Summary
Finlay's failure to downsize may be a consequence of the recession. On the other hand, it may be part of long term liquadtion plan structured to benefit secured creditors at the expense of others debtors like the jewelry trade. Regardless, here is why the industry needs a better way to manage financial risk.
Analysis
I won’t go into a lengthy analysis of Finlay’s results, it isn’t necessary. What prospective investors and the industry needs to know is the company is in default on its debt, not paying its vendor’s, and is using nearly all of its free cash flow to pay down secured debt. That said, the company still owes about $366 million to various classes of debt holders. According to its end of April balance sheet, that debt consisted of about $237 million in long-term debt and another $129 million to short-term notes. Now that Finlay is in default, all that $366 million is due on demand from its secured creditors.
How is the Finlay going to pay that debt? That’s a good question. Frankly, the company has been looking for a buyer for its specialty stores since the beginning of the year, may be longer. Its latest attempt to sell the stores was on June 16th when the company announced it was seeking investors. Now, several weeks later it’s probably looking for liquidators since no “white knight” appears to have emerged. However, the company may have waited too long to make the final decision to close the business.
As of the end of April, Finlay had $316 million in inventory on its balance sheet. In today’s market, asset based lenders would probably loan Finlay no more than about 60% of that value or about $190 million if it were a going concern, which it isn’t. Now, they may have to settle for the best a going out of business sale can yield to recoup the remainder of their secured debt. Using ABL’s value, the shortfall could be as much as $126 million as of the end of April 2009. If that turns out to be the magnitude of the shortfall, trade creditors are likely to get nothing for their receivables, including those standing 3rd to first ranked secured creditors.
Whatever the shortfall, the only remaining assets will be about $44 million consisting of furniture, fixtures, and store improvements, which will have negligible value in today’s market. Eventually, the corporation will file bankruptcy in order to discharge the remainder of its debts and terminate its leases, except for those that Zale Corporation has guaranteed. They may linger for months, if not years, until Zale pays off the liability or negotiates a settlement with the developers.
In retrospect, you have to question management’s intention after 2007. That was the year following the BB & B acquisition leading up to the company’s announcement that it was exiting the department store business to focus on the specialty jewelry business. Clearly, the purchase of Bailey Banks and Biddle was in large part, the company’s undoing. The fact is, they never grasp the monumental task that was necessary to make BB & B viable until it was too late. That begs the question of whether management ever intended to implement an alternative specialty jewelry strategy. However subtle, it was this intent that kept suppliers in the game with the expectation that they would ultimately benefit from sales to a downsized “national guild jewelry chain” and it was their cooperation that was essential if management was to maximize the payback to the secured creditors.
Effectively, a case could be made that Finlay has been in Chapter 7 all along, except without the watchful eyes of the court and creditor’s committee. By the time, Finlay does file for Chapter 7, there probably won’t be any material assets to distribute to unsecured creditors.
This isn’t the first time sophisticated financial experts have attempted to outsmart the trade. Most recently, Friedman’s secured creditors tried to do it twice, and Whitehall followed suit. In Friedman’s case, unsecured creditors eventually received distributions totaling about $.34 on the dollar after the court ruled against management’s and secured creditor’s liquidation plan. Similarly, the courts ruled against management’s plan to liquidate Whitehall’s assets as being unfair to all classes of creditors. There’s no reason to expect a court supervised, speedy, free-market liquidation wouldn’t have maximized returns to all creditors in Finlay’s case, but the trade wouldn’t act. So, now the industry will never know.
Moving on, what ‘s certain is the trade will be faced with even more bankruptcies and liquidations as the recession affects retailers, wholesalers, and suppliers alike. Warren Buffet, the legionary investor, has been publicized as saying 25% of the industry will be out of business within a year. Whether that’s really his opinion is problematic, but the number of businesses on the verge of collapse is growing and the supply side of the industry needs better ways to manage financial risk in this environment.
