What’s the Value of Hedge Funds?

Bankruptcies are never pleasant, but Whitehall’s creditors got a particularly unpleasant surprise at the company’s first bankruptcy hearing.

According to witnesses and court documents, company attorneys say they can claim ownership of consignment goods unless the goods’ UCC filings are “perfected.” Among the issues: Whether the UCC filings used the exact name of the chain (spelling of the company name switched from “Whitehall Jewelers” to “Whitehall Jewellers”) and the proper location (which had switched from Chicago to Delaware). If they didn’t, the UCCs are not “perfected,” the lawyers claimed.

“It’s a complete gotcha,” said one observer to the first day hearings. “Only a bank and a hedge fund that is exiting the industry would try to pull this.” (Executives from Whitehall, formerly owned by Prentice Capital Management, did not return requests for comment. The issue has since been settled.)

It’s another reminder that outside investors come from a different world than the jewelry industry, and they don’t always play by the industry’s rules.

As the industry seeks more capital, hedge funds and other forms of private equity are becoming a significant factor in our industry. Two of the most prominent jewelry companies—Zale and Tiffany—have on their boards “activist investors” who control a portion of their stock.

Yet, for the most part, their record in the industry is dismal. Major retailers like Friedman’s, Whitehall, and Fortunoff all filed Chapter 11 or were liquidated after being purchased by hedge funds. Analysts and observers say that’s because there is something fundamentally different about the jewelry industry. “The jewelry industry is an entrepreneurial industry,” said one industry veteran who has dealt with private equity funds. “It does not lend itself to a corporate culture.”

A vendor who was caught in the Fortunoff bankruptcy agreed. “The hedge funds want faster returns than is possible,” he said. “This industry is more of a long-term business. It is not one that lends itself to quick profits. Styles don’t change and people don’t buy jewelry every day.”

Nicholas White, a former Zale executive who is now a consultant with Gerson Lehrman Group, agreed most of the funds don’t want to stay in the business for the long haul. “They want to flip these businesses,” he said. “They go in there with the idea they will cut business and do whatever they can to make the businesses look good on paper. And at some point [when things don’t work out] you see a lot of these funds just decide to cut bait and then you have them filing for Chapter 11. It is a form of financing that is not necessarily good for a business that is struggling and needs to grow and be turned around.”

Jewelry analyst Ken Gassman, a Wall Street veteran, says the funds’ mentality must be kept in mind. “A typical hedge fund has five deals,” he said. “One is a bust, three are mediocre, and one is a home run. So, if you get a weakling, you have to kick them to the curb as soon as possible and not put another dime into it.”

Ben Janowski, another industry analyst, says that mentality has prevented a lot of businesses from turning themselves around. “These businesses can only be fixed with long-term patience and very careful management,” he says. “Whitehall had been struggling for years. It is not something that you can turn around in a year. [Former Whitehall president Ed] Dayoob made a valiant effort, but you can’t re-merchandise in a year.”

In addition, White says a lot of the investors at these funds don’t understand jewelry. “They get into the more intellectual and academic sides of retail and lose the individuality of the business,” he explains. “Jewelry is sold, it’s not bought. It’s not like you go into the store to buy a razor. People don’t say, ‘I want a marquise diamond in a six-prong Tiffany setting.’ It’s the interface with the sales associate that sells it, and that is atypical of any retail business you can think about.”

Gassman argues that the best person to run a jewelry business is a “good merchant,” and a merchant’s mind-set is often different from Wall Street’s. “Every time you get a financial type, they will say things like, We need to increase inventory turn, so let’s get rid of the inventory that doesn’t sell. It doesn’t work that way. You need to have something that’s fresh and exciting and new.”

The blame shouldn’t be placed only on the funds, some argue. Since the people behind them know so little about jewelry, they’re often receptive when “someone calls them up and tells them a beautiful story, and [they get] sold a bill of goods,” Janowski says.

One big exception to the general griping about hedge funds is Berkshire Hathaway, owned by famed investor Warren Buffett. Berkshire Hathaway owns three jewelry retailers (Ben Bridge, Helzberg, and Borsheims) as well as a large jewelry wholesaler (Richline).

But Buffett seems to have a strict hands-off policy regarding his companies. He never consolidated his three retailers and lets them function independently. And while Richline is an amalgam of several prominent trade brands, its sister retail companies are not required to buy from it.

Appearing at a Michael Anthony plant this summer, Buffett said he believes in “[acquiring] terrific companies run by terrific people. And then I don’t have to do anything. … We trust our managers. They’ve earned that trust. They’ve delivered over the years, and we let them run their businesses. I take no credit for any of their successes, and I take no blame for any of their failures.”

Of course, many investors say they subscribe to that philosophy. The head of the fund that bought Fortunoff told JCK soon after that acquisition, “We bought the business because it’s a wonderful business, not because we want to change it.” Yet such words aren’t always matched with action.

“There have been some good jewelry people involved [in these instances], but those have not been the people that were listened to,” said White.

The track record is not all negative. In addition to Buffett, NRDC, the company that purchased Fortunoff, has received praise for its handling of Lord & Taylor. And even hedge fund critics say they shouldn’t all be painted with one brush. “There are some really good funds out there,” White says. “The people who invest in them are generally considered very professional investors.”

Still, at this point, their track record has led to considerable skepticism.

“Maybe the hedge funds are right,” said the Fortunoff vendor. “They make a lot more money than us. But I think if they weren’t [in the industry], there would be less cash, but we would be better off.”