Summary
As Finlay cautions the market that it will likely default on its debt, creditors should brace for one of the most unusual and costly bankruptcies in recent times. Here's why.
Analysis
Public companies usually don’t comment on Christmas sale trends or publish a going concern warning mid quarter. But that’s exactly what Finlay Enterprises did on Wednesday. Realistically, Finlay will probably file for protection from its creditors immediately following Christmas unless there is a Miracle on 34th Street this year. Actually, Finlay’s is located on Fifth Avenue, but no matter the company will need a miracle if it isn’t to break any number loan covenants, at least that appears to be what the company is telling the market. What’s next?
That’s complicated. Finlay isn’t just another jewelry company about to close its doors. It’s different. Here’s how. For one thing, Finlay doesn’t have absolute control over the selling space or the marketing of product in its 687 department stores. For another, it doesn’t collect it’s sale receipts daily, but receives periodic settlements from the department stores net of lease fees.
Contrast that with a traditional jewelry company bankruptcy, in which the retailer closes stores to reduce costs, liquidates inventory to maximize cash flow, and rejects leases as a part of a reorganization plan.
To complicate matters, Finlay also operates about 105 jewelry stores under three brands, Bailey Banks and Biddle, Carlyle, and Congress Jewelers. While, Finlay has operational control over these mall stores, Zale Corporation guaranteed the original lease payments when it sold B B & B to the company last November for a bout $200 million should it default. In the event Finlay fails to make a lease payment or rejects a lease entirely, Zale is liable. What’s not certain is Zale’s rights to the properties should Finlay default, complicating a both a Chapter 7 liquidation or a Chapter 11 reorganization.
Lastly, in the event of liquidation after Christmas, it problematic whether department stores like Macys, The Bon Ton, or Dillard will buy the existing inventory from Finlay to run their jewelry departments. There are several reasons why. First, department stores have been losing jewelry market share for nearly 8 years, management will likely reduce space allocated to jewelry. Second, precious metal and diamond pricing is declining, department stores may prefer to buy new product from their own suppliers. Third, much of Finlay’s inventory may be the wrong goods as consumer tastes and buying behavior changes emerge during a lengthy recession. If true, Finlay could find it nearly impossible to liquidate the magnitude of inventory necessary to close down the business and pay creditors with the number of retail outlets available.
In short, with appraisal values falling, Finlay’s liquidation could be the most expensive ever, yielding secured creditors, preferred bond holders, and general creditors some of the lowest recovery rates in recent history. The only alternatives appears to be an outright sale of the company or a reorganization where the company sells most of its inventory to department stores and restructures the business around its free standing luxury brands. Neither of which seem viable in today’s economic environment.
