Summary
Buying back about 20% of its stock, Zale management may be positioning the company to go private. But that alone won’t be enough to turn the company around. Here’s why.
Analysis
In a move that is sure to please its new hedge fund investors, Zale announced that the board had authorized the buyback of $200 million of its stock. According to Zale, the buyback would be funded by the proceeds from the sale of Bailey, Banks, and Biddle to Finlay Enterprises. The $ 200 million sale of BB & B closed concurrently with the buyback announcement.
As of early morning trading, Zale’s stock price modestly increased to $20.50 from its $19.55 close on Friday. Whether activists shareholders are responsible for the board’s decision isn’t clear. However, such a large buy back raises serious question as to just what management’s plans are in the future.
Recently, several hedge funds have bought about 18% of Zale’s stock. These include Citadel Investment Group, SAC Capital Advisors LLC and Breeden Partners. According to analysts, “the funds think the stock is undervalued and the company's capable of generating good cash flow”; cash flow that could be used to fund for interest payments in the event of a LBO.
In 2006, the stock climbed to the high 20’s after merger talks between Signet and Zale became public. At that time, CEO Burton said that a Zale-Signet merger was too complex to complete and that the deal wasn’t in the best interest of shareholders. In other words, Signet’s offer was too low. Now, privatizing the company just may be what management has on its mind. Selling at less than its value in July of 2006, the buy back equates to about 20% of the 49 + million shares outstanding which is a good start at taking the company private at a value price too; something that may appeal to the company's new hedge fund investors.
Just how Zale will proceed remains uncertain. The new Chairman, John Lowe, has said he believes shareholders best interest will be served if the company remains independent. But that may be posturing. In any event, Zale’s performance in the upcoming holiday season will be pivotal in any decision the board makes.
From the hedge fund's point of view, a privatized Zale Corporation could be a big winner. Anyone can do the math, but number crunching aside, the real question is whether the company can find the right leader to drive profitable, top-line sales. For most of the last decade, Zale has been run by former department store merchants. However, as much as jewelry retailing has to do with big box retailers, it is also very different.
There is a reason why most department stores use lease operators like Finlay to run their jewelry departments. In part it’s due to lower product turn. At one time a year, most demand forecasting model don’t work; meaning there is a certain intuition needed to manage jewelry which is completely inconsistent with department store merchandising. Another factor is the value of the product. Most department store products derive their value from fashion which is time sensitive. Out of season product has little value and should be cleared.
In contrast, jewelry has intrinsic value because it is made from precious metals and gemstones. It is by definition more timeless and less timely than typical department store products. The very act of clearing last years merchandise actually devalues current product in the customer’s eyes. A concept inconsistent with departments store promotional mentality. Then there are the service, visual merchandising, and brand issues which distinguish fine jewelry retailing even further from mass merchandisers and discounters alike.
It’s these differences that management doesn’t seem to grasp which has lead to most of the mistakes the company has made both tactically and strategically during the last decade. Even during some of its most profitable years, a department store mentality drove many of the decisions about acquisitions, growth, product quality, mix, and pricing.
It’s these decisions that are responsible for the company’s decline today and it’s this same kind of thinking that’s shaping management’s decisions now. Until shareholder recognize the need for a different retailing paradigm, virtual earnings and endless number crunching is about the best shareholder, private or otherwise, can expect.
