Summary
While stock buy backs may increase Zale's short term share price, here's why the the company has actually declined in value.
Analysis
Zale announced that the board had authorized the repurchase of an additional $50 million in stock. That brings the total authorization to $350 million for FY 2008. According to the company, it has repurchased approximately $250 million year to date, leaving about $100 million yet to be bought back. While most companies have stock repurchase plans, the number, frequency, and magnitude of Zale's buy backs in FY 2008 should concern investors.
Clearly, there are circumstances when stock buy backs are in the best interest of a company and its shareholders. These include low stock valuations and special circumstances were the company has substantially more cash on hand than is required for current operations and strategic growth. From one point of view, that happened when Zale sold its luxury brand Bailey, Banks, and Biddle for about $200 million. The company used the proceeds of the sale to fund its initial stock repurchase. However, a case could have been made that management could have created more value for shareholders if it had invested that $200 million in strategic initiatives such as launching an off-mall jewelry format or materially developing its e-commerce business.
The fact management chose to sell its luxury jewelry division when the high end market was out performing all other segments of the industry should have raised concerns about the company's direction, but the choice to reinvest the money in nonproductive 'treasury stock' should have concerned shareholders even more. Granted, reducing number of shares outstanding would temporarily increase the value per share of Zale's stock, but not necessarily the company's enterprise value. At best, that would remain the same or at the worst decline because of reduced capital investment.
Subsequently, the board amended its repurchase authorization, increasing the total amount to $300 million. As of the end of 3rd quarter, the company had actually repurchased about $250 million. While no cash flow statement was included with Q3 earnings report; the balance sheet shows debt increased by about $83 million during the quarter. That means the company borrowed money to pay for a substantial part of the stock repurchase.
Now the board has further amended its repurchase authorization by $50 million, bringing the total planned stock buy back to $350 million for FY 2008. Assuming the company meets current analyst’s estimates for a 4th quarter loss, its likely Zale will have to borrow more than half the cash required to fund the last $100 million of its stock repurchase plan.
According to Zale's plan its share price will increase as the number of shares outstanding decreases. However, management may be disappointed. The fact is share price appreciation isn't happening today. Currently, the stock is trading at a discount to its hypothetical value. That means company value has declined in the market. Accordingly, it's reasonable to think that continued discounting, reduced investment in capital assets, less productive inventory, and the failure to initiate a strategic turnaround, will further reduce Zale's earning potential and its enterprise value too. That's especially likely if the company borrows more money to complete the buy back.
What's management's end game? Simply put the board's gambit is that share values will increase because investors now own a part of a company that is declining in value at a slower rate than the decrease in number of shares outstanding. But that's bad gaming strategy. Current results suggests increased leverage and minimal investment will likely decrease enterprise value faster than management can cut costs.
Shrewd at best, Machiavellian at worst, the board's tactics will likely destroy shareholder value if measured in terms competitive ratio's or Zale's future earning's stream regardless of the board's manipulation of per share values.
