We’ve gotten an unusual number of calls and e-mails recently from vendors and others in the jewelry industry asking us for our insight on Zale. They express worries that internal turmoil, lack of communication, confusion, mistrust and fear permeate the business climate at Zale.

 

From an analytical viewpoint, we see four key factors that have raised uncertainty levels about this company:

 

• Management turnover, especially at the highest levels, seems excessive.

• Financial results are lackluster, at best.

• Growth has slowed, and management says a “meaningful number” of stores have been identified which could be closed.

• 77 percent of Zale’s shares are owned by 11 institutional investors, some of whom are known activist shareholders. Management and directors own 0.1 percent of Zale’s shares, and have options to purchase 0.9 percent more, so they potentially control only 1 percent of the company’s voting shares.

A Cautionary Note: No Inside Information

It is important to emphasize that we have no inside information about what is going on at Zale. Our perspective comes from reading financial reports and legal filings, listening to others in the industry, and visiting stores. If we had inside information, we couldn’t write about the company candidly for fear of legal retribution related to accidentally divulging proprietary non-public information.

 

What We Hear

In a word: uncertainty. We’ve been following Zale for nearly two decades, and uncertainty is nothing new at this company. Zale got into trouble nearly two decades ago, and except for some brief periods, it seems to remain mired in uncertainty and distress.

 

Zale’s board of directors seems to have a short fuse. “If it can’t be fixed by the end of the day, get someone new to run the company,” the directors appear to be saying. Corporate turnarounds, especially the size of Zale, don’t occur overnight. Thus, the directors are creating uncertainty because employees and vendors don’t know who will be running the company next week.

 

As a result of board’s short fuse, there has been a succession of top people at Zale. Some would argue that Bob DiNicola has been the only stable force. We’d disagree. Even when he was there, the company did not produce consistent, stable results.

 

He retired, and Beryl Raff took over. She didn’t last long, because we believe DiNicola left her an untenable situation. Zale didn’t get off track in the five short months that Raff was Chairman; it was already off track when DiNicola retired.

 

DiNicola came back, but his heart did not appear to be in the business. He quickly arranged for an executive team to run the company – Mary Forte and Sue Gove. While both Forte and Gove have impeccable credentials in their respective fields, neither had the breadth of experience to run the company alone. Companies can’t be run by a team, in our experience. One person must be in charge. Under the Forte/Gove shared governance era, there was no single “go-to” person. Insiders tell us that there was friction between Forte and Gove which also created uncertainty within the company.

 

Betsy Burton took charge, but after a little over a year, she, too, is out. We worried about her new strategy. From our viewpoint, Burton was creating a company that was reminiscent of the Kay Jewelers organization that almost went down in flames about two decades ago. She wanted to centralize the organization in the name of cost savings. Wall Street loves it. We predict that customers will hate it, because a centralized organization, especially in merchandising, creates a homogenous product assortment. Within a relatively short time, Burton predicted that 80-90 percent of Zale’s and Gordon’s product line will be identical. She said those two brands – Zale’s and Gordon’s – will differentiate themselves via promotions and the in-store experience. That will be a trick that we haven’t seen anyone else replicate in our nearly three decades of following U.S. retailers.

 

Now, Neal Goldberg is at the helm. It is too early to tell what he has in mind. He seems to have the credentials, but the big question is this: will Zale’s board give him time to implement his strategy? If we were Goldberg, we’d have taken as much of our compensation as possible up front, with the rest put in escrow.

 

What else is a problem at Zale?

The company seems to suffer from lack of clear communications. This seems to foster fear and mistrust, in our opinion. It appears to be permeating the vendor community. Vendors are afraid to talk about Zale for fear of losing the company as a client, though no one will say explicitly that they have been threatened by Zale management.

 

Burton may have had a strategy, but people weren’t clear about it. Communications is the key here, and Zale may be guilty of failure to communicate.  

 

How Does Zale Compare?

It may not be fair to compare Zale to others in the industry, because the company is at a different place in its life cycle.

 

However, we don’t see people leaving major competitors at the same rate, nor do we see people leaving major competitors and taking jobs at Zale. The word appears to be out on Zale: take a job at Zale at your own risk.

 

Zale Has A Lot Going For It

Zale’s major asset with shoppers is its brand name. It is a venerable name, and it has significant brand equity among American shoppers.

 

Zale sells good quality merchandise at fair prices. However, our mystery shopping visits indicate that the quality of many of its store personnel has declined. That can be fixed, though it is usually a slow process.

 

Zale is a huge company. It’s not going out of business. (However, we remember saying the same thing about Heilig-Meyers, the world’s largest furniture retailer, and its death was measured in months, not years. So, we could be wrong about Zale, though we hasten to note that Zale does not have the problems that brought Heilig-Meyers down.)

 

Shareholders Get What?

The group of people who most want Zale to succeed, aside from its employees and vendors, are Wall Street investors. Unfortunately, many in this group do not understand the jewelry business or Zale. They are impatient. I was one of them for two decades. The motto of many Wall Street investors is “ready, fire . . . and, oh, aim.”

 

Based on Zale’s latest proxy materials (October 12, 2007), eleven institutional shareholders own 77 percent of Zale’s shares. In contrast, Zale’s directors and top management own only about 0.1 percent (one-tenth of one percent) of Zale’s shares, and they have options to purchase an additional 0.9 percent (nine-tenths of one percent) of ZLC shares. That means the directors and top management have a stake in only 1 percent of the company.

 

Some of Zale’s large institutional shareholders have a reputation for being activist owners. Activist shareholders have been known to ask for a seat on the board of directors; they could precipitate the sale or break-up of a company, especially when it is undervalued, as many believe Zale is.

 

It is not possible to predict that all eleven of Zale’s shareholders might band together to force the company to make changes, but it is not an inconceivable idea, either. Even under Delaware law (Zale is incorporated in Delaware, a state with laws that favor directors and management of a company), a unified action by 77 percent of a company’s shareholders could cause a lot of heartburn for Zale.

 

Zale and Sterling explored a business combination last year, according to legal filings. Due to many complexities, they did not get together. If that deal had gone through, Zale’s shareholders might well be on the way to achieving a better return. Sterling’s owners, Signet Group, also a public company, would probably have achieved a less favorable return. Merging two companies the size of Zale and Sterling would have taken far longer and cost far more than anyone can imagine. It always happens that way, based on our experience.

 

As it stands, Zale will either need to bootstrap itself up from the abyss that it has fallen into, or it will need to be acquired by a private entity that can re-create the company away from Wall Street’s short-term mentality.

 

Zale recently sold Bailey Banks & Biddle; that raised some cash. We continue to believe that Piercing Pagoda is not a good fit, though it may hang around for financial reasons (great cash flow). Zale’s and Gordon’s will likely continue to experience identity problems among shoppers. Peoples and Mappins, both doing well now, will suffer under the centralized merchandising plan. And Zale will likely be no further down the road to retail success this time next year. The company won’t be in big trouble, but it will have simply treaded water for a year, in our opinion.

 

Don’t forget, Zale’s board is impatient. Should Neal Goldberg buy a house in Dallas or not? We’ll take bets.