatthecompanytakethefollowingeasystepstocreateadditionalsourcesofliquidity:

AppraiseLondonrealestateassetsanduseasasourceoffundingthrougheither:1)mortgagefinancingor2)adding

appraisedrealestatevaluetothecollateralbasketofthecreditfacility.$162.5million.Usingestimateof$250millionappraisalvalueand65%advancerate.

Employconservativeleverageagainstauctionsegmentthroughfixedratetermfinancing.Managementrecommends3.5x4.0xAdjustedDebt/throughthecycleEBITDA,inclusiveofmortgagerelateddebt,andhasbeenunwillingtodisclosetheirdefinitionofthroughthecycleEBITDA.Wewouldadvocatefor2xDebt/throughthecycleEBITDA,butweexcludemortgagedebtfromthiscalculation.Wecomputethetrailing7yearaverageauctionsegmentEBITDAtobe$206millionimplyingincrementalborrowingcapacityof$112million.

IncreaseSFSloantovaluetostatedtargetlevelof85%ofoutstandingloanbalances.$54million.

AppraiseNewYorkrealestateandcontributeresidualequityvalueofNewYorkpropertytothecollateralbasketofthecreditfacility.$41million.Usingestimateof$400millionappraisalvalue,65%advancerateoftotalpropertyvalueless$219millionmortgageloan.ThecompanyhastheabilitytoprepaythemortgageonJuly1andthisisanopportunetimetoimprovethetermsofthemortgage.

Subtotal:$370million

#2:Totalsourcesofcapital:$1,346million

#2minus#1=$851millionofexcesscapital!

CalculatingtheCost:

$851millionofexcesscapitalrepresents$12.33pershare,or28%ofthecurrentstockprice.Webelievethecompanycanimmediatelyreleasethisexcesscapitalwithoutmateriallychangingtheearningspowerofthebusiness. 4 AssumesQ22014adjustedcashflowfromoperations(excludingchangesinaccountsreceivable,duetoconsignors,and

unusualinventoryinvestment)lesscapitalexpenditures

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ThisdegreeoffinancialmismanagementisunacceptableparticularlygiventhepersistenceofexcesscapitaloverthetenureofMarcatosinvestment.Theboardandmanagementmusttakethenecessarystepstocurethisdynamic.Werecommendtheimmediaterepurchaseof$500millionofSothebysshares.Thisamountrepresentsthecurrentcashandrevolvercapacitylesstheentirereserveforworstcasescenarioliquidityrequirements.SharerepurchasesaremuchmoretaxefficientthanaspecialdividendandwebelievethatSothebyssharesareacompellinglongterminvestment.Theremainingexcesscapitalcanbeaccessedinshortorderandredeployedintoactivitiesthatclearthecompanys15%ROIChurdleorcanbereturnedtoshareholdersthroughadditionalsharerepurchases.Futurefreecashflowgeneratedbythebusinesswillalsobeavailabletofundgrowthinvestments.

Weexpectthatwiththisanalysis,theFinanceCommitteeoftheboardwillbeequippedtofulfillitsdutyasfiduciariestoshareholders.Whilethesenumbersappearlarge,theirmagnitudeonlyservestohighlightthederelictionofresponsibilityofSothebysboardandmanagement.AsoneofSothebyslargestshareholders,wealsolookforwardtoathoroughdiscussionwithitsnewCEOregardingtheimportanceofintelligentcapitalallocationincreatingvalueforshareholders.

Sincerely,

MickMcGuire

cc:JohnAngeloFinanceCommitteeJessicaBibliowiczKevinConroyTheDukeofDevonshireDanielLoebDanielMeyerOlivierRezaFinanceCommitteeMarshaSimmsRobertTaubmanFinanceCommitteeDianaTaylorFinanceCommitteeDennisWeiblingFinanceCommittee,ChairmanHarryWilsonFinanceCommittee

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