Summary
Betting on an inside straight, Breeden Capital has little leverage and few opportunities to make a profit. Other than blind luck, here's how they might do it.
Analysis
What happens when management can’t turn a company around and can’t find a buyer, their stock gets bought by an activist investor. That’s the 21st century, politically correct name for a ‘corporate raider’ and that’s what just happened to Zale stock. According to SEC documents filed on Monday, Breeden Capital Management LLC reported a 7.7% stake in Zale Corporation, propelling share prices up about 4.7% in early trading. According to information in the filing, Breeden Capital paid an average of about $22.00 for its shares, a lot lower than the stocks high of $31.72, but a 10.6% premium over the stocks recent low of $19.86.
What Breeden Capital wants is clear, higher stock prices, share buy backs, and dividends. Just what they can add to achieve those things isn’t clear. Zale’s cash flow is declining as operational leverage works against the company and it doesn’t have a lot of fungible assets to sell. Currently, it leases most its stores and home office facility, so there isn’t much under valued real estate on the books that could be turned into cash. It sold its credit business years ago, leaving its distribution center and IT as functional parts that could have some meager out sourcing value. That leaves its trade names.
Working with Goldman Sachs, Zale management has already recognized that it needs to realign its strategic portfolio. For instance, Piercing Pagoda and Bailey, Banks, and Biddle are unlikely to be keepers if the company plans to grow its mid market diamond jewelry business. In particular, BB & B has substantial value. Doing about $309 million in annual sales, the 73 store chain could probably be sold for upwards of $350 million. Unfortunately, any gain from a BB & B sale would probably be offset by a loss from the disposal of Piercing Pagoda.
Another possibility is a merger, probably with Signet Group PLC. A long shot, but many of Zale’s recent operating changes would facilitate such a deal, especially if the company sold off Piercing Pagoda and BB & B. The rationale goes something like this. According to CEO Burton, the major impediments to a Signet-Zale merger were structure and price. Zale’s decision to eliminate division presidents and centralize its buying organization, which mirrors Kay’s US operating structure, would make it easier and less expensive to combine the two companies.
Other initiatives which would improve Zale’s value to Signet are the company’s store closure plans. According to Burton, Zale will likely announce that it will close a number of locations during its 3rd and 4th fiscal quarters. Just which brands and how many locations aren’t known, but the number will probably be substantial. The company has already closed most, if not all, of its kiosks in Canada, so Piercing Pagoda cold figure prominently in any closure program.
Many of these changes could enable a turn around if Breeden Capital has the influence to get the right people in place. Realistically, the mid market jewelry business, especially the diamond jewelry part of it, is in flux. Department store jewelry busnesses like Finlay Enterprizes continue to lose market share and independent’s share of market continue to shrink, all while the loose diamond and jewelry manufacturing industries continue to fragment. No one brand has such a dominate position in the US market that would insulate it from a well planned attack from the likes of Zale. But that would require a change in leadership at both the board and operating levels, something Breeden Capital probably can’t orchestrate with its 7.7% ante.
Failing that, the changes could act as a catalyst making a Zale merger or private equity deal more likely in the future. Terry Burman, Group CEO for Signet said, “[T]he commercial rationale remains for a transaction… [But] if we do an acquisition with Zale we would have to curtail our expansion plan”. With about 60% of its expansion plan completed by the end of 2008, Signet could afford to reassess its growth strategy and end up with the best of both businesses and a dominate share of the US jewelry market too.
