Can Private Equity make Zale into Tiffany? (ZLC, TIF, BRK-B)

In our daily stock and market rumors wrap up each morning, an interesting issue stood out this morning.  Zale Corporation (NYSE: ZLC) may be in play.  This is a continuation of other rumors about it being in play, but it really looks like the situation is coming to a head.  The company may not be solvent on its own and could head toward bankruptcy if things get worse again in the economy.  Reports from the NY Post have three private equity operations  TPG, Golden Gate Capital pursuing Zale.

We want to see is if private equity can turn this ship around.  More importantly, could Zale end up being a real rival for Tiffany & Co. (NYSE: TIF)?

As far as Tiffany & Co. goes, the horse race may not even be close even if the private equity firms can turn the ship around entirely.  For starters, Warren Buffett took a stake in Tiffany last year through Berkshire Hathaway Inc. (BRK-B) buying some 10% preferred shares.  Buffett has ownership of many jewelry brands: Ben Bridge Jeweler, Borsheims Fine Jewelry, Helzberg Diamonds, and Richline Group.

There is a reason Buffett is not in Zale Corp… It has had a very hard time competing during the recession.  Still shares have risen to over $3.70 this morning after seeing almost a $2.50 low after reports of private equity interest yesterday. Things are bad enough at the jewelry retailer that shares were trading under $2.00 per share in mid-February.  The stock was also at $8.50 in late 2009 and the 52-week range is $1.80 to $8.51.

If a private equity firm wants to win Zale and have its shareholders play along, it will probably want at least $5.00 per share.  Whether the company is worth more or less than that is arguable.  Still, that is the level that enough new shareholders might have a shot at over-riding the old shareholders who are in at higher prices.  After all, problems out the wazoo or not, Zale was an $8.00 stock at the end of 2009 and was at $30 as recently as 2008.

At the end of March, Zale was given a breather from Citi regarding a $6 million fee that was coming due that week to cover a shortfall in credit sales which had been required under an existing contract.  Citi is still due this and already said it does not plan to renew its credit pact with Zale in 2011.

Earlier reports in March noted that Sun Capital would provide a $600 million bridge loan to the company and buy $100 million in preferred shares, but the reports were also out that the private equity offer from Apollo was rejected.

Tiffany & Co. is profitable and should remain that way.  The company has the best brand recognition of any jeweler in America.  Tiffany is now on the way to becoming twice the size of Zale with $2.7 billion in sales last year sales versus $1.78 billion billion at Zale.  Thomson Reuters sees Fiscal Jan-2012 sales from Tiffany at $3.23 billion.

The trick for Zale is that it has different brands that target different customer segments.  It has mall kiosks, so much of the sales are not going to be as high-end.  Despite the huge Tiffany mark-up on items for the stamp, it is still the brand of choice.  With Zale’s financial trouble, private equity can probably succeed on a turnaround.  Costs can be cut, underperforming operations can be killed, and many more employees can be given the proverbial pink slips.  Still, making a goal of Zale becoming the next Tiffany is probably a far fetched notion.

Zale does have stock options that trade.  The May2010 $5 Calls cost $0.20 right now.  That gives far less downside on a de-leveraged basis (1 or 2 contracts versus 100 shares) when an offer comes for the company.  If something has not happened by May, the odds will be that private equity firms decided this is an untenable situation.

JON C. OGG