Zale, Sterling Merger: Still a Bad Idea

 A Reuters article from last night again raised the possibility of a Zale/Sterling merger:

“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. 

Now, it’s worth noting that this article includes no sources that say this is currently a subject of discussion. And, of course, there have been talks on this before, when both companies had different CEOs, but they went nowhere.

Consolidation in not uncommon these days, but the industry folks I spoke to are none too enthusiastic about this idea. Signet’s slow, deliberate, arguably unadventurous nature can drive people crazy, but it’s one of the things that has gotten it where it is. Swallowing Zale would put a lot on its plate, and strain its financial resources, which has always been one of its biggest advantages, as demonstrated by the way its advertising swamps the TV airwaves every holiday. Signet would also have to take on Zale’s not-insubstantial debt. As one Zale veteran told me: “It would get Zale out of the doghouse, but I’m not sure how it would benefit Signet. They are doing just fine without them.” This vet thinks there could be more value in Signet cherry-picking certain Zale assets, like its Canadian division, or (a longer shot) Piercing Pagoda.

That said, there is a growing industry consensus that something needs to happen with Zale. The company’s comps have risen considerably, and I’m hearing that its Vera Wang line has been particularly strong. The Zale chain is also—smartly, I think—carving out a niche as a somewhat edgier, more youth-oriented alternative to Kay. Consider: Kay uses Jane Seymour for a brand. Zale, Jessica Simpson. Zale has long been active in social media. Kay just launched its first Facebook page. Kay’s commercials are backed by sentimental strings. Zale’s, modern pop-rock. Sterling’s commercials tend to end with an embrace or a kiss. Zale’s…well, check out this ad.

The problem is, for all the inroads Zale has made, it is still saddled with heavy interest from its 2010 loan arrangement with Golden Gate. Eventually, Zale must change that arrangement or refinance it. (And, by the way, when people talk about the sometimes-harmful impact of private equity, this is the kind of situation they mean. Golden Gate was cast as Zale’s savior, and yet it’s burdened Zale with heavy interest, and pocketed large fees to change certain covenants. And the arrangement is structured so that no matter what happens to Zale, Golden Gate wins.)

The company has said it is working on getting new financing, and from what I understand, the people there have time. But at the 24 Karat dinner in January, trade members were again nervously speculating about the company. Not that anyone is forecasting doom, mind you—but the trade would clearly feel much better about the company if it got out from under the shadow of Golden Gate. As one analyst told me: “It’s ironic. The advertising is better, the company is run better. But the balance sheet is much, more worse.”

JCK News Director