Every time the subject of Zale Corporation comes up, the first question is, “Will the company be sold?”

 

The quickest retort is this: Everything has its price.

 

But that’s not a fair answer. Here’s how we answer the question:

 

• When Betsy Burton was at the helm, she was trying to dress up the company to be sold, in our opinion.
• Now that Neal Goldberg is at the helm, his charge is to rebuild Zale.

We don’t have any insight or inside information about what is going on inside of Zale’s board room; these are strictly our opinions. We haven’t talked with any of its board members or top executives about the possibility of the company being sold. Thus, you could argue that our analysis is fiction; we’d argue that our twenty years on Wall Street and subsequent investment banking experience gives us an edge to understanding the deliberations that may be going on inside Zale’s boardroom.

 

Burton: A Flash in the Pan

Betsy Burton, who had been served on Zale’s board of directors since mid-2003, was named to run the company in early 2006. She had some retail experience; mainly, she was a CEO type. She was not a merchant. We think the board may have told Burton to “dress up the company so we can sell it quickly.”

 

Burton set about harvesting the low-hanging fruit. She said the right things to placate Wall Street. She was earnest in her endeavor.

 

But she was not a merchant. A good merchant would have known that you can’t fix a company the size of Zale in a few months. She would have argued with the board that their goal was simply not possible.

 

From the beginning, there was talk that Burton would hire someone to run the company. We think that was simply board rhetoric; she was buying time to get Zale cleaned up to be sold, in our opinion.

 

When Burton exited the president’s job, she left the board, too. We were a bit surprised that she didn’t return to her board position. However, it appears that she took the high road: she couldn’t fix the company herself, so she should not remain on the board in a position that would have allowed her to second-guess her successor.

 

Goldberg: A Merchant

We haven’t met Neal Goldberg yet. But he speaks with confidence on the conference calls with investors. He doesn’t mince words with Wall Street. He tells them what they want to hear …and some of what they don’t want to hear.

 

Goldberg is a merchant – better, a fashion merchant. Jewelry is fashion. If anyone can rebuild Zale, Goldberg should be the right choice.

 

Goldberg has delivered on all of his promises. Granted, he doesn’t go into detail like his predecessors; Betsy Burton, Mary Forte, and others went into far too much detail, and were second-guessed by everyone, especially Wall Street.

 

Given Zale’s current state, Goldberg’s programs resonate: they make sense, they seem logical. That is the first step toward success.

 

Goldberg has a three-prong program to fix Zale:

 

• Focus on the company’s core value-oriented customer – Simplify the company’s product assortment, its marketing message, and its stores. Make it easy for the customer to understand Zale’s value concept of “good, better, best.”

• Focus on operational effectiveness – Become more efficient at everything the company does. Develop a lean, mean organization.

• Focus on financials – Generate cash! Jewelers: this is the most important concept Goldberg has introduced – get rid of obsolete merchandise – take no prisoners. For Wall Street’s benefit, Goldberg and the board are using the cash to repurchase the company’s stock.

Here are some of Goldberg’s accomplishments at Zale Corporation. Further, we have included some of his comments from a recent conference call with investors. Our opinion: these comments sound like a merchant who is in the game for the long term.

 

• Same-store sales were up nearly 6 percent in the quarter ended April, while most jewelers reported a decline in sales. How did Zale’s do it? Heavy discounting was the primary promotional program. The company’s gross margin fell by nearly 5 points (500 basis points) from 52.1 percent of sales to 47.5 percent of sales. Clearance goods represented about 20 percent of sales in the April quarter; typically, clearance goods are 8-10 percent of sales.
  
  You can argue that if the company had given away its product, sales would have been infinite. We’d argue that the current level of discounting, which will likely continue through the summer, achieves a balance between leveraging fixed costs and moving clearance goods out the door. Indeed, the company’s operating cost ratio was 48.6 percent in the quarter, down from last year’s 49.4 percent; the total dollars were up.
  
  By brand, all brands except the Zale Outlet stores posted a positive same-store sales comparison; the Zale Outlet division posted a modest negative same-store sales comparison against last year.
  
  The average ticket (all brands) was $175 versus $172 last year for the April quarter. This means that there were just over 2.7 million transactions this year versus 2.6 million transactions last year. Further, the average ticket is impressive, given the level of discounting related to the clearance merchandise.

• Zale is reducing the number of items in its assortment. Further, it is buying goods that are consistently higher quality. It has cut its vendor base by 50 percent since January.

• Zale has identified 135 Pacesetter stores that will serve as pilot stores for new programs and initiatives. The store staff in these Pacesetter units will receive more training; the jewelry assortment and presentation will be enhanced. There is new signage, and the interior of these Pacesetter stores have been simplified. These stores are located across a broad geographic area. While they tend to be larger stores (as a group, they represent 20 percent of the company’s revenues and a greater portion of its profits), they cross all demographic target strata.

• Zale’s marketing message is being simplified. Its “Mom Rocks” promotion for Mother’s Day was successful, according to management. Sales through Mother’s Day period in May were in line with the 5-6 percent gains in the quarter ended April. Further, research indicates that Zale’s message of “America’s Diamond Store Since 1924” resonates with its customers.

• Zale has been reorganized into functional areas, rather than by store brand. With Bailey Banks & Biddle gone, this strategy may be successful. However, we worry that the products and promotions could easily become homogenized.

• Direct sourcing efforts continue. Top management recently was in India and China meeting with its vendor base.

• Once most of the clearance merchandise is gone, Zale plans to focus in two merchandise areas:

• Diamonds and diamond jewelry
• Colored gemstone jewelry

• Over 100 underperforming stores have been closed.

• The warranty attachment rate is running at 52 percent, a very high level.

• Inventory levels are down by $53 million, year-over-year, after eliminating the Bailey Banks & Biddle goods. However, the annualized inventory turn slowed to 1.15 times versus 1.21 times last year.

• Zale has seen no slowdown in its bridal business. Historically, the number of weddings is unaffected by economic cycles.

• There has been some softness in the credit approval rate. However, Zale uses third party credit, so it has no increased exposure to bad credit in the current soft environment.

• The company has implemented selective price increases, especially in goods where costs have risen significantly over the past few quarters. It also has been able to get better prices by ordering earlier.

• In an interesting twist to feeding Wall Streets seemingly insatiable appetite for information, Zale has said it will no longer provide quarterly sales results at the end of the quarter. All financials – sales, profits, financial strength – will be presented in one press release roughly three-four weeks after the close of the quarter. The company will continue to report holiday sales results in early January.

The table below summarizes Zale’s key financials for the quarter ended April, 2008:

 

 

Zale: Not For Sale Right Now

So, back to the question: will Zale be sold?

 

As we quipped earlier, everything has its price. Assuming Goldberg can rebuild Zale, then Wall Street should reward the company with a valuation that would make it difficult to find a buyer. Most buyers of companies looked for distressed situations with cheap valuations. 

 

If rebuilding the company takes longer and costs are higher than the board is willing to invest, then Zale will likely be sold, despite whether it is fixed or not. We remind readers that the Zale board appears to have a short span of attention and little patience, based on its past actions.

 

Our conclusion at the present time: Zale is not for sale.

 

This is not to say that someone might come along and offer a premium for the company. If so, the board would have a tough time defending its position to reject the suitor (witness Yahoo’s recent struggles). But, our opinion is that Goldberg has not been put at the helm to sell the company, but rather to rebuild it, perhaps to its former glory.