The auction house posted a financial disclosure last week that raised a lot of interest but what about all those guarantees?

This commentary by Marion Maneker is available to AMMpro subscribers. (The first month of AMMpro is free and subscribers are welcome to sign up for the first month and cancel before they are billed.)

It wasn’t supposed to be this way. Going private was supposed to alleviate Sotheby’s need to deal with public disclosures that could roil the art market. Yet last week Sotheby’s issued an independent auditor’s report of the auction house’s financial statements for 2019 and 2018 that caused a flurry of questions about the firm’s future in the wake of the global pandemic.

Although Sotheby’s is no longer traded on the public stock market, it was acquired with a substantial amount of debt. That debt requires the company to be audited every year to protect the bondholders. Deloitte did the oversight work. As part of that audit, Sotheby’s management was required to assess their business as a going concern. It just so happens that all of this routine compliance took place during a cessation of the bulk of Sotheby’s business activity.

Those events prompted Sotheby’s to make a statement like this in a financial disclosure posted on the company’s website last week:

Due the significant uncertainty associated with the material adverse impact the COVID-19 pandemic has had on our operations and liquidity, we are unable to predict or quantify with certainty the effect on our liquidity, our ability to meet our obligations when they become due, or our ability to maintain compliance with our financial covenants under the New Credit Facilities Agreements over the next twelve months.

One can only imagine the astonishment—mixed with excitement and fear—in offices around Manhattan as Sotheby’s competitors read the disclosure. Was Sotheby’s about to default on its bonds? How could have this have happened so quickly?

Part of the problem with the statement is that it is a requirement. The company needs to acknowledge what everyone else is fully aware of: we’re all living in an age of intense uncertainty. Auctions are scheduled to resume in late June and early July in New York and Hong Kong, two thirds of the art market triangle that accounts for bulk of the public selling. Whether those sales will come off and how much art and other cultural artifacts will be offered remains unknown at this time. That “X” factor is everything we need to know about the art market—and Sotheby’s options going forward—right now.

The good news is that shortly after Deloitte issued their report, Sotheby’s announced it would be going ahead with sales in New York at the end of June. A big lot, a Lichtenstein, was announced and the house made its first move toward solidifying those plans which include selling previously announced major works by Francis Bacon and some more of the legendary Anderson collection. If Sotheby’s can resume selling  shortly after the Summer solstice, there’s a good chance the second half of the year will mitigate the worst-case scenario presented to the bondholders in the disclosure.

If Sotheby’s cannot resume public auctions, well, the York Ave. auctioneer isn’t the only concern in the art market we’re going to have to worry about. Like airlines, restaurants and sports teams, the social distancing measures put in place around the world would force the owners of all the major auction houses to rescue their businesses by a mixture of radical measures and injection of capital. In Sotheby’s case, that would mean Patrick Drahi would have to put his own money in or find a buyer. Sotheby’s has proven to be a property that attracts buyers in distressed times. Just ask Steven Cohen who injected capital into the firm after the global financial crisis.

If that doesn’t happen, there could be a re-negotiation with the creditors or a conversion of debt to equity as took place this morning with the clothing company J.Crew. Sotheby’s sterling brand name almost assures it will attract financing in one form or another it gets its back up against a wall.

Finally, we’re forgetting that the statement doesn’t fully account for the efforts Sotheby’s has been making to stanch the losses. The document provides a convenient list of what those are:

• the postponement of all our previously scheduled major spring sales to early summer
• the conversion of a number of our live auctions to online auction formats which have subsequently seen early success
• a reduction in employee salaries and unpaid staff furloughs
• the deferral of discretionary and sale-related spending
• the deferral of employee incentive compensation
• reductions in capital spending, and
• a drawdown of $195 million on our revolving credit facility in April 2020.

Although these measures were offered with the belief they would allow Sotheby’s to meet its obligations, “we can provide no assurance that the COVID-19 pandemic will not continue to further negatively impact our operations.”

It’s not easy writing these highly vetted financial documents. To the extent that they must include the worst outcome as a plausible event, they tend to erase what we all might think of as common sense. Nonetheless, the documents is a reminder of the great cost of uncertainty and change. Sotheby’s would undoubtedly like to see a transformation of global art selling. But no one wants to see that take place within the space of a few months.

The disclosure document also alerts us to the position Sotheby’s had taken late last year for this Spring’s sales. Sotheby’s guaranteed $265m in property that almost surely includes the Lichtenstein announced Friday, the Bacon triptych and work from the Anderson estate and Ginny Williams’ estate. $221.7m of that amount was committed before the end of the year with around 30% of the figure laid off with third parties through Sotheby’s system of irrevocable bids. Another $43.3m was committed to sellers in four months that followed. That leaves Sotheby’s with $202m in art at risk which is both a testament to the amount of money Sotheby’s new management is willing to use as working capital for its auctions and the confidence they still have in the broader art market.

Bargain hunters have made no secret of their interest in acquiring art at a discount. Were Sotheby’s desperate, they could easily have taken irrevocable bids at attractive prices. The short-term loss would worth the reduction in risk. Instead, Sotheby’s seems to be willing to let it ride which may tell us a lot more about how seriously to take those warnings about its ability to survive in the long haul.