Summary
Finlay's restructuring and likely subsequent bankruptcy marks a turning point for $65 billion jewelry industry. Here's why.
Analysis
The retail jewelry business just got a lot more complicated as Finlay begins clearance sales in the majority of it department store jewelry operations. According to reports, Finlay will be discounting much of its inventory to raise cash as it exits the department store business. That will impact sales and margins of almost all mid market jewelry chains including Zale Corporation and Signet Jewelers that own the Kay and Jared brands. It also will further destabilize the jewelry manufacturing industry that is alrady in a liquidity crisis.
Specializing in gold jewelry, gemstone jewelry, and branded watches, Finlay will look to liquidate or sell to department stores upwards of $500 million of retail inventory in order to repay banks and bond holders about $520 million in secured debt. What will be left over for suppliers is anybodies guess as is how long this voluntary restructuring will continue until it becomes a full fledged Chapter 7 liquidation is uncertain. But it probably can be measured in weeks not months as many unsecured creditors expect.
A bigger question is just how much of Finlay’s inventory is asset goods as opposed to consignment inventory. Historically, Finlay has always funded much of its working capital requirements off balance sheet with consignment inventory. In the past about 40% or more of the company’s goods were owned by suppliers and paid for when Finlay sold it. Clearly, secured creditors have charge against asset goods, but what about consignment inventory. Suppliers faced that problem in both the Friedman and Whitehall liquidations. In both those instances, the courts ruled in favor of suppliers even if the UCC’s weren't properly perfected.
But this time, it’s different. Finlay isn’t in bankruptcy so funds collected from the sale of consignment inventory are a part of the pool of liquid assets available to pay creditors according to their debts is securitized. At best that means some of the larger consignment suppliers may be third in line, just above unsecured creditors. At worst, they are stand “pari-passu” with the class of all unsecured creditors. If true many domestic and overseas consignment suppliers could find that they are in substantial financial jeopardy as the company effectively pierced the veil of security offered by UCC’s
Finlay has also said that it is closing its New York office and a distribution center in Connecticut which will eliminate about 396 jobs. Evidently, the plan is to consolidate what remains of department store operations and distribution functions into its Greensboro, NC facilities which are the corporate headquarters for the Carlyle jewelry chain. However, while it’s uncertain just what will go where, what is certain is a facility designed to support 35 mall jewelry stores isn’t likely to be able to facilitate the logistical requirements of nearly 700 jewelry departments, clearing about $500 million in inventory.
Besides depressing jewelry prices further in about 40 states, Finlay’s reorganization will likely hasten the demise of the department store jewelry segment. The fact is department stores have been loosing market share in jewelry for the last decade. Now some department stores may vacate the category all together, while others substantially reduce it presence in the big box stores altogether. For instance, according to an article in the Journal Sentinel Online, “Mary Kerr, spokeswoman for Bon-Ton Stores Inc., the parent company for Boston Store, said the company hasn't determined yet whether it will sell fine jewelry in the future.” On the other hand, Macys which accounts for about 50% of Finlay’s big box business already manages the jewelry business for some of its stores in-house, suggesting they will continue in the fine jewelry business. Still, Macys weak balance sheet and declining sales may make a $100 million investment in inventory in practical if not impossible to finance in today’s credit markets.
How all these changes will affect specialty retail jewelers is also uncertain. Operating departments in most major malls in about 40 states, Finlay’s clearance sale of about one-half billion in retail inventory will combine with approximately $150 million in clearance goods in Zale stores to depress prices even further in a market already suffering from near depression like demand. Clearly, these events will steal market share from local competitors. How much is any bodies guess, but Signet Jewelers hinted that last years clearance by both Zale and Friedman Jewelers cost the company about 200 base points in spring 2008. However, theses events aren’t going out of business sales, at least not yet, so the impact could be less.
Still, we are only in the first quarter of 2009 and the fall out from the Christmas is just be quantified. Besides, Finlay and Zale’s problems, Fortunoff, Christian Bernard, and The Shane Company have filed for bankruptcy, while hundreds, probably thousands of independents are running deep discount clearance sales hoping to raise enough cash to stay in business. Finlay’s sell off can only exacerbate their liquidity crisis.
The manufacturing industry will also be affected unfavorably by Finlay’s restructuring, at least in the short term. The most obvious effect will be the write down of receivable and potential loss on consignment goods sold during the clearance sale. One analyst touted the most recent deal struck with suppliers as tantamount to “giving gold and diamond jewelry away for free.” That may turn out to be prophetic. Then there’s the need to finance new inventory for companies like Macys and Dillard which are likely to remain in the jewelry sector only if the industry is able to offer favorable terms and that may be problematic.
The fact is the jewelry industry from the diamond pipe line to retail jewelers is too cash intensive. Perhaps that kind of profit model was marginally viable when interest rates were low, gold leases cheap, and ABL credit lines abundant. But that was then, now everything has changed. So this is likely to be the first test of how jewelry manufacturers and retailers are going to cope with these new realities. My guess is that they will do so very poorly. That isn’t meant to be pejorative, but it’s recognition that despite many warnings, nothing less than abject financial catastrophe is likely to motivate real change and that beyond intellectual curiosity, little rigorous planning has been done by most industry players to sort out the industries liquidity issues.
Nevertheless, on a hopeful note, much of the technology exists to mitigate the problem as does a retailing environment where consumers will embrace material changes in how jewelry is sold. That’s about the only good news.
