Summary
Hedge funds have had a spotty record of success in retail, but they are proving to be a complete failure in the jewelry sector. Here's a look.
Analysis
In an unusual move, three jewelry suppliers ask the court to grant a petition to put Freidman Jewelers in Chapter 7 bankruptcy. Owed in excess of $9.0 million, the three creditors also acted on behalf of the supply side of the diamond industry which included diamond large diamond suppliers Paul Winston-Eurostar, Sumit Diamond, Rosy Blue, and Master Diamond.
In response, Freidman’s filled for protection from its creditors under Chapter 11 which was granted by a Delaware court. This is the second time in three years Friedman’s has filled Chapter 11; the first being in 2005. At that time, Freidman had been under investigation by the SEC regarding certain transactions concerning its credit card receivables to third parties, as well as, various state AG’s investigations about its private label credit card practices in its retail stores. Subsequently, with the support jewelry industry suppliers, Freidman’s was reorganized in late 2005 under the control of hedge fund Harbinger Capital Partners Master Fund Ltd which bought Crescent Jewelers out of bankruptcy in 2006.
Now, most of those suppliers want Freidman, its subsidiaries, and affiliates liquidated to pay merchandise receivables rather than reorganized for a second time. According to the company, it currently has assets between $100 million and $500 million versus debts in access of $100 million. Should the court approve another reorganization plan, suppliers stand to loose millions of dollars in pre-filing trade receivables only to be asked to extend credit again for the second time in the hopes hedge fund owners can run the business better this time around.
Hedge fund involvement in retailing has increased significantly in the last five years. However, their track record of success is spotty at best. Sears Holding is probably the most visible example of how hedge fund’s perception of retailing can decrease shareholders value; at least if Sears’ current performance is the measure. Hedge funds have increasingly been engaged in the jewelry industry. In addition to Harbinger’s investment in Friedman Jewelers, hedge funds were actively involved in the bankruptcy and subsequent liquidation of Fabrikant & Sons, a billion dollar private diamond and jewelry wholesaler that filled Chapter 11 in 2006.
Most recently, Breeden Capital acquired about 18% of Zale Corporation. Now with two members on the board, Richard Breeden is seeking to do what Harbinger Capital couldn’t do with the third largest specialty retail jeweler in America, make money. Like Sears today, Breeden is looking to sell the corporation, otherwise its assets, in order to maximize Zale share holder value that has decreased by more than $600 million in the last 12 months. However, except for himself, he certainly won’t increase the value for most of those shareholders; even if he can find a buyer in today’s uncertain economy.
Meanwhile, the likelihood of an operational turn around grows less certain as suppliers watch large jewelers like Freidman go “Chapter 22” under hedge fund management. As much as suppliers need the business, they can’t afford to be left holding handful of worthless receivables time and time again as hedge funds sell off assets to fund large stock buy backs (Sears and Zale).
Much in the way suppliers looked to cut their losses with Freidman, Zale suppliers will want to deleverage their risk of a catastrophic loss from Zale. That makes a Zale turn around even more problematic with Richard Breeden and his protégé on the board.
