Signet Jewelers' (NYSE:SIG) Board of Directors should rethink the company's offer of $21.00 per share for Zale (NYSE:ZLC) shares in view of TIG Advisors LLC's recommendation that shareholders vote against Signet's offer. TIG Advisors is a material stockholder of Zale Corporation. This is a once in a lifetime opportunity for Signet to rethink its high-risk decision to acquire Zale.
By now, Signet stockholders must have realized that buying Zale Corporation is a strategic mistake. Granted, there have been short-term gains to Signet shareholders, which in large part have already been realized by those shareholders of record when the offer was announced. However, at issue for current shareholders is whether Signet's stock will ever see sustainable gains above current share prices, which have ranged between $94.22 on February 20, 2014 and $106.95 on April 2, 2014. The answer to that question is very unclear. Here is why:
1. Malls are a declining distribution channel:
In the U.S., especially now with J.C. Penney (NYSE:JCP) and Sears Holding Corp. (NASDAQ:SHLD) closing anchor stores (Struggling Malls Suffer When Sears, Penney Leave), the decline of malls' efficacy as an efficient and growing distribution channel is problematic. Essentially, buying Zale saddles Signet shareholders with substantial incremental store closing costs as malls decline, while giving non-specialty jewelers and independent, client-driven jewelers the competitive advantage.
2. Signet lacks the depth in management to integrate Zale:
The fact is that Signet in general, and specifically Sterling, is very thinly managed by a group of very focused buyers, merchandisers, marketers and store operation people that operate within a highly centralized culture that values low risk above all else. Consequently, Signet's planning and execution processes are typically very methodical and time consuming, which begs the question whether such an organization has the flexibility and necessary competencies to integrate Zale's disparate culture or the time to do it while continuing to focus on running day-to-day Jarred, Kay, etc. retail operations.
3. Signet has less than a one in three chance of success:
Notwithstanding the strategy issue, actual organizational change statistics indicate that only about 70% of those companies that attempt to implement such large scale change either fail or materially fail to achieve the expected financial objectives (Beer & Nohria, 2000). In fact, over the last 30 years, there has not been one successful large specialty jewelry merger or acquisition in the U.S., Canada, or the U.K. Granted Sterling did acquire Kay Jewelers in 1989, but that was a reverse merger from both an economic and marketing point of view. Today, Sterling's original brands are mediocre, regional brands that typically underperform the Kay brand year over year. Clearly, in the context of historical success, considering institutional and jewelry industry trends, the Signet-Zale deal has less than one in three chance of succeeding.
4. Scale saving do not fit industry facts:
Clearly, the combined businesses do not need two IT departments, two HR departments, two distribution centers, two general counsels offices, two real estate and store planning departments, two loose diamond buying departments, two core basic merchandise buying departments, or for that matter, two home offices? However, assuming that Signet has sufficient depth in management to integrate, train, and manage those expanded functions, which is a high-risk assumption, Rich Duprey (Motley Fool, Duprey, 2014) comments that Signet would have global scale with market-leading shares in the U.S., Canada, and the U.K., which will not, defacto, turn into lower merchandise costs and higher productivity. Indeed, contrary to department store experience, market share-driven scale efficiencies are much less important in the low volume, high value, and high perceived risk specialty jewelry business.
For instance, only under certain circumstances does buying more rough or loose diamonds translate into lower total supply chain costs. Likewise, whether Signet buys a one metric ton of gold or ten, the price of gold is the same. Similarly, branded product companies like Seiko, Citizen, Movado, and Bulova will not offer Signet lower prices, in part because to do so would violate the law, and partly because the those companies derive no incremental, material, economic benefit from the combination of the two firms. In contrast, employee wage and benefit costs may increase at Zale, bringing actual pay and benefits in line with Kay and Jared levels in the U.S. marketplace.
5. Zale was in the midst of a successful turnaround:
While Zale did post a small profit in 2013 after five years of losses, Motley Fool (Duprey, 2014), it remains to be seen what that means in the future. The fact is that Zale has continued to consistently lose market share to the industry as a whole and to Kay Jewelers. Moreover, long term, how viable is Zale's current positioning?
Clearly, looking at sales and operating earnings growth, net of internet sales and accounting changes for warranty repair sales, suggests that it is highly problematic if the company has a positioning/product strategy that gives the company a unique, competitive advantage in the marketplace. In fact, besides the strong emphasis on credit, Zale management has unsuccessfully tried to become a clone of Kay Jewelers, which brings nothing strategically to Signet Jewelers.
What is more? It is problematic whether Signet can reverse that despite pundits' suggestion to the contrary. For instance, if Signet's positioning and merchandising prowess is so strong, why hasn't the company been more successful in driving sales in its regional brands? Similarly, after two decades, why has Signet been unable to drive superior sales and profit results from its H. Samuels and Ernst Jones brands in the U.K.?
In reality, given the accelerating decline of the mall as an effective distribution channel, weak positioning, limited capital for investment, and high debt, left to the company's own means, Zale poses no material threat to Signet. Additionally, as an acquisition, it brings nothing strategic to Signet's long-term business. Management should be focusing on developing a sustainable, long-term strategy for Signet instead of compounding its developing strategic problems by acquiring Zale. Clearly, it's problematic for Signet to do the Zale acquisition and successfully face the greater distribution channel threat at the same time. Signet's culture is not adept at doing two big things at once.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.