Summary
As Finlay is delisted from the Nasdaq and its bond rating lowered to that of "Junk", Macy's and Zale investors need to consider the consequences of a Finlay bankruptcy. Here's why
Analysis
Finlay Enterprises, Inc announced its stock would be sold on the Over the Counter Exchange (OTC) after it is delisted from the Nasdaq on July 11, 2008. Finlay had been notified earlier that the company was not in compliance with certain minimum listing requirements to continue trading on the Nasdaq Exchange.
The delisting is just one of several events that have raised questions about the department store lease jewelry operator’s future. Earlier Standard and Poor’s had reduced the company’s credit rating from “B” to “CCC” after Finlay reported weak 1st quarter sales. The “CCC” rating means Finlay’s debt is valued as “Junk” in the bond market. In particular, the rating means that Finlay’s future liquidity depends in large part on a “favorable” business environment; a description only the most optimistic trader would use to describe today’s economy.
To say Finlay’s future is “uncertain” would be an understatement. Its department store jewelry business has been in decline for years both in terms of the number of departments and the average sales per department. The company has sought to offset that decline by acquiring higher end, specialty retail jewelry businesses such as Carlisle and Congress Jewelers. Most recently, the company bought about 70 Bailey Banks and Biddle stores from Zale Corporation for about $200 million. That transaction significantly added to their leverage which was already about the highest in the industry. It also increased Finlay’s working capital requirements at a time the company was about to lose about 150 less cash intensive, jewelry departments.
Some analysts believe the company has “bet the farm” on the turn around of the BB & B stores which were under performers under Zale’s management. Relatively speaking, the high end luxury jewelry market has continued to grow despite the poor economy. The problem is BB & B is really a turn around business itself. Whether Congress and Carlisle can throw off enough cash to mitigate soft department store jewelry sales and fund BB & B turn around requirements is problematic.
Clearly the company will need supplier financing this fall if it is to buy the inventory necessary to support Christmas sales in the 4th calendar quarter. However, vendors may be reluctant to provide unsecured credit to Finlay this year after both Friedman and Whitehall Jewelers filled bankruptcy in the first half of 2008. That will be particularly true if vendors lose their right to consignment merchandise because of unperfected UCCs in the case of the Whitehall default.
Should Finlay be unable to secure sufficient vendor support, it would have no other choice than file for protection from its creditors. That would start a chain reaction which would have significant consequences for the department store industry, especially Macy’s, and specialty jewelry retailers, most especially Zale Corporation. Macy’s would be most affected of all the department stores from a sales and inventory point of view. Whether the company would buy the fixtures and inventory and take the business in-house, look to start fresh with new assortments, or out source the business again remains to be seen.
On the other hand, Zale Corporation will be “on the hook” for Bailey, Banks, and Biddle store lease payments that it guaranteed as apart of the luxury chains sale to Finlay in November 2007. According Zale’s latest 10Q, the future value of that contingent liability is about $85 million. Unfortunately that liability is looking less contingent and more certain as Finlay’s business outlook worsens.
In retrospect, Zale Board’s decision to guarantee those leases in the event of a Finlay default has to be one of the most imprudent business decisions in the company’s history. While the guarantee may have facilitated the sale of its high-end division to Finlay, it reduced the future enterprise value of Zale by many times more than the value it gained from BB & B's sale.
