Summary
Troubled GE Capital and Falcon Harbinger bought time to get their weak balance sheets into better shape before pulling plug on Finlay Enterprises. Here's why Finlay needs new investors and soon.
Analysis
It was widely reported that Finlay struck a deal with its vendors and bondholders to avoid immediate bankruptcy. According to Finlay the company will exit its department store business and concentrate solely on its 65 remaining luxury stores to build a national guild jewelry chain.
Finlay wasn’t clear about just how the department store jewelry operation would be shut down. The company is under contract to provide jewelry management services for nearly 700 jewelry departments as well as provide staffing, inventory, and advertising support. Whether the company has negotiated specific shut down dates or will continue to operate the departments until the contract terms mature is unclear. If it’s the latter, the new deal isn’t much different than where Finlay was before the deal.
Then there is the issue of inventory. Must department stores acquire Finlay’s inventory, if so, how much and on what terms? Otherwise, Finlay must generate sufficient cash flow to pay interest on its $520 million debt obligation using the revenue generated from the remaining 65 guild stores after it closes the 40 under performing branches. Granted the company has said it would reduce staff in the home office and in certain jewelry departments, but that’s what every jewelry company is doing in response to the recession and won’t significantly improve the company’s liquidity problems.
About the only material change is that reticent suppliers aren’t likely to force Finlay in to Chapter 7 liquidation, as bond holders feared, now that they have accepted the company’s payment schedule. That gives debt holders GECC and Harbinger about 179 days of breathing room to come up with Plan B.
In the interim, selected vendors are likely to receive about 50% of what they are owed and have the added security of ranking third behind the banks and bond holders in the event of a default. Just how much better that will be depends on the kind of liquidation values creditors can expect 6 months from now, especially if both demand and prices continues to decline. It’s important to note that nothing in this deal precludes bond holders from putting Finlay into Chapter 7, so GE Capital and Harbinger hold all the cards now, at least for the next 6 months.
Then there’s the question of inventory replenishment. How and when will Finlay pay for it? Are new receivables secured? Or will both the department store operation and the specialty retail stores have to survive on existing inventory alone, a clear recipe for failure. Unlike a Chapter 11 reorganization where a company arranges for DIP (Debtor in Procession) financing which securitizes vendor’s new receivables, suppliers have no such guarantees in this deal. As one analysts said, that’s tantamount to vendors “agreeing to essentially provide the company with gold and diamond jewelry for free”.
The fact is Finlay has insufficient cash to satisfy its working capital needs and this deal only serves to highlight that problem further, not resolve it. Clearly, neither troubled GE Capital nor Phil Falcone's Harbinger wants another default now, so it’s better for them if they can delay putting Finlay into bankruptcy in the hope that government bailout money might strengthen their weak their balance sheets over the next six months.
What’s Plan B? Who knows? Clearly no one expects the economy to turn around by August and even if it improves, it takes about 6 months for jewelry consumption to begin to rise. That means Christmas 2010, not 2009, is a likely turn around point for the industry. But that doesn’t mean a return to 2006 sales levels, just positive sales growth.
How long will GE and Harbinger wait until they pull the plug on Finlay’s new strategy? In part it depends on whether a national guild jewelry business is viable and on whether 65 disparate jewelry stores constitute such an entity. From a creditor’s point of view, it’s clearly a different business, with an entirely different set of risk factors, and returns which may not be of any interest to GE Capital or Harbinger. Most likely these two companies want their money back, at least as much of it as can get and as soon as possible.
So, Finlay will need new investors to capitalize their new venture and a lot sooner that 2010. Unfortunately, the market didn’t respond favorably to the announcement. Trading in the OTC market, Finlay’s stock jumped to $0.05 per share to the high end of its recent trading range, while its debt continued to sell at a steep discount.
