April 30, 2015 Volume XLI, Issue IV

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Sotheby’s

NYSE: BID

Dow Jones Indus: 17,840.52 S&P 500: 2,085.51 Russell 2000: 1,220.13 Trigger: No Index Component: NA Type of Situation: Business Value

Price: $ 42.71

Shares Outstanding (MM): 69.0

Fully Diluted (MM) (% Increase): 69.6 (1%)

Average Daily Volume (MM): 0.7

Market Cap (MM): $ 2,973

Enterprise Value (MM): $ 3,013

Percentage Closely Held:

Third Point 9.6%,

Marcato 9.5%

52-Week High/Low: $ 45.08/35.30

Trailing Twelve Months Price/Earnings: 25.4x

Price/Stated Book Value: 3.4x

Long-Term Debt (MM): $ 300 Implied Upside to Estimate of Intrinsic Value: 65%

Dividend: $0.40

Payout 24%

Yield 0.9%

Net Revenue Per Share: 2014 $ 13.48 2013 $ 12.34 2012 $ 11.21

Earnings Per Share: 2014 $ 1.68 2013 $ 1.88 2012 $ 1.57

Fiscal Year Ends: Company Address: Telephone: President/CEO:

December 31 1334 York Avenue New York, NY 10021 212-606-7000 Tad Smith

Clients of Boyar Asset Management, Inc. do not own shares of Sotheby’s common stock.

Analysts employed by Boyar’s Intrinsic Value Research LLC do not own shares of Sotheby’s common stock.

Introduction

Sotheby’s (“BID” or the “Company”) is a dominant auctioneer in the fine art market, with 9 auction houses around the globe generating in excess of $6 billion in annual auction sales. Sotheby’s has built up tremendous value as a luxury brand since its founding in 1744 and operates a high margin business (2014 adj. EBIT margins 30%) that is a near-duopoly (alongside Christie’s). Sotheby’s auction sales have grown at an impressive 7% CAGR since 1992 and should continue to benefit from an improving economy and the development of a new class of ultra-wealthy individuals in emerging markets.

Despite these favorable business characteristics, Sotheby’s profitability and share price have languished since 2011. This reflects an increasingly competitive environment to win artwork for consignment at auctions, with Sotheby’s more frequently resorting to offering guaranteed prices and seller’s discounts. At the same time, Sotheby’s has failed to keep pace with Christie’s in the burgeoning contemporary art market and in attracting private sales. The Company’s balance sheet has also been a point of consternation for shareholders, with net cash and valuable real estate sitting idle and a growing Finance business sub-optimally funded. This led multiple activist hedge funds (led by Third Point’s Dan Loeb) to build large stakes in the Company and agitate for wholesale

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change beginning in mid-2013. After an extensive, high profile proxy fight, the activists ultimately gained board representation in 2014 and recently managed to oust Chairman and CEO William Ruprecht. Yet Sotheby’s shares have declined 20% since the initial euphoria following the activists’ arrival as change has been slow and profit margins remain under pressure.

In our view, the recent board and management changes (new CEO Tad Smith just took over on March 31) should provide the catalysts for Sotheby’s to better capitalize on its extremely attractive market position and boost profitability. The Company already implemented an initial cost savings plan in 2014 that produced a 250 bps improvement in EBITDA margins, but margins still remain more than 600 bps below 2010 levels. In addition to cost cutting, a more disciplined auction pricing strategy could have an outsized impact on profitability. The Company made an initial increase in auction commission rates earlier this year and the CEO changes at both Sotheby’s and Christie’s (two weeks apart) suggest both companies will refocus on profitability over market share. Longer term, a rejuvenated leadership at Sotheby’s is aiming to better position the Company to win contemporary art sales and private sales, to grow its Finance and online businesses, and to extend the brand.

In valuing Sotheby’s, we estimate a modest 100 bps improvement in auction commission margins plus ongoing cost savings could produce a nearly 50% improvement in EBITDA over the next 3 years assuming the art market grows at or slightly below its long-term historical average rates. The new board should also provide the catalyst for Sotheby’s to unlock excess capital. The Company currently has essentially zero net leverage (excluding the Finance segment) and close to $500 million in un-monetized prime real estate. By our estimates, the Company could free up close to $1 billion (34% of the current market cap) in 2015 via working capital improvements, asset sales, and re-levering the balance sheet to 3x EBITDA. Ongoing cash generation could take this closer to $2 billion over the next 3 years. At 10x 2017E EV/EBITDA, we estimate Sotheby’s intrinsic value could exceed $70 per share over a 2-3 year timeframe.

History & Recent Developments

London bookseller Samuel Baker founded Sotheby’s and held its first auction in 1744, selling the library of Sir John Stanley. The Company built up its position as the leading auctioneer with increasingly high profile auctions over the ensuing decades. Sotheby’s opened its first New York office in 1955 and vastly increased its scale there in 1964 with the acquisition of Parke-Bernet, the largest fine art auction house in the U.S. The Company was renamed Sotheby Parke Bernet Group. Sotheby’s continued its global expansion in the ensuing years, opening offices in Paris and Los Angeles in 1967 and becoming the first auction house to hold an auction in Hong Kong in 1973.

By 1982, Sotheby Parke Bernet (then publicly listed in the UK) was struggling with excessive debt and declining profitability due to expensive international expansion and a faltering economy. The Company was forced to close multiple auction houses, vacate its Madison Avenue property and lay off 25% of its staff.

1 Then in

1983, Sotheby’s received multiple hostile takeover bids from a pair of American corporate raiders. This created the opportunity for real estate developer Alfred Taubman to sweep in as a white knight, purchasing Sotheby’s for $139 million. Taubman set about improving the economics of the business with special attention paid to ending “bidding rings” of a small group of art dealers who purportedly controlled auctions and depressed prices. Sotheby’s completed an IPO on the NYSE in 1988, with Taubman retaining voting control of the Company.

The Company grew rapidly during the 1990s alongside competitor Christie’s as both auctioneers benefited from a globalizing fine art market and enacted steadily increasing commission rates including fixed seller’s fees (introduced in 1995). Unfortunately, the two competitors’ pricing policies proved to be a bit too closely coordinated. In April 1997, the U.S. Department of Justice began a price fixing investigation into Sotheby’s and Christie’s. Christie’s CEO Christopher Davidge and Sotheby’s CEO Diana Brooks eventually implicated both companies in a tightly coordinated price fixing scheme. Sotheby’s ultimately pled guilty in October 2000 to fixing auction commission rates and paid $65 million in fines and issued $62.5 million in redemptions to clients. Alfred Taubman resigned as chairman and agreed to cover $156 million of Sotheby’s $256 million in additional liabilities related to a class action lawsuit settlement. This did not keep him out of jail; in 2002 he was sentenced to one year in prison.

Despite Mr. Taubman’s indictment and extensive explorations of a sale between 1999-2003, including a reported takeover attempt by LVMH, the Taubman family managed to keep the Company public and retain

1 The Art of the Steal, Christopher Mason.

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control throughout the scandal and its aftermath. In September 2005, the Company completed a recapitalization with Alfred Taubman to eliminate the dual share class structure and reclaim voting control from Mr. Taubman. Mr. Taubman exchanged 14 million class B shares (62% voting control) for $168 million and 7.1 million Class A shares (12% stake). Mr. Taubman died in April 2015 but his son Robert Taubman remains on Sotheby’s board.

Despite the price fixing scandal, Sotheby’s continued to grow steadily through the 2000s alongside the global art market, with revenues increasing 155% from 2000 to $918 million by 2007. However, the Company paid the price for excessive auction guarantees when the global financial crisis impacted the art world in 2008-2009. While art auction sales have recovered in recent years, increasing competition with Christie’s for consignments has eroded profitability and kept BID shares below their pre-recession highs. This set up the conditions for an extended battle with activist shareholders beginning in 2013.

Activist Battle

Dan Loeb’s activist hedge fund Third Point initially filed a 13D in late August 2013, declaring a 5.7% stake in Sotheby’s that eventually reached nearly 10% (currently 9.6%). Third Point called the situation at Sotheby’s a crisis of leadership and called for Chairman and CEO William Ruprecht to resign. Loeb cited as evidence the Company’s loss of market share in the key, rapidly growing contemporary and modern art category. Other criticism included underperformance internationally, especially in emerging markets like China and the Middle East, and the lack of a strong technology/Internet sales platform. Third Point also called out Sotheby’s management team’s lack of “skin in the game” with CEO and Chairman Ruprecht holding just 153,000 shares (excluding unvested shares) or a 0.2% stake in BID. Third Point also ridiculed the Company’s lavish travel and entertainment expenditures and lack of cost controls. Activist hedge fund Marcato Capital also disclosed a 5% position in July 2013 and has built its stake to 9.5%. Marcato’s public commentary on Sotheby’s has primarily concentrated on the Company’s lagging return on equity and poor capital allocation policies.

In response, in October 2013 Sotheby’s adopted a shareholder rights plan or poison pill that, among other restrictions, prevented outsiders from acquiring 20% of the Company. The Company resisted the activists’ efforts for months, with an extended proxy battle for board control that included multiple lawsuits. Finally on May 4, 2014, Sotheby’s and Third Point reached a settlement that included withdrawal of Third Point’s litigation over BID’s shareholder rights plan. Third Point received three board seats and signed a standstill agreement.

New Management

In addition to the appointment of Third Point’s nominees to the board, there has been a fuller replacement of management since the proxy battle ensued. This started with the hiring of a new CFO, Patrick McClymont (previously a partner at Goldman Sachs’ investment banking business) in September 2013. More recently, Chairman and CEO William Ruprecht finally announced his resignation in November 2014. Ruprecht (age 59) was a Sotheby’s lifer (35 years of service) who had guided the Company since the anti-trust fallout in 2000, but his failure to grow profitability after the financial crisis and his recalcitrance in the face of shareholder pressure ultimately proved his undoing.

On March 16, 2015, the Company announced that Thomas “Tad” Smith (age 49) would replace William Ruprecht as CEO at the end of the month. Mr. Smith previously served as CEO of The Madison Square Garden Company (2014-2015), President of Local Media at Cablevision (2009-2014) and various positions at Reed Elsevier Group (2000-2009). The CEO and Chairman positions were also separated, with Lead Independent Director Domenico De Sole (age 71) appointed Chairman. De Sole was initially nominated to the board in December 2013 to pacify shareholders. Mr. De Sole formerly co-founded luxury retailer Tom Ford and served as CEO of Gucci from 1995 to 2004—his tenure ending shortly after French billionaire Francois Pinault’s (who also owns Christie’s) luxury goods holding company Kering (then PPR) gained control of Gucci. His extensive experience running a global luxury brand could be a valuable asset for Sotheby’s.

Business Description

Sotheby’s organizes its operations under three segments: Agency, Principal, and Finance. Agency is Sotheby’s core auctioneering business, encompassing the matching of sellers (or consignors) and buyers of artwork. Sotheby’s primarily conducts the Agency business via public auctions, which may be held at any of its 9 auction houses located around the world and typically number close to 250 per year. To a lesser extent, Sotheby’s brokers private sales. Sotheby’s Agency business generates revenue from commissions on completed sales, principally in the form of a “buyer’s premium” paid on top of the closing hammer price of property sold at auction according to a set schedule (12%-20% depending on the sale price). Sotheby’s may

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also collect additional commissions from the seller or share a negotiated portion of the buyer’s premium with the seller, depending on the individual case. Sotheby’s generated $825 million in Agency revenue in 2014 (87% of total Company-wide segment-level revenue) including $758 million in auction commissions on $5.2 billion in net auction sales (14.7% net auction commission margin) as well as $60 million in private sales commissions from $625 million in gross private sales. Auction revenue also includes auction guarantee and inventory revenue from gains and losses tied to artwork in cases where Sotheby’s Agency business has provided guaranteed minimum prices to consignors. The auction business also generates a small amount of revenue from other ancillary sources such as the production and sale of catalogues, insurance and advertising.

Sotheby’s Agency Segment Results ($ thousands)

2011 2012 2013 2014

Gross Auction Sales $ 4,986,639 $ 4,473,625 $ 5,127,155 $ 6,075,345

growth 16.3% -10.3% 14.6% 18.5%

Net Auction Sales $ 4,240,573 $ 3,809,656 $ 4,338,948 $ 5,151,419

Buyer's Premium 17.6% 17.4% 18.2% 17.9%

Auction Commissions $ 701,776 $ 622,391 $ 687,853 $ 758,213

Net Auction Commission Margin 16.6% 16.3% 15.9% 14.7%

Private Sales $ 814,581 $ 906,510 $ 1,179,038 $ 624,511

Private Sales Commissions $ 67,848 $ 74,632 $ 88,171 $ 60,183

Private sales margin 8.33% 8.23% 7.48% 9.64%

Auction guarantee and inventory activity $ 125 $ (1,623) $ (2,186) $ (15,462)

Other $ 21,989 $ 21,831 $ 19,801 $ 22,192

Total Agency Rev. $ 791,738 $ 717,231 $ 793,639 $ 825,126

The Principal segment includes Sotheby’s activity as a principal investor, rather than an auctioneer or

guarantor. Sotheby’s occasionally makes principal investment in artwork rather than providing auction guarantees to sellers. Principal activity is conducted to opportunistically acquire property for future auction and may be used to accommodate sellers needing liquidity. To a lesser extent the segment includes retail wine sales and its equity stake in the Acquavella Modern Art gallery/dealer (carried at $10.2 million). The segment held $59 million in inventory as of December 31, 2014.

The Finance business provides liquidity to artwork owners in the form of loans that are secured by borrowers’ artwork. This may take the form of short-term advances secured by property that consignors are committed to sell through the Company’s Agency business, or term loans (up to 2 years with variable interest rates) that the Company believes may establish beneficial relationships with collectors and/or may provide a future source of inventory. The Company may also occasionally issue term loans to refinance purchases of art by clients at Sotheby’s auctions or private sales. The average loan portfolio balance was $583 million in 2014 and generated a 7.2% gross margin or $42 million in finance revenues.

Sotheby’s Performance by Segment ($MM)

Year ended December 31, 2014 Agency Principal Finance All

Other Reconciling

Items Total

Revenues $ 825,126 $ 69,958 $ 42,018 $ 9,956 $ (9,005) $ 938,053

Interest income $ 1,857 $ — $ 18 $ 8 $ — $ 1,883

Interest expense $ 35,189 $ — $ — $ — $ — $ 35,189

Depreciation and amortization $ 20,110 $ 298 $ 130 $ 37 $ — $ 20,575

Segment income before taxes $ 188,045 $ 71 $ 26,491 $ 7,343 $ (28,929) $ 193,021

From a geographical standpoint, the high end art market is increasingly global with Sotheby’s helping to

connect buyers and sellers from across the world. But based on the location where the physical sales are conducted, Sotheby’s still generates the lion’s share of revenue from its auction houses in New York, London, and Hong Kong. Overall the Company generated $397 million in revenue (42%) in the U.S., $271 million in the UK (29%) and $165 million in China (17%) in 2014.

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Sotheby’s Revenue Breakdown by Country ($ thounsands)

2012 2013 2014

United States $ 338,162 $ 352,450 $ 397,113

United Kingdom $ 221,716 $ 230,304 $ 271,505

China $ 108,399 $ 153,909 $ 165,066

France $ 40,972 $ 46,891 $ 48,032

Switzerland $ 41,061 $ 41,150 $ 46,226

Other countries $ 25,961 $ 39,465 $ 19,116

Intercompany revenue $ (7,779) $ (10,491) $ (9,005)

Total $ 768,492 $ 853,678 $ 938,053

Industry Dynamics and Recent Environment

The artwork collection market is worldwide and almost immeasurably large. According to The European Fine Art Foundation (TEFAF), the global art and antiques market recorded over €51 billion (roughly $60 billion) in transactions during 2014. The overall market is highly fragmented, with at least 40,000 art dealers, galleries, and auction houses catering to millions of collectors around the world. There were an estimated 39 million transactions in 2014 according to TEFAF, equating to an average transaction value of just modestly over $1,000.

Duopoly at the Top

Despite the fragmented nature of the overall art market, the landscape becomes much more concentrated at the higher end of the spectrum. Private art dealers (including gallery and art fair sales) likely account for at least a slight majority of overall transaction volume. However, only ~2% of dealers have sales over €50 million and auctioneers account for a larger share of high value sales. Looking toward the highest end of the market, a virtual duopoly between Christie’s ($6.8 billion in auction sales in 2014) and Sotheby’s ($6.0 billion) exists outside of Mainland China (which is still nearly shut off from direct access for Western auction houses). By comparison, Phillips, the largest competitor behind Sotheby’s and Christie’s outside of Mainland China, reportedly generated just $337 million in art sales as of 2013

2 and we estimate auction sales

totaled less than $500 million in 2014 based on press releases. Phillips spent hundreds of millions of dollars trying to crack into the impressionist and modern art market around the turn of the century without success, which ultimately led parent LVMH to sell the Company in 2002-2003 (the largest chunk sold for a symbolic $1) just 4 years after taking control.

Including private sales, Sotheby’s and Christie’s accounted for $15 billion or roughly 25% of total art market sales last year, with the share far higher at the high end of the market. According to TEFAF there were only 1,530 lots sold at auction for over €1 million in 2014 including only 96 for over €10 million. Although not quite an apples-to-apples comparison ($/€), Sotheby’s reported 743 lots sold for over $1 million (for an aggregate $3.2 billion hammer price before adding buyer’s premium commissions) which roughly translates to close to 50% share of these highest value auctions.

Sotheby’s and Christie’s have established their positions over the course of 200-plus years, and there are many reasons to believe they will retain their dominance over the long term. There are huge network effects in the auction business, with the ability to draw on a large base of potential bidders an essential factor in any successful auction. Sotheby’s has built relationships with thousands of collectors and dealers across the globe, with 90 offices in 40 countries. These factors enable the Company to source high value art for auction and attract maximum demand, offering the best chance for a successful sale. Sotheby’s specialists are also experts in determining the authenticity and provenance/sales history of works of art, and its brand alone lends an additional aura of authenticity and prestige to any auction. Sotheby’s can provide expertise in valuation, handling, storage, etc. in over 70 categories of fine art, decorative art and jewelry.

2 Financial Times, “Could Phillips be a Game Changer?” 10 Sep. 2014.

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Strong Long-Term Trends but Recent Share Loss

Sotheby’s historical results reflect the Company’s dominant position in a stable (over the long term) industry. While there have been waves in terms of the level of pricing competitiveness with Christie’s to win consignments, Sotheby’s auction sales have grown at a very impressive rate over the long term. Overall, aggregate auction sales (including the buyer’s premium) increased at an impressive 8.5% CAGR from $2.7 billion in 2004 to $6.1 billion in 2014. During the preceding 12 years from 1992 to 2004, net auction sales (gross auction sales unavailable) increased at a still very healthy 6.2% CAGR. Auction revenue growth has not quite kept up with auction gross sales over the long run, but has tacked fairly closely; auction revenue grew at a 6.4% CAGR between 2004-2014.

Over the past several years, Sotheby’s revenue model has more markedly de-coupled from auction results. This reflects share gains by Christie’s and an increasingly competitive pricing environment, with steadily declining auction commission margins. As illustrated in the following chart, Sotheby’s auction commission margins declined from 18.3% in 2010 to 14.7% in 2014—the Company’s lowest on record looking back to 2003. While gross auction sales grew by 42% over that time frame, Sotheby’s Agency revenue increased by just 13%. Overall, the Company did not surpass its 2007 peak revenue total until 2014. By comparison, Christie’s reported an approximately 54% increase in auction sales (revenue is not publicly disclosed) over the same time. This suggests Sotheby’s has not only resorted to heavy commission discounting to win auction consignments, but has also lost ~200 bps of market share to Christie’s—not an ideal combination.

Sotheby’s Auction Margins Declining and Losing Share

18.8%

16.4%

18.7%

17.0%

16.5%

15.1%

20.7%

18.3%

16.6%

16.3%

15.9%

14.7%

12%

14%

16%

18%

20%

22%

$0

$1

$2

$3

$4

$5

$6

$7

$8

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

So

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Au

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arg

in

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B)

Sotheby's Auction Sales Christie's Auction Sales (est.)

Sotheby's Net Auction Commission Margin

New Management Teams May Spur More Rational Pricing

While these trends are not encouraging, recent management shakeups at both companies could be catalysts for a more rational pricing environment. Third Point head Dan Loeb has specifically voiced concerns over Sotheby’s pricing strategy. As far back as October 2013, he noted in his letter to then-Chairman and CEO Ruprecht, “ … based on discussions with market participants, it is our understanding that it has been Sotheby’s who has most aggressively competed on margin, often by rebating all of the seller’s commission and, in certain instances, much of the buyer’s premium to consignors of contested works.” The recent appointment of industry outsider Tad Smith as CEO, as well as three Third Point nominees to the board (including Dan Loeb), bodes

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well for a change in strategy. As Third Point further described, “Sotheby’s should be competing based on the quality of its service, its expertise, and ability to generate the highest possible price for its customer.” Interestingly, Christie’s also unexpectedly announced the replacement of CEO Stephen Murphy in December 2014, just weeks after Mr. Ruprecht’s announcement and at least ostensibly due to the destructive pricing environment, according to some reports.

3

In fact, Sotheby’s has already taken some action in 2015, announcing a hike in its base buyer’s premium rates in February. At the standard rate, buyers will now pay 25% commission on the first $200,000 of the sales price, 20% between $200,000 and $3 million, and 12% thereafter. The previous cut-offs were $100,000 for 20% and $2 million for the 12% rate. This should provide a roughly $40 million (~5%) impact on auction commission revenue in 2015. A reduction in the level of auction guarantees/rebating (discussed later) will be far more important in improving auction margins going forward, but we are optimistic this represents a first step in a much broader change in strategy away from excessive competition on price by Sotheby’s new management. The CEO change at Christie’s may also portend a move away from their market share-driven strategy of recent years.

Market Outlook and Growth Prospects

Beyond an improvement in the pricing environment, there are several favorable tailwinds and/or areas of underperformance that collectively form an attractive list of opportunities for Sotheby’s new management team to capitalize on in the coming years. In the following sections we detail some of the more meaningful opportunities.

High Net Worth Individuals

Given the demographics of the high-end art collector crowd, the ongoing global expansion of the high net worth class represents a favorable long-term tailwind for Sotheby’s. The number of high net worth individuals (HNWI; defined as $1 million or more in net investable wealth) exploded 15% Y/Y in 2014 to 13.7 million with $52.6 trillion in wealth, according to UBS. This is approximately double the 7 million HNWIs with $27.7 trillion in wealth in 2003. Looking at the ultra high net worth (UHNW; $30 million or more in investable wealth) segment that more closely overlaps with Sotheby’s clientele, the population exceeded 211,000 with combined wealth of $29.7 trillion. These totals are up 6%-7% Y/Y. UBS predicts ~20% growth over the next 5 years to 250,000 and >30% growth in wealth to in excess of $40 billion, which if realized should be highly supportive of similar growth rates in the art world.

4

Emerging Markets

Beyond the broadly favorable environment for wealth generation among the ultra-wealthy, the ongoing shift in wealth generation toward emerging markets should support the rise of a new generation of art collectors in emerging markets. Notably, Asia has seen an explosion in the ultra-wealthy since the global recession, led by China. While growth slowed in 2014, Asia still saw a 5.8% increase in UHNW individuals’ collective wealth to $7.0 trillion, placing it fairly close behind Europe ($8.4 trillion) and the U.S. ($10.3 trillion) as the third-wealthiest region. Meanwhile, the Middle East (up 13.1% to $1.0 trillion) and Africa (up 12.9% to $395 billion) were the fastest growing UHNW regions in 2014 albeit from much lower bases. To support this growth, Sotheby’s has opened or expanded its offices around the globe, including in Qatar, Russia, Brazil, and China. BID significantly expanded its Hong Kong gallery/exhibition facilities in 2011-2012. The Company also received approval from the Chinese government for a 10-year equity JV with Beijing GeHua Art Company in 2012 and held its inaugural Beijing sale in September 2012. The Company now has locations in 40 countries and reported one third of auction buyers were new to the Company in 2014, accounting for approximately one fifth of sales globally.

The impact on the art world has already been evident in Asia in recent years, especially in China. According to some reports, China is now the second largest market for art and antiques after the U.S. For Sotheby’s, this has translated into explosive sales growth at its Hong Kong auctions and for Asian art as a major collector’s category more generally. The Company expanded its Hong Kong calendar beyond the traditional twice-annual auctions in 2013, with the first evening sale in Hong Kong in 4Q13. Overall Sotheby’s revenue in

3 The Wall Street Journal, “Christie’s CEO Murphy Steps Down,” December 2, 2014

http://www.wsj.com/articles/christies-ceo-murphy-steps-down-1417541875 4 Wealth-X and UBS Ultra Wealth Report, 2014

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China has increased from $60 million (6.5% of total) in 2007 to $165 million (17.4%) in 2014 (principally in Hong Kong plus $28 million in sales from 2 exhibitions held in Beijing). The Company has also held an increasing number of auctions featuring Asian art around the globe in recent years. Sotheby’s Asian art auction sales increased 44% Y/Y to an estimated $840 million in 2013, up from an estimated ~$500 million in 2010. Asian art sales were not separately disclosed in 2014 but the Company did disclose they recorded over $900 million in sales in Asia and over $1 billion in sales to Chinese buyers around the world.

Sotheby’s Annual Revenue in China, 2007-2014 ($ millions)

$60$52 $50

$112

$156

$108

$154

$165

$0

$20

$40

$60

$80

$100

$120

$140

$160

$180

2007 2008 2009 2010 2011 2012 2013 2014

Rev

enu

e ($

MM

)

Source: Artprice.com, Annual Report, 2014

Contemporary Art

Contemporary art is a key category that has increasingly become a must-have for high-end collectors. Postwar and contemporary art (artists born after 1910) has grown to a ~48% market share of auction sales according to TETAF, up from only ~28% in 2003. While this growth partially reflects the burgeoning market for contemporary Chinese art, there has also been a major surge in value for some American and European artists. However, Sotheby’s does not appear to have re-deployed enough resources into the category and is under-represented relative to other categories. The Company’s contemporary art sales increased a solid 22% or $261 million in 2014, but this translates to only $1.45 billion (hammer price) or 28% of the Company’s overall net auction sales. By comparison, Christie’s reported a far more impressive 39% increase in post-war and contemporary art sales in 2014 to $2.8 billion. Although the comparison is inexact (Christie’s figures include post-war and contemporary gross auction sales plus private sales), we estimate this translates to roughly 50% greater contemporary sales by Christie’s than Sotheby’s in 2014. Sotheby’s underperformance in the category has been highlighted by Third Point, among others, and we would expect the new management team to more pro-actively confront this weakness. The Company’s Worldwide Head of Contemporary Art Tobias Meyer departed in late 2013, which may explain some of the recent underperformance. The Company has a team of 60-plus professionals in the category today, but we would expect the Company to look to cut overhead in struggling art categories and reposition its workforce to win more contemporary art consignments.

Private Sales

The private sales business is another opportunity for Sotheby’s. The Company’s private sales volume grew nicely post-recession until last year, surpassing 2007 levels by 2011. To further support private sales, the Company launched private selling exhibition galleries, branded S-2, in New York in 2011 and in London in 2013. However, as illustrated in the following chart, despite the overall gains (pre-2014) the Company has ceded share to Christie’s since the recession. The Company drastically underperformed in 2014, with private sales plummeting 47% to $625 million versus 26% growth to $1.5 billion at Christie’s. The Company blamed the performance on a number of “non-recurring high value transactions” in 2013, with private sales commission revenue declining 32% to $50 million in 2014 despite a 43% increase in the number of transactions. With the overall dealer sector (including dealer and gallery sales plus private sales) accounting for an estimated 52% of

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global art trade according to TETAF, there is no reason Sotheby’s should not be able to garner a much larger share of private sales over time given its scale and expertise in sourcing art and its reputation in the industry.

Sotheby’s vs. Christie’s Private Sales, 2006-2014

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2006 2007 2008 2009 2010 2011 2012 2013 2014

Pri

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Sotheby's Christie's

Online Sales

Online sales of art and antiques reached €3.3 billion or a 6% share in 2014 and are growing at ~25%, according to TETAF. However, online sales are still largely relegated to the low end of the price spectrum (principally between $1,000 and $50,000). Expansion of online sales at the higher end offers the potential to introduce more first-time buyers into the auction process, particularly younger buyers and those in emerging/under-represented countries. At the same time, capturing a greater share of the lower end of the market could still provide a meaningful boost to Sotheby’s top line. This has been another area of under-investment for Sotheby’s prior to 2014. BID recorded a 42% increase in online buying last year according to the Company, but this included just 10 lots sold for over $500k. Christie’s again appears to be outperforming here, recording a 54% increase in online-only sales to $35 million in 2014.

Fortunately, the Company appears to be stepping up its focus here. Fifteen years after a highly anticipated initial dot-com era foray with Amazon that produced no tangible results, and 13 years from the Company’s initial partnership with eBay, Sotheby’s re-launched a partnership with eBay in July 2014. Sotheby’s will be the anchor tenant for the launch of eBay Live Auctions in the spring of 2015. This will enable eBay clients to bid on live auctions in real time, beginning with Sotheby’s New York auction house. In particular, this partnership could allow the Company to capture more lower-priced (but potentially higher margin) lots via the online channel without requiring extensive investment or tarnishing the brand. For now, evening sales and other high value items will be excluded from eBay.

Financing Business

Artwork financing is an increasingly large business that Sotheby’s historically has not participated in meaningfully. With an unmatched (outside of Christie’s) network of existing relationships with art collectors as well as expertise in valuing art, this is a business Sotheby’s should own. The Company only fully developed a dedicated Finance business unit in 2013, but has already grown the portfolio to $644 million by year-end 2014. With an attractive 7.2% return on assets on low-risk lending (loan to value of 48%) and minimal operating costs, this could turn into an attractive profit stream for Sotheby’s. Gross profit totaled $33 million in 2014.

Brand Expansion and Licensing

Better monetization of the Sotheby’s brand equity is another potential growth lever that has been cited by activist shareholders. The Company’s largest licensing deal is for Sotheby’s International Realty, the Company’s former luxury real estate brokerage business that was sold to Realogy for $100 million in 2004. As part of the sale, the Sotheby’s International Realty trademark is licensed to Realogy (50-year term with a

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50-year renewal option) and currently generates ~$7 million per year in licensing revenue. Additional licensing activity includes art auctions in Australia, art education, and print management. Given the brand’s status as a purveyor of luxury, there should be room for additional brand extension across luxury categories. This could include licensing as well as direct operational expansion into new sales/auctions of other luxury goods. The Company has made some effort to expand the brand, including the S-2 galleries and Sotheby’s Wine auctions. More recently, in February 2015 Sotheby’s made a $30.7 million investment for a 25% stake in collector car auctioneer RM Auctions in February 2015. The new partnership will be rebranded RM Sotheby’s, and the Company has governance participation as well as the potential to increase its stake over time. The collector car market is an estimated $2 billion and growing nicely.

Art Market Risks and Sotheby’s Exposure

Auction Guarantee and Principal Risk

Sotheby’s provides minimum guaranteed auction sale prices to consignors in some cases, in order to secure artwork. The Company typically negotiates to receive a percentage of the overage (excess proceeds above the guaranteed price) in the case of a sale. But Sotheby’s also takes on the liability to cover the difference if the sale price is below the guarantee. The Company must also pay the guaranteed price if no sale is completed, although Sotheby’s is entitled to recover this in a future auction or sale. Sotheby’s also occasionally makes principal investment in artwork rather than providing auction guarantees to sellers.

While auction guarantees do create some financial exposure for Sotheby’s, the risk of loss appears limited. Generally, Sotheby’s takes multiple safeguards to minimize the liability created by auction guarantees and principal activity. The Company’s guarantee or purchase price is based on a highly informed estimate of a work’s market value, and historically its pre-sale auction estimates prove reasonable. Sotheby’s did issue large amounts of auction guarantees prior to the financial crisis, peaking at $902 million in net auction guarantees issued during 2007. This led to an $83 million loss on principal activities in 2008 including $60 million of losses on auction guarantees. Nonetheless, the Company recovered $44 million of this loss via auction commissions on the same properties, and the Company had virtually eliminated exposure by the end of the year with only $7 million of issued net guarantees during 2009 (which may also explain a substantial part of the decline in sales volume).

Additionally, since 2009 Sotheby’s has generally obtained counterparties to take on a portion of the risk. Typically these are major art dealers or collectors, who agree either to provide an irrevocable bid at auction or to share in covering any shortfall if the auction guarantee is not met. In exchange, counterparties are generally entitled to a share of auction commission and/or overage if the property is successfully sold to another party. Overall losses were modest in recent years, with the Principal segment basically break-even. The Company also recorded a $1.7 million write-off of an irrevocable bid counterparty’s liability in 2Q 2013 and $10 million in inventory writedowns in 2014 ($8.8 million in 2013).

It is worth keeping an eye on this part of Sotheby’s business, however, as the prevalence of auction guarantees has once again crept up in recent years. During the past year, the Company’s credit agreement was amended to increase the maximum limit of net auction guarantees (after irrevocable bids and other risk-sharing agreements) to $600 million from $300 million. Overall Sotheby’s auction guarantees totaled $148 million at year-end 2014, partially offset by $42 million in irrevocable bids. Guarantees declined to $79.5 million (prior to $28.2 million in irrevocable bids) by February 25, 2015 following the completion of auctions in early 2015. The Company held an estimated liability of $5.3 million on its balance sheet for these guarantees as of year-end 2014. By comparison, total auction guarantees were $61.5 million at the close of 2013. At year-end 2012, total auction guarantees were $69.5 million gross and were essentially fully covered by irrevocable bids, and they were fully eliminated by the close of February 2013 auctions. The Company’s inventory balance should also be monitored. Inventory totaled $217 million at the close of 2014, including $158 million within the Agency segment principally consisting of failed auctions of guaranteed properties. This is up from $192 million at year-end 2013 and $92 million a year earlier.

Despite the growth in guarantees, the balance sheet risk remains relatively modest. In our estimation, the far greater risk—already creating an ongoing financial impact—from the growth in guarantees is on net auction commissions as evidenced in declining net auction commission margins. This likely reflects the growing impact of revenue sharing arrangements with auction guarantee counterparties. As discussed, we are optimistic

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the new management team will re-evaluate Sotheby’s consignment strategy and refocus on pricing discipline over maintaining market share at all costs.

Art Market Bubble Risk

Somewhat related to the risk that Sotheby’s over-extends itself financially with guarantees/principal investments is the broader risk that the art market is entering “bubble” type territory and could be subject to a severe downturn. Without a doubt, the severe downturn in 2008-2009 demonstrated that art auction activity is closely tied to the broader economy. However, the current global macroeconomic environment is hardly comparable to 2007 and art market activity has only recently fully recovered to pre-recession levels.

Taking a longer-term perspective, art collecting is not exactly a new hobby; in fact it is one of the oldest known to civilization, and there is no reason not to expect global demand to continue to grow over time. Further supporting Sotheby’s art brokerage business, art has proved not to be just an item for consumption, but a decent store of value over time (at least for premium pieces). We would not advocate art as an investment class per se, and there are many complicating factors in measuring the long term investment returns on artwork (selection bias, liquidity, transaction and storage costs, etc.). Nonetheless it is widely viewed as such, and popular measures of the high-end art market provide some support. According to the widely-cited Mei Moses World All Art Index, long term returns (gross) are comparable to the stock market; the index recorded a 7% trailing 10 year CAGR from year-end 2003-2013 versus 7.4% for the S&P 500 Total Return Index. Post-war and contemporary art (10.5%) and traditional Chinese art (14.9%) performed even better.

5 Overall, the art market is

estimated to have grown from $20 billion in 2003 to $66 billion in 2013 (12.7% CAGR) according to TEFAF data. Looking longer term, the Mei Moses Index has increased at a very respectable 6.9% CAGR over 40 years from 1973-2013.

Nor does the art market look bubbly based on current penetration rates. As mentioned, the population of high net worth individuals is approximately 13.7 million, encompassing $53 trillion in wealth. At least 600,000 millionaires (of 32 million) are mid-to-high level art collectors according to TEFAF, equating to a modest penetration rate of only 4-5%.

6 Total transaction volume of over $60 billion translates to turnover of only 0.1% of

HNWI wealth. According to Deloitte estimates, 400,000 HNWI/UHNWI art collectors hold $1.5 trillion in art assets or ~3% of wealth. Looking at the extreme end of the wealth strata that more closely overlaps with Sotheby’s business, according to UBS the average billionaire holds only 0.5% of his or her net wealth in art. This suggests the art market is still very far away from reaching blatantly “bubble” sized proportions. It should also be noted that private collectors account for only approximately 30% of dealer transactions according to TETAF, and institutional activity may be less subject to volatility.

China Risk

If there is a real risk of an art bubble anywhere, China is clearly the greatest concern. As detailed, Sotheby’s China sales have grown ~175% since 2007. Overall, based on sales at the top 4 auction houses, art sales nearly quadrupled between 2008-2012 before cooling off over the past 2 years. However, we would note that the market size is not clearly disproportionate to the nation’s economy or its population of ultra-wealthy individuals. Still, art selling activity will likely be volatile in China based on the country’s economic path and political environment. Importantly, the Mainland China market is much more bubble-prone than Hong Kong given its insularity, and Sotheby’s direct exposure to Mainland China auctions is extremely modest. Mainland China auction sales (as measured by auctions at the top two Mainland auction houses Beijing Poly Auction and China Guardian) exploded from approximately $400 million in 2008 to $3.1 billion in 2011, before crashing back to $1.49 billion in 2013 according to Deloitte and ArtTactic data. This reflects the typical boom-bust patterns seen in Chinese markets in recent years and in particular a crack-down on shadow Chinese art investment funds/trusts and likely some impact from President Xi’s broader crackdown on graft. But the Hong Kong art market features a much deeper, global base of buyers and has posted steadier growth over time. The Company did see a fairly sharp decline in Hong Kong revenue in 2012 which was partially attributable to China’s general economic slowdown, but management also cited a number of major single-collector sales in 2011 that were not repeated. BID’s China revenue rebounded back above 2011 levels by 2014.

5 Mei Moses art indexes via Deloitte Art & Finance Report 2014

6 Bloomberg Business, “Art Market Nears Record With $66 Billion in Global Sales,” March 12, 2015

http://www.bloomberg.com/news/articles/2014-03-12/global-art-market-surged-to-66-billion-in-2013-report

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Balance Sheet /Free Cash/Capital Deployment

Sotheby’s has historically posted relatively strong free cash flow, with high EBITDA to free cash flow conversion. Working capital fluctuations (particularly due to the impact of Sotheby’s major auction season near the year-end on receivables/payable balances) create annual volatility, and operating cash flow totaled just $44 million in 2014 due to the timing of payments to consignors on late 2013 sales as well as the funding of inventory acquisitions. But leveraged free cash flow totaled $214 million ($3.09/share) in 2013 and averaged $174 million over the past 5 years, or approximately 64% of EBITDA. This reflects the modest balance sheet leverage and the business’ low capital intensity, with capital expenditures averaging <2% of revenues.

Sotheby’s balance sheet has been under-leveraged for many years, which ultimately contributed to the arrival of activist shareholders in 2013. In fact, the Company held a net cash position on its balance sheet through 2012-2013 while only paying modest annual dividends ($0.40/share) and not repurchasing stock. Facing intense shareholder pressure, Sotheby’s replaced its CFO in late 2013 and overtook a review of its capital allocation policy, ultimately responding by issuing a $300 million special dividend ($4.34/share) in February 2014. The Company also purchased a token $25 million in stock in 2014 under a 5-year, $150 million authorization that essentially offsets dilution from stock-based compensation.

Despite the initial efforts, the Company remains very underleveraged today, with $980 million in gross debt (including a $235 million mortgage and $445 million in borrowings to support the Finance segment) versus $694 million in cash ($531 million of which is held overseas, most subject to additional tax upon repatriation) or net leverage of just below 1.0x 2014 EBITDA. Excluding Finance segment debt and equity, the Company actually holds a modest net cash position. Fortunately, improvement looks in store for 2015. Sotheby’s suspended a Company-wide capital allocation review earlier this year as the Company decided to wait for the new CEO/management team to participate. With the appointment of Tad Smith as CEO in late March, the announcement of a more meaningful return of capital plan appears imminent.

In addition to simply taking on more debt to return capital to shareholders, there are numerous levers that a more return on equity focused board/management (as Sotheby’s finally appears to possess) could pull to unlock very substantial incremental capital for shareholders. Real estate represents a substantial portion of Sotheby’s asset base that has been long overlooked. The Company owns its flagship York Property in New York City (land and building including 489,000 square feet of building area), which houses its North American auction salesroom and principal N.A. exhibition space. The Company re-acquired the property in February 2009 for $374 million and currently holds a $235 million mortgage due July 2035 against the property. The mortgage includes optional prepayment on July 1, 2015, otherwise the interest rate increases from 5.6% to 10.6%. It nearly goes without saying that, given the current interest rate environment, management plans to refinance the mortgage before July. This presents Sotheby’s the opportunity to take out a much larger mortgage on the property or even explore a sale-leaseback transaction. Given the building’s prime location and the marked recovery in the New York City real estate market since the recession, the York Property is likely worth at least 50% more than the Company paid for it. Sotheby’s also holds 235,000 square feet of prime real estate at New Bond Street, London that is primarily either owned or held under freeholds/long term leases.

Together we estimate Sotheby’s could generate at least $400 million by mortgaging or executing sale-leasebacks on these properties. Additional cost savings from rationalization of its real estate and/or moving back-end functions to lower-cost locations may also be possible. Regarding real estate, Sotheby’s disclosed in the Company’s 2014 10-K,

“Management believes Sotheby's worldwide premises are adequate for the current conduct of its business, but has performed a review of its real estate holdings, including the York Property and the New Bond Street premises. As the Board of Directors is currently searching for a new CEO, the results of this review will be further evaluated by the Board in consultation with the new CEO after taking into account the strategic and operating requirements for these locations.”

Sotheby’s also has substantial under-productive working capital trapped in its operating businesses. In the Finance segment, the Company historically financed its portfolio with cash on hand. In response to shareholder pressure, the Company opened a dedicated Finance segment credit facility in 2014. The Company currently holds $445 million or a 69% leverage ratio based on the year-end Finance portfolio balance. Average

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borrowings were $306 million or only in the neighborhood of 55% of receivables during the year. This is well below the Company’s initial 85% leverage target, which management attributed to loans not qualifying under its facility and using foreign cash balances versus paying repatriation taxes and taking on foreign loan funding. We estimate the Finance segment generated a reasonably attractive ~7.5% return on assets but just a 7% return on equity during 2014. Given the low cost of borrowing (2.9%) and low risk (average loan-to-value 48%), this suggests the Finance segment could still support substantially more leverage. At an 85% leverage ratio, we estimate the Company could have generated a far more attractive 18% ROE while freeing up another ~$169 million in equity.

As discussed earlier, Sotheby’s also holds $217 million in inventory between the Agency and Principal segments—more than double the balance held only 2 years ago. Sotheby’s appears to be generating a questionable return on its principal investment portfolio and excessively using auction guarantees. Between the lack of principal segment income and inventory write-downs, this inventory is consistently producing net losses prior to accounting for any auction commissions ultimately earned on the portfolio. A return to a more disciplined art procurement strategy could potentially free up another $100 million or more of unproductive/loss generating capital.

Furthermore, in the Agency business, Sotheby’s could free up capital by tightening its payment terms. The Company’s standard auction policy requires buyers to pay within 30 days and the Company typically pays consignors within 35 days. However, the Company sometimes provides buyers extended payment terms “typically…no longer than one year” other than in “limited circumstances.” While the Company tries to match consignor payments to the buyer’s schedule, clearly there are some exceptions—at year end 2014, Sotheby’s reported $116 million in receivables for which Sotheby’s has already paid the consignor plus another $23 million in receivables extended over one year that have been reclassified as notes receivable. A stricter payment policy in the Agency business could potentially free up another ~$100 million in working capital.

We Estimate Sotheby’s Could Unlock >$14/share in Capital ($ thousands)

York Property @ $561MM (50% appreciation from 2008 purchase price), 70% LTV $ 157,700

New Bond Street/London @ $2.3k/sq. ft, 158.5k sq.ft., 70% LTV $ 245,525

Excess Finance segment equity @ 85% debt financing $ 169,073

Excess Inventory $ 100,000

Excess Net Receivables $ 100,000

Incremental Debt @ 3x Agency 2014 EBITDA (factoring incremental mortgage debt) $ 232,009

Excess Capital $ 1,004,307

per Share $ 14.43

Collectively, we estimate the aforementioned actions could free up close to $800 million in incremental capital. If Sotheby’s were to leverage the balance sheet at 3x Agency segment 2014 EBITDA ($243 million), this could free up another $200 million-plus in cash even after counting the incremental real estate borrowing toward the leverage target. All together, we estimate Sotheby’s could unlock over $1 billion or in excess of $14/share (34% of the current market cap) in capital based on 2014 figures. Another year of earnings growth and free cash flow could take the total up to $1.3 billion. While we do not expect the Company to complete these changes overnight, fortunately the new board/management team appears keenly aware of the need to free up under-earning capital. We would also note that Marcato Capital in particular has emphasized the need for a balance sheet shakeup, arriving at a similar $1.1 billion in excess capital using their own estimates (April 2014 presentation).

Financial Outlook and Valuation

Sotheby’s shareholder returns have been somewhat underwhelming for several years. Shares performed roughly in line with the market over the past 2.5 years but are still trading roughly in line with their mid-2007 levels. More recently, BID shares have pulled back nearly 20% from their late-2013 highs as the initial investor enthusiasm over the arrival of high-profile activist shareholders quickly simmered as Sotheby’s buckled down for an extended proxy battle and the Company’s 2014 results underwhelmed. At the current share price

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Sotheby’s trades at approximately 19x TTM P/E (FY 2014) and 10x 2014 EV/EBITDA. While this is not overwhelmingly cheap on the surface, we do not believe it reflects the Company’s hidden excess capital or its tremendous brand value and dominant position in a high margin, duopoly-type business with an impressive long-term record of above average growth in the underlying art market.

Importantly, the recent pullback also appears to be discounting the likelihood that ongoing shareholder activism and the new management team will catalyze meaningful change. On the contrary, we believe the Company is closer than ever to making real changes. Activist shareholders are likely getting restless after nearly 2 years of sub-par returns on their investments, and they have finally succeeded in revamping the board and appointing a new CEO. The Company’s history of sub-par capital allocation and a “lazy” (unleveraged/under-leveraged) balance sheet should be the easiest and quickest fixes. As detailed, we believe the Company could quickly unlock in excess of $1 billion in capital that could be returned to shareholders. Operational changes will take more time, but it already appears Third Point and new management are aware of the need to take action. The list of potential reforms includes implementing better auction pricing discipline; re-deploying assets into key categories where the Company is underperforming like contemporary art sales and private sales; expanding and improving ROE for financing activity; and developing a better online sales channel.

The aforementioned reforms could have a meaningful impact on Sotheby’s earnings power in the medium term, and should solidify its competitive position in the longer term. But in the near term, an even greater impact could be accomplished via cost cutting and greater expense discipline. Sotheby’s has not been an exemplar of expense discipline over the years, with expense growth steadily exceeding revenue growth. Since 2010, adjusted EBITDA margins have declined from 38.0% to 31.8% despite a 21% increase in revenues. Looking even farther back, EBITDA margins in 2014 were in excess of 400 bps below the pre-recession peak in 2007. However, the Company is already showing great progress in reversing this trend. Facing intense shareholder pressure, the Company initiated a review of its cost structure in late 2013 and implemented a cost savings initiative in 2014 that ultimately reduced core operating expenses by 1.5% and helped produce a 250 bps Y/Y improvement in EBITDA margins. As illustrated in the following table, this included across-the-board marketing and general and administrative savings.

Marketing and General & Administrative Savings in 2014 ($ thousands)

2014 2013 Variance

F/(U) Original

Commitment Variance

F/(U)

Auction direct costs as a % of Net Auction Sales * 1.55% 1.78% 0.23% 0.10% 0.13%

Marketing expenses $ 16,566 $ 22,487 $ 5,921 $ 4,000 $ 1,921

Professional fees 54,285 61,624 7,339 9,000 (1,661)

Other general & administrative expenses 104,511 113,834 9,323 4,000 5,323

Total general & administrative expenses 158,796 175,458 16,662 13,000 3,662

Total marketing and general & administrative expenses $ 175,362 $ 197,945 $ 22,583 $ 17,000 $ 5,583

* Management’s original commitment of a 10 basis point reduction in this metric would have equated to approximately $5 million in savings assuming a similar level of Net Auction Sales as 2013; while a 23 basis point reduction equates to a cost reduction in excess of $10 million.

Unfortunately, it appears the Company’s 2015 expense plan represents a regression. As illustrated in the following table, the Company projects significant expense increases across the board in 2015. Some of these increases are a reflection of encouraging action in implementing growth opportunities the Company has under-invested in historically. However, this does not appear to be countered with meaningful cost cutting in core G&A/legacy expense lines that Sotheby’s margins suggest are still bloated. Furthermore, although salaries and related costs declined by 170 bps as a percentage of revenue in 2014, it still represents a hefty 33.1% and is projected to increase 4%-5% in 2015. With the subsequent announcement of Tad Smith as CEO in March

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2015, we believe the Company will explore much more aggressive cost savings initiatives than what has been announced/enacted to date.

Sotheby’s 2015 Expense Targets Underwhelm

Targeted Category of Expense Increase Business Rationale

Auction direct costs as a % of Net Auction Sales 0.05% Enhanced efforts to support new middle market auction sales

Marketing expenses, net of expected advertising revenues * 10%

Implementation of revamped marketing strategy to increase brand preeminence and accessibility

Full-time salaries 4% - 5% Investments in growth activities, as well as inflationary salary increases, net of savings from the restructuring plan enacted in July 2014

Professional fees 3% - 4%

Incremental senior level recruitment expenses, including the cost of recruiting a new CEO, and consulting fees associated with certain Board level strategic initiatives, among other items

Other areas of general and administrative expense 2% - 4%

Higher facilities related expenses, as well as higher travel and entertainment costs associated with increased business-getting activities

* Marketing expenses less revenue received from the sale of advertisements in Sotheby’s lifestyle magazines and other periodicals.

Regarding the outlook for auction activity in 2015, Sotheby’s disclosed in their 2014 10-K,

“The global art market continues to reflect strong demand and high prices. In this strong market, the competitive environment for high-value consignments is robust and auction commission margins remain under pressure.”

Year to date through April 27, 2015, BID’s aggregate auction sales total of $1.35 billion slightly trails 2014 figures of $1.38 billion and the Company’s forecast for auction results through June suggests sales will remain roughly in line with 2014. This reflects lower sales in the April auctions in Hong Kong and flat sales in the UK as well some currency headwinds. While the Company’s commentary also suggests more of the same in terms of auction commission margins, the new CEOs taking the helm at both Sotheby’s and Christie’s in 2015 may provide the catalysts for both companies to revisit their recent mutually destructive pricing strategies. This is clearly a top priority at Sotheby’s, with the Company implementing a price increase earlier this year.

Even under conservative assumptions, a combination of expense savings, auction commission margin improvement, and modest revenue benefits from incremental investments in under-performing categories presents highly attractive earnings upside for Sotheby’s. The following table illustrates our base case assumptions for Sotheby’s financial outlook over the next 3 years. In our base case, we assume Sotheby’s gross auction sales markedly slow from 18.5% in 2014 and an average of 10% over the past 4 years (and 8.5% over the past 10 years) to flat results in 2015 and 7% growth in the following years, roughly in line with longer term averages and the 40 year historical average appreciation rate in the high-end collectible art market (per Mei Moses Index). This implies no pickup in volume and no market share gains against Christie’s. Greater traction in the low-to-middle segment of the auction market (including through building out the online sales channel) could provide meaningful additional upside as well.

We project commission pricing remains under pressure in 2015, but the Company can expand auction commission margins gradually by 50 bps per year beginning in 2016 to 15.7% in 2017 (still marginally below 2012 levels and well under the 17% long-term average). Combined with the aforementioned gross auction sales growth, this will translate to nearly $200 million in incremental auction revenue in 2017. Importantly, incremental auction revenue via higher commissions carries almost 100% incremental margin. A recovery in private sales to $1.0 billion (just above BID’s 2013 levels and still 20% below Christie’s 2014 total) could add another $20 million in high margin revenue. In terms of cost savings over the next 3 years, we project salary and G&A expenses grow at mid single-digits in 2015 per Company guidance and continue to grow at or close to 4% per annum. This translates to roughly 10 bps in incremental operating leverage over the next 3 years, with upside if the Company gets more aggressive with cost savings or revenue exceeds our expectations. Taken together, these

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assumptions—which we view as relatively conservative—add up to an impressive 3-year EBITDA CAGR in excess of 13% to nearly $440 million by 2017.

Sotheby’s Historical Financial Results and Projections, 2015-2017E ($ thousands)

2011 2012 2013 2014 2015E 2016E 2017E

Gross Auction Sales $ 4,986,639 $ 4,473,625 $ 5,127,155 $ 6,075,345 $ 6,075,345 $ 6,500,619 $ 6,955,662

growth 16.3% -10.3% 14.6% 18.5% 0.0% 7.0% 7.0%

Net Auction Sales $ 4,240,573 $ 3,809,656 $ 4,338,948 $ 5,151,419 $ 5,148,597 $ 5,508,999 $ 5,894,629

Buyer's Premium 17.6% 17.4% 18.2% 17.9% 18.0% 18.0% 18.0%

Auction Commissions $ 701,776 $ 622,391 $ 687,853 $ 758,213 $ 756,844 $ 837,368 $ 925,457

Net Auction Commission Margin 16.6% 16.3% 15.9% 14.7% 14.7% 15.2% 15.7%

Private Sales $ 814,581 $ 906,510 $ 1,179,038 $ 624,511 $ 749,413 $ 869,319 $ 999,717

Private Sales Commissions $ 67,848 $ 74,632 $ 88,171 $ 60,183 $ 59,953 $ 69,546 $ 79,977

Private sales margin 8.33% 8.23% 7.48% 9.64% 8.00% 8.00% 8.00%

Auction guarantee and inventory activity $ 125 $ (1,623) $ (2,186) $ (15,462) $ (2,500) $ - $ -

Other $ 21,989 $ 21,831 $ 19,801 $ 22,192 $ 22,858 $ 23,543 $ 24,250

Total Agency Rev. $ 791,738 $ 717,231 $ 793,639 $ 825,126 $ 837,155 $ 930,457 $ 1,029,684

Total Rev. $ 831,836 $ 776,271 $ 863,629 $ 938,318 $ 931,417 $ 1,036,642 $ 1,102,428

Auction direct costs % net auction sales 1.54% 1.59% 1.78% 1.55% 1.60% 1.60% 1.60%

Marketing % rev. 1.8% 2.3% 2.6% 1.8% 2.0% 2.0% 2.0%

G&A % rev. 19.4% 20.4% 20.3% 16.9% 17.6% 16.3% 15.8%

Salaries and related % rev. 32.3% 35.2% 34.4% 33.1% 35.1% 32.8% 31.9%

Adj. EBITDA $ 292,955 $ 235,658 $ 246,438 $ 298,613 $ 280,200 $ 378,307 $ 437,280

Adj. EBITDA margin 35.2% 30.4% 28.5% 31.8% 30.1% 36.5% 39.7%

In valuing Sotheby’s, we ascribe a multiple of 10x 2017E EV/EBITDA, roughly in line with the Company’s current 10.1x EV/EBITDA multiple (excluding Financing segment net debt and prior to factoring in excess real estate) and long-term average. This is a discount to other high margin franchise businesses in light of the uncertainty in the trajectory of art auction volumes and ultimate margin gains. Factoring in excess capital and incremental free cash flow generation over the next 3 years, we derive a forward-looking intrinsic value estimate of approximately $70 per share for Sotheby’s. This implies 65% upside or a ~21% IRR looking out to the end of 2017. If management can make faster than anticipated headway in any of the aforementioned growth and cost savings initiatives and/or the auction market competitive environment improves faster than expected, there should be incremental upside to our intrinsic value estimate. Additional upside could come from return of capital/accretive capital deployment such as large scale share repurchases; our intrinsic value estimate ascribes no additional value to our projections for $700 million or more in net cash/real estate on the balance sheet by 2017. Re-leveraging the balance sheet to 3x 2017E EBITDA could potentially free up nearly $2 billion in capital or nearly 2/3 of Sotheby’s current market cap.

Sotheby’s Estimate of Intrinsic Value, 2017E ($ thousands)

EBITDA - 2017E $ 437,280 multiple 10x Enterprise Value $ 4,372,805

net cash (ex-Finance segment), 2017E $ 544,403 Real Estate - in excess of 2017E mortgages @ 70% LTV $ 168,405

Equity Value $ 5,085,613

Diluted Shares, 2017E 72,006

Sotheby's Estimate of Intrinsic Value per Share, 2017E $ 70.63

Implied Upside to Intrinsic Value 65%

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Risks

Risks that Sotheby’s may not achieve our estimate of the Company’s intrinsic value include, but are not limited to, failure to retain experts and their client relationships; failure to implement price increases or loss of market share due to stricter auction guarantee and commission pricing; sales declines in Asia due to intensifying competition from Beijing auction houses and/or macro factors; a general downturn in the art auction business; inability to reduce inventory and accounts receivable balances; dilutive capital deployment; and loss of key management personnel.

Analyst Certification

Asset Analysis Focus certifies that the views expressed in this report accurately reflect the personal views of our analysts about the subject securities and issuers mentioned. We also certify that no part of our analysts’ compensation was, is, or will be, directly or indirectly, related to the specific views expressed in this report.

Sotheby’s

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SOTHEBY’S

CONSOLIDATED BALANCE SHEETS

(Thousands of dollars)

ASSETS Dec. 31, 2014 Dec. 31, 2013

Current Assets:

Cash and cash equivalents $ 693,829 $ 721,315

Restricted cash 32,837 32,146

Accounts receivable, net 913,743 812,582

Notes receivable, net 130,796 176,529

Inventory 217,132 192,140

Deferred income taxes and income tax receivable 17,078 12,385

Prepaid expenses and other current assets 34,107 25,176

Total Current Assets 2,039,522 1,972,273

Notes receivable 568,942 336,896

Fixed assets, net 364,382 379,399

Goodwill and other intangible assets, net 14,341 14,850

Equity method investments 10,210 11,040

Deferred income taxes and income tax receivable 38,202 55,520

Trust assets related to deferred compensation liability 50,490 53,231

Pension asset 28,993 37,284

Other long-term assets 19,738 33,053

TOTAL ASSETS $ 3,134,820 $ 2,893,546

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current Liabilities:

Due to consignors $ 980,470 $ 922,275

Accounts payable and accrued liabilities 111,639 93,581

Accrued salaries and related costs 88,915 83,128

York Property Mortgage 218,728 3,630

Accrued and deferred income taxes 13,828 26,040

Other current liabilities 15,627 13,835

Total Current Liabilities 1,429,207 1,142,489

Credit facility borrowings 445,000 —

Long-term debt, net 300,000 515,148

Accrued and deferred income taxes 21,192 22,392

Deferred compensation liability 49,633 51,831

Other long-term liabilities 11,550 22,021

TOTAL LIABILITIES 2,256,582 1,753,881

Shareholders’ Equity:

Common Stock, $0.01 par value 695 691

Additional paid-in capital 408,874 387,477

Treasury stock, at cost (25,000) —

Retained earnings 569,894 790,603

Accumulated other comprehensive loss (76,766) (39,453)

Total Shareholders’ Equity 877,697 1,139,318

Noncontrolling interest 541 347

TOTAL EQUITY 878,238 1,139,665

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 3,134,820 $ 2,893,546

Copyright © Boyar’s Intrinsic Value Research LLC. All rights reserved www.BoyarValueGroup.com

Asset Analysis Focus is not an investment advisory bulletin, recommending the purchase or sale of any security. Rather it should be used as a guide in aiding the investment community to better understand the intrinsic worth of a corporation. The service is not intended to replace fundamental research, but should be used in conjunction with it. Additional information is available on request. The statistical and other information contained in this document has been obtained from official reports, current manuals and other sources which we believe reliable. While we cannot guarantee its entire accuracy or completeness, we believe it may be accepted as substantially correct. Boyar's Intrinsic Value Research LLC, its officers, directors and employees may at times have a position in any security mentioned herein. Boyar's Intrinsic Value Research LLC Copyright 2015.

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