PHILADELPHIA/NEW YORK, Feb xx (Reuters) - Jewelry store operator Zale Corp ZLC.N is on the rebound after being left by customers and shunned by vendors during the recession, and its best hope to prosper may be a marriage to larger rival Signet Jewelers Ltd (SIG.N).
Zale, which operates the Zales and Gordon’s chains, has made strides in the last two years by closing unprofitable stores and adding brands like Vera Wang bridal jewelry at its venerable 88-year-old namesake chain.
But Zale, which has lost hundreds of millions of dollars in the last three years, is still recovering from a collapse in sales during the financial crisis, when it lost many shoppers to Signet’s Kay and also scared suppliers.
In contrast, Signet’s U.S. business, which also includes the more upscale Jared, is flush with cash thanks to sales gains and marketing firepower Zale can only dream of. Signet also owns its own credit card business.
There may be a limit on how much Zale can accomplish on its own and it may be prompted to look for a buyer, investment bankers and analysts said.
“The Zales name has taken a beating, but it’s still a brand that people know. It’s a brand that could get resurrected with the right people and resources behind it,” said one retail investment banker who declined to be named because he was not authorized to speak to the media.
“Signet is more skilled at marketing, so with them at the helm at Zale, it could become a prominent name again,” the banker said.
Zale declined to comment. Signet could not be immediately reached for comment.
In 2009, Zale went through a severe liquidity crisis that saw it cancel orders, alienating vendors, many of which preferred to do business with Signet.
Zale has a current market capitalization of $97 million. Its long-term liabilities total $494 million.
“It’s a turnaround company so there is risk, but it wouldn’t be an expensive gamble. Signet couldn’t build a second national chain for what they could get Zale for,” said the banker.
Two years ago, Signet said building a new nationwide U.S. chain would take too much time and be too expensive and that an acquisition would be the second route. Signet, which also operates the upscale Jared chain, gets 80 percent of revenue from the United States and the rest in Britain.
In 2006, Zale ended tentative, short-lived merger talks with Signet, which have been a blessing for the latter: Zale’s shares are now worth one-ninth of what they were at the time.
“They’ve talked before. They know each other. They reach similar demographics. It would be a mismatch for someone like a Tiffany to buy Zale, but in this case there are similarities,” said a second retail investment banker who declined to be named because he was not authorized to speak to the media.
“The best thing that could happen to Zale would be to get taken over by someone with deeper pockets and greater marketing expertise -- and Signet fits that bill,” the second banker said.
A deal would have a lot of synergies -- such as cost savings in the back office and management -- and give the combined company better clout with vendors, bankers said. As a result, Signet could afford to pay as much as $5 to $6 a share, or $161 million to $193 million, and still have the deal add to earnings after the first year, bankers said.
If Signet did buy Zale and wanted to close overlapping stores, it would not have to wait long. The leases of some 230 stores out of 1,160 stores, excluding its Pagoda kiosks, expire this year, and about 60 percent of leases are up for renewal by the end of 2015.
Zale operated a combined 818 Zales and Gordon’s stores as of July 31, 2011, compared to 1,045 three years earlier, helping same-store sales to rise. The chains account for more than 60 percent of Zale sales.
A deal would be unlikely to run afoul of regulators since the $60 billion U.S. jewelry market is so fragmented, bankers said. According to IBISWorld, Signet has a 9.7 percent share of the U.S. jewelry market, more than double Zale’s 4.6 percent.
Still, Signet would be buying a work-in-progress and it might be wiser to build solo.
“If Signet wants to expand fast -- Zale is a smart option. If they want to take a more tempered approach, organic growth might be more attractive,” said one consumer banker, who declined to be named. The banker was not authorized to speak to the media.
Zale’s main appeal is its cheap price tag, Canadian assets and national U.S. presence, bankers said.
Since the fiscal year that ended July 31, 2008, right before the financial crisis erupted, Zale has had total net losses of $427.4 million.
But after a severe liquidity crisis during the 2009-2010 holiday season that had many wondering about Zale’s prospects, things have improved. Sales at stores open at least a year rose 7.1 percent, excluding the impact of currency, in the fiscal year ended July 31, 2011. And they have continued to rise.
In May 2010, Zale secured funding from private equity Golden Gate Capital in exchange for giving the private equity firm warrants to buy about 25 percent of the retailer’s shares.
Golden Gate declined to comment on its stake in Zale.
One of Zale’s most attractive assets is Peoples Jewellers, Canada’s largest jewelry chain. It would allow Signet to tap an international market beyond Britain, where sales have been tepid at best.
What’s more, Zale’s Canadian chains, which also include Mappins, last fiscal year had sales of $1.4 million per store, up 16.1 percent from 2009 and far above the $1.18 million per Zales store.
Despite the efforts to close underperforming stores, Zales stores are far less productive that Signet’s Kay, where sales last year were $1.7 million per store
Still, despite the inexpensive price tag on Zale, some analysts think Signet has room to grow on its own.
Lazard Capital Market analyst Jennifer Davis said Signet still has room to grow through Kay locations out of traditional malls and it could add as many as 300 Jared stores nationally.
Reporting by Jessica Hall and Phil Wahba; Editing by Steve Orlofsky