From a single Zales Jewelers store in 1924, to six retail brands with approximately 1,900 stores throughout North America and online at www.zales.com and www.gordonsjewelers.com, Zale Corporation is now a leading specialty retailer of fine jewelry in the United States. Besides, Zale Corp. is a public company trading on the New York Stock Exchange (NYSE: ZLC). It may well serve a barometer for America’s jewelry market attracting regular comments on the part of many analysts probing the situation in the jewelry industry.
Tom Taulli writing for www.dailyfinance.com reminds for instance that back in early February, Zale Corporation (ZLC) hired turnaround firm, Peter J. Solomon, to help the retailer deal with its suffocating debt load. Since then, there has been discussions with a variety of private equity firms which has stirred-up some rumors along the way.
However, last week, says the analyst, Zale got a deal done. Golden Gate Capital, which has much experience in the retail space, has agreed to lend $150 million to the company for a five-year term. This is a secured loan, which also includes warrants to purchase up to 25% in Zale.
Zale also restructured its bank facility with Bank of America (BAC), GE Capital (GE) and Wells Fargo (WFC). Each has committed $125 million.
Next, Zale put together a deal with TD Financing Services to offer a store credit card for its Canadian outlets. As for the U.S., there are continued negotiations with Citibank (C).
Clearly, Zale has worked hard to put these transactions together - and the result is improved liquidity. Going forward, the company will have more time to focus on its operations, not financial engineering. Yet, there are many challenges facing the jewelry retailer, www.dailyfinance.com concludes.
Analyst Nicholas White of Gerson Lehrman Group believes that “Zale failed to find an equity buyer, but it did get an expensive bridge loan in its place. The question, where will the bridge loan lead the company? Clearly, lenders and investors alike aren’t certain, choosing instead to protect their downside rather than rallying around the company. Not surprising, Zale found no equity investors for a minority interest in the business. Let’s face it, who would put pure equity in a business with as bad a track record as Zale without having absolute control of the enterprise? Now Zale has a new lender and a minority partner.”
Still, lenders and borrows are probably happy with the deal, since Zale’s original large investor, Breeden Capital Management gets to continue to run the business with two board members (Breeden & Cotter) despite the dilution, Nicholas White says in his article posted on www.glgroup.com. But two chiefs are usually two too many. Zale’s by laws call for eight board members. The current chairman, John Lowe has announced his retirement in December 2010, and GGC has two board members, Kaluzny & Morrow.
Whether Braverman (wholesale diamonds) and Sonsteby (Accounting) will stay remains to be seen. The eighth board seat was held by former CEO Neil Goldberg, which remains to be filled. So, if you are wondering who's running the business, so is everyone else. Bluntly, it looks like management by consensus, not a typical recipe for success in a turnaround.
The debt restructuring is also problematic. For example, the new credit line exposes the three new lenders (Bank of America, G.E. Capital, and Wells Fargo) to less risk, and the newest lender, Golden Gate Capital, gets 15% interest (10% cash and 5% cash or kind) and 11.1 million warrants for 25% of the company on a fully diluted basis with an exercise price of $2.00/share. All secured by a second claim against inventory and receivables and a first claim against all remaining assets.
According to Reuters, Zale's management will have a net debt of $160 million and $250 million in liquidity after the deal closes. Taken at face value, that works out to be $130 million in long term debt and $120 million in debt which will become current after August 31, 2010. Assuming Zale still has to fund at least two more quarters of losses (2010-Q4 and 2011-Q1), it argumentative whether the company has sufficient working capital to take advantage of any uplift this fall, let alone weather an economic slowdown, which is at the best equally probably.
While the change in liquidity has to be an incentive for some suppliers to consider selling Zale on open terms, the net improvement isn’t that attractive to most of the jewelry supplier community. Whether vendors can factor Zale’s paper is problematic, especially given its current management structure. Likewise, insurance on Zale’s receivables is uncertain.
If the new Zale isn’t that appealing to some suppliers, it’s even more unappealing for many investors. The problem is value or rather the lack of it. For example, current investors will have to absorb a 25% dilution in value, as well as, stand back while GGC sweeps $22.5 million in cash and/or kind off the top of EBIT. That’s likely to leave very little for investors when the company’s operating earnings haven’t exceeded $7.2 million for the last two years and according to Reuters online is expected to lose ($3.49) per share for FY 2010 and another ($2.11) per share for FY 2011. Indeed, not only is value lacking, but loses of that magnitude positions the new financing as little more than a band aid in the face of a life threatening hemorrhage.
Frankly, it’s hard to make a case for a turnaround at Zale or even the beginnings of one. Granted, management has closed about 187 stores and eliminated 2,400 employees since 2006. But, there is no indication it is any closer to understanding the modern jewelry consumer or establishing salient brand values in the marketplace. Zale only hope seems to be to continue to cut costs faster than its bleeding market share. That’s not very strategic or sustainable in the long run.
That's especially so, since every operational part of Zale is substantially weaker than it was a half decade ago or six months ago for that matter. In contrast, most of Zale's direct competition has gotten substantially stronger, which brings us to that bridge again. We build bridges to help us get from where we are to where we want to go. You have to question whether this bridge is going nowhere?
