Greenbackd

Zale Corporation (NYSE:ZLC) is an undervalued asset situation with a well-known activist investor, Richard Breeden of Breeden Capital Management LLC, holding two seats on the board. At yesterday’s closing price of $4.82, the company has a market capitalization of $154M. We estimate the liquidation value of the company at around $243M or $7.63 per share, which means that ZLC is trading at 63% of our estimated liquidation value.

About ZLC

ZLC is a specialty retailer of fine jewelry in North America. According to its website, at July 31, 2008, ZLC “operated 1,396 specialty retail jewelry stores and 739 kiosks located mainly in shopping malls throughout the United States, Canada and Puerto Rico. ZLC operates under three business segments: Fine Jewelry, Kiosk Jewelry and All Other. During the fiscal year ended July 31, 2008 (fiscal 2008), the Fine Jewelry segment generated approximately 88% of the Company’s net revenues, while the Kiosk revenues represented 12% of total revenues. On November 9, 2007, the Company completed the sale of its Bailey Banks & Biddle brand.”

The value proposition

ZLC is an undervalued asset situation with substantial Inventory and Property, Plant and Equipment (see most recent quarterly report here). Set out below is our summary analysis of the balance sheet (the “Carrying” column shows the assets as they are carried in the financial statements, and the “Liquidating” column shows our estimate of the value of the assets in a liquidation):

Perhaps unsurprisingly for a jewelry retailing business, ZLC’s asset value is predominantly in its Inventory and Property, Plant and Equipment. We don’t have any great insight into the jewelry retail business. We can see that consumers don’t have much discretionary cash available at the moment, so in a fire sale tomorrow the discount to the carrying value of Inventory could be substantial. On the other hand, there is no immediate need to sell the Inventory because jewelry is not a wasting asset and can even be a store of value. We lean towards the latter argument. ZLC has $984.6M in Inventory that we’ve written down by 15% to $837M or $26.24 per share. We’ve applied a 50% discount to the $728M worth of Property, Plant and Equipment (Gross) to arrive at $364M or $11.42 per share. We estimate the company’s liquidation value at around $243M or $7.63 per share, which means that, at yesterday’s closing price of $4.82, ZLC is trading at 63% of our estimated  value in a liquidation.

The catalyst

Activist investor Breeden Capital Management disclosed its holding in ZLC in its original 13D on September 17, 2007. Breeden has continued to buy shares of common stock in ZLC, disclosing in the most recent 13D filed November 28, 2008 that it controlled 28.46% of the company.

Breeden Capital Management’s Richard Breeden is a former chairman of the Securities and Exchange Commission. Breeden recently led a dissident shareholder group to win three seats on the board of tax preparation and accounting services company H&R Block Inc.

ZLC appointed Breeden Capital Management’s Richard Breeden and James Cotter (Cotter is a founding partner) to its board of directors on January 17, 2008

Conclusion

With ZLC trading at a substantial 33% discount to its value in liquidation and Breeden continuing to buy stock, ZLC seems like a good bet to us.

ZLC closed yesterday at $4.82.

The S&P 500 closed yesterday at 848.81.

[Disclosure: We do not presently have a holding in ZLC. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.]