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Archive for the ‘Breeden Capital Management’ Category

Zale Corporation (NYSE:ZLC) has released its results for the quarter to January 31, 2009. After reviewing the results, we have significantly reduced our original estimate for the company’s liquidating value since we initiated the position at $4.82 on December 3, 2008. Our initial analysis of ZLC’s balance sheet was overly optimistic. We’ve now applied more dour assumptions to ZLC’s results and, as a result, we’ve decided to close the position.

We started following ZLC believing it to be an undervalued asset situation. With former Chairman of the SEC turned activist investor, Richard Breeden of Breeden Capital Management LLC, holding two seats on the board, we thought it looked like a reasonable opportunity. At its $4.82 closing price on December 3, 2008 the company had a market capitalization of $154M. We estimated ZLC’s liquidation value at that time to be around $243M or $7.63 per share. After reviewing ZLC’s Q2 financial results and applying more dour assumptions for the value of the assets in liquidation, we now believe there is a risk that ZLC has no value in liquidation.

The value proposition updated

Set out below is our summary analysis of the balance sheet (the “Book Value” column shows the assets as they are carried in the financial statements, and the “Liquidating Value” column shows our estimate of the value of the assets in a liquidation):

zlc-summary-2009-q2Conclusion

At its $1.35 close yesterday, ZLC has a market capitalization of just $43M. When we started coverage in December last year, ZLC traded at $4.82 and had a market capitalization of $154M. Our ZLC position is down a punishing 72% on an absolute basis. The S&P 500 Index closed at 848.81 on December 3, 2008 and closed yesterday at 764.90. That’s a return of -9.9% for the index and means we’re off 62.1% on a relative basis, which is still very disappointing. The simple fact is that this was an unforced error. Our original analysis of ZLC was overly optimistic. We’ve been applying more dour assumptions about the recovery values of assets in liquidation to our most recent analyses. If we had been applying the more dour assumptions at the time we made our original assessment of ZLC, we would not have initiated the position.

[Full Disclosure:  We do not 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. Do your own research before investing in any security.]

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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):

zlc-summary1

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.]

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