Signet (SIG) buying Zales (ZLC): a takeover scorecard

Last week, shareholders of mall jewelry company Zales (ZLC) voted to approve the takeover of the firm by its rival Signet (SIG).  SIG, a UK-listed company owns Kay and the more upscale Jared, as well as a number of (much less interesting, in my view) UK brand names.  The acquisition price is $21 a ZLC share, or about $670 million.

When I was working I liked luxury goods in general and the jewelry business in particular.  My portfolios contained Tiffany (TIF) and SIG more often than not, and Bulgari (now a part of LVMH) from time to time.  ZLC never.

What I’m primarily interested in today is to outline ownership percentages that are important in any US-based takeover.

1.  at 80% ownership, the acquirer can file a consolidated tax return, meaning losses in one part of the company can be used to offset otherwise taxable income in another.  As well, funds can pass freely from one part of the combined company to another without being considered (taxable) dividends.

2.  at 90% ownership, under the law in Delaware (where virtually every publicly traded US company is domiciled) the acquirer can force the other 10% to tender their shares.  Not having a minority interest makes running the combined company much easier administratively.  Specifically, the firm doesn’t have to concern itself with a tiny number of shareholders whose sole aim may be to become enough of a nuisance to be bought out at a higher price.

3.  at 90% ownership, dissenting shareholders do have the right to appeal to the Delaware Court of Chancery.  There, they can argue that they–but not the vast majority who have accepted the takeover offer–deserve a higher price.  Whatever the outcome, they are still compelled to sell their shares.

The process can be time-consuming.  It’s also risky.  The dissenters’ funds are tied up while the appeal is being heard–and if they lose, they’ll end up with the takeover price, less their legal expenses and will get the money maybe two years from now.

4.  SIG and ZLC are in the same industry.  If I understand US tax law correctly (a big “if”), this fact makes the accumulated tax losses of ZLC more readily available to SIG than would normally be the case.  This could be important, since my cursory reading of the ZLC 10-k suggests ZLC lost just under $500 million in the US during 2009-2012.  Those losses would be worth around $140 million to SIG if they could be used immediately, even if ZLC already used some of them in 2009 to recapture earlier taxes paid.

this may well be an interesting chancery court case

Several large institutional owners of ZLC shares have voiced their intention not to tender all/some of their shares to SIG and to seek a higher price in chancery court.  This may simply be bluster.  If not, I think the case will be an interesting one.

SIG has said that it expects to improve ZLC’s operating results by $50 million a year by using the SIG sourcing apparatus and by another $20 million by plugging ZLC into SIG’s administrative structure.  It expects a final $30 million from sales growth and repairs.  Then, of course, there’s that $140 million in potential tax benefits.

What I find interesting is that just about all this extra value is created by the fact that SIG is the new owner.  A private equity buyout, for example, wouldn’t have anything like the same positive effect, since it wouldn’t have the appropriate sourcing and repair infrastructure (I’ve visited the SIG diamond vault, by the way).  And their use of ZLC tax losses would be far more restricted.

Are minorities entitled to share in value being created solely from intellectual any physical property owned by SIG?  If it come to chancery court, the argument should be interesting.






the curious case of Chow Tai Fook Jewellery (HK:1929)–Tiffany (TIF), too

…toss in Wynn Macau (HK: 1128), as well.

Chow Tai Fook

Chow Tai Fook is a Hong Kong-based jeweler that IPOed there last December.  The company’s main business is chuk kam (24 karat) gold objects, the stuff that’s sold by weight, not market up by 100% (or more) over direct costs.  It’s not only decoration, but you can bury it in the back yard if you’re wary of banks.  And you can wear your wealth to work, in case you find out you have to flee the country right away.   (You wouldn’t chuckle if you’d lived through 1940-1960s China.)

The firm has expanded from the SAR into the mainland, and from chuk nam to high-end “fine” jewelry designed to flaunt your wealth, not hide/preserve it.  In recent years, the latter has become an increasing percentage of Chinese jewelry consumption.

a December 2011 IPO

The IPO was anything but a rousing success.  The stock was priced at HK$15, to raise US$ 2 billion.  But it came to market just as Beijing’s efforts to slow down the domestic economy were causing affluent mainlanders to cut back consumption.

The issue closed on day one at $13.80–and headed south from there.  It finally bottomed some months ago at HK$8.40.  Ouch!!

…so, what’s curious?

Here’s the thing.

The economic evidence over the past few months is that China is slowing further, despite signals from Beijing of its change to a more expansive government economic policy.

The EU is a mess.

US industry is slowing down and the “fiscal cliff” is getting closer.  Burberry and Tiffany have revised down earnings, in large part because of disappointing sales in China.  So too have tech companies like Intel.


since July 27th,

Chow Tai Fook share are up by 26.5%–vs. the Hang Seng index up 6.9%

BTW, Wynn Macau shares are up by 30.0% over the same time span

TIF began rising a little earlier in the month, but has gained almost 25% from its low–compared with about an 8% rise in the S&P 500.

why this good performance?

It’s a little like the case of Benjamin Button, whose body went through the opposite of what nature usually does.


–If this were ten or fifteen years ago, I’d say investors are seeing through current weakness and beginning to discount in advance the recovery that the government policy change will likely bring.

But reacting to government cues is not the winning strategy it once was.  That’s partly because the economic problems the world faces today are more structural than cyclical.  Also, the rise of hedge funds has reoriented markets sharply in the direction of short-term trading than they have ever been.

Besides, luxury goods makers like Hermes and LVMH haven’t experienced the same stock price lifts.

–new bets on China?  But, if so, why no response from Hermes, LVMH or Coach?  Also, why would UK-US (lower-end) jeweler Signet be having better stock performance than the other three?

–influence of EU investors?  My impression has been that a lot of the damage to Hong Kong stocks during the middle months of 2012 was due to panicky selling by EU-based investors.  The clear new bullishness emanating from Europe may be resulting in portfolio managers plowing back into Asia.  That might explain why 1929 or 1128 are doing well.  But why TIF?  …or why SIG and not LVMH?

–minimizing exposure to the EU?  For aesthetic reasons, I like this better than “bets on China,” because it’s a more sophisticated wager–one based on avoiding a bad experience rather than necessarily having a good one.  Still, why TIF?

You could build a “synthetic” TIF-ex-the-EU, by combining SIG +1929.  Not a perfect replacement, but if the main idea is to avoid the EU probably an acceptable one.

my take

I’m sure there’s a method to the apparent madness.  At this point, however, I don’t know what it is.

I could say that professional investors are shifting their portfolios toward secular growth areas (as opposed to more cyclical ones) where they see profit growth will be the strongest next year.  Yes, that’s true, but it’s what most managers always do.  So it’s flirting with tautology.  The crucial question is why jewelry and casino gambling?

Is there something special about these two areas?  …or is there something awful about everything else?

One thing I am convinced of is that solving the puzzle correctly can bring investing rewards.

I own 1128 and 1929 but none of the rest of the names I’ve mentioned here.  I have no burning desire to add to any–although if I can figure out what’s going on I might develop one.

If someone were forcing me to buy  one of the names, it would probably be 1929.  The fact that it’s the most speculative of the stocks is not a coincidence.  I should knock off the caffeine instead.

Tiffany’s even more dazzling 2Q11

the results

TIF reported July quarter  results (like most retailers, the company’s fiscal year ends in January of the following calendar year) just prior to the opening bell on Wall Street last Friday.   The numbers were better than the stunningly good results of 1Q11.

Sales were up 30% year on year at $872.7 million.  Earnings per share, at $.69, were 33% higher than in 2Q10.  Remove non-recurring items–mostly the costs of moving the New York head office, however, and eps were up 58%, at $.86.  This compares with the brokerage house analyst consensus of $.70, with estimates ranging from $.64 to $.77.

TIF raised its full-year earnings guidance by $.20/share to $3.65-$3.75.  My interpretation of management’s (very brief) remarks about this lift is that, as the business looks now, TIF should easily surpass this figure.  The only possible sign of weakness comes from Europe, where comps were “only” up 12% on a constant exchange-rate basis.  But during a time of political and social turmoil, there’s no sense in their raising the guidance bar any further.

Makes sense to me.

stuff I think is worth noting

–TIF bought back 330,000 shares of stock during the quarter at an average price of $74.29.  Not necessarily the greatest trade ever, but it tells you management thinks the intrinsic value of the company is significantly higher than that.

–Comps (comparable store sales) were stronger in 2Q than in 1Q for all regions of the world except Europe.  High-end jewelry sold especially well.  Chinese customers outdid themselves.

–3Q-to-date is just as strong as 2Q.

–Dollar weakness played a role in boosting earnings from Japan and Europe.  There’s no easy way to figure out the exact number, but my back of the envelope guess is that eps would have been around $.08 less without a rise in the ¥ and the €.  I think the $ will be a secular weak currency and that’s part of the icing on the cake of the TIF story.  But I don’t think we’ll see a gain this big again soon.  We might even see some giveback in 3Q11.

–Capital spending plans remain unchanged at around $250 million, but TIF will open 17 new stores this year–one fewer in the US than previously planned, one in Europe.  Eight remain penciled in for Asia-Pacific.

–Thursday-Friday trading in TIF wasn’t what I would have expected.  Before the open on Thursday, jeweler SIG (every kiss begins with Kay; he went to Jared) reported stellar US results for 2Q11.  US comps were up about 12%.  Despite this hint that TIF’s results would be unusually good, TIF shares faded after an initial rise to close down about 1% for the day.  On Friday, post results, TIF was up by 9.3%.

Isn’t Wall Street supposed to discount information in advance?



US sales (51% of the business in 2Q) were up 25% year on year at $438.2 million.  Half that gain came from purchases by foreign tourists, led by Chinese visitors.  Comps in the Fifth Avenue flagship store, a mecca for foreigners, were up 41% vs 2Q10.

The biggest factor was higher price.  Statement jewelry at prices of at $20,00-$50,000 and $50,000+ were notably good sellers.  However, units were up for all categories selling for at least $250.  Only silver jewelry, at the lowest price points, didn’t come to the party.


Sales were $173.2 million (20% of sales), up 55% year on year during 2Q in this region.  Comps were up 51%.  China and Korea were the strongest areas.

What can I say.  I thought the 31% growth in comps for 1Q were great.


Sales were up 21% to $142.5 million (17%).  Comps were +8%; the rest was currency.  Sales momentum was good throughout the island nation, and built as the quarter progressed.  Purchases by Japanese tourists in Hawaii and Guam, counted in US results, were also good.


For the first time, TIF is mentioning foreign tourists–China and Russia–as a factor in its fledgling European operations, although most purchases are still by locals.  At $101.3 million, sales were up by 32%.  Comps were up 11%; the rest was currency.  Unit volume increases were the biggest factor in growth.  The UK was good; the continent was better.


TIF has an “other” business, which consists of wholesale sales to emerging markets where TIF has no stores plus trade in rough diamonds.  The total for 2Q11 was $17.4 million.  I haven’t included it in my percent-of-sales calculations.  It’s not big enough to move the needle.

the stock

Same idea as three months ago  …except my numbers have changed a little.

I think TIF can earn $4 a share in fiscal 2011.  My base case for fiscal 2011 is $4.75.  If we apply a 20x multiple to those figures, we get an $80 target based on this year’s results and $95 based on fiscal 2012.  In an uptrending market, the multiple would easily be 25x, implying a correspondingly higher stock price.

In contrast, in a bad market/economy, next year’s earnings might be flat at $4, or even down a bit.  Applying a 12x multiple gives you a price of $48 (at the absolute bottom in 2008-09, TIF traded at under 9x depressed earnings of $2).

At Friday’s close, then, the $25 of upside I think possible is almost exactly counterbalanced by $20 of downside if the economy goes mildly south.

As it turns out, even though I told myself (repeatedly) that I was going to let the force of the downtrend of the past month or so play out without my buying anything, I found myself replacing the TIF I sold at $76.50 earlier in the year at around $63.50 on the day the market hit 1106.  That tells you something about me; it also says I think the more bullish outcome is more likely.

To my mind, the key variable is not China, which I think will go from strength to strength, or the overall US economy, which I think will be a story of the differing fortunes of haves  have-nots (think Europe in the 1980s) that will aggregate into only modest progress.  The big issue I see is that US comps generated by US citizens have got to lose steam at some point.  As long as they don’t drop to zero, I think the stock will be ok.

The fact that TIF was a $58- stock just a handful of days ago suggests a certain level of anxiety on Wall Street’s part about retail names.  To me, this means that there may be a chance to add to the stock at lower prices than Friday’s.

bottom-up investing in a world turning top-down

the old days


I started looking seriously at non-North American stock markets in 1984, after six years researching a number of sectors in the US market.  At that time, UK and continental European investors used almost exclusively a top-down style.  That is, they used macroeconomic analysis to select the countries they were interested in.  They then either bought banks, on the idea that the loan portfolios mirrored the economic structure of the countries; or they ventured into other sectors based on their economists’ view on what would be the areas of greatest economic strength.

…vs. the US

This process stood in stark contrast to what American investors did–which was to select individual stocks, mostly based on firm-specific factors, but with a little industry or sector guesswork also thrown in.  In fact, Peter Lynch of Fidelity Magellan, the most successful investor of that generation, wrote in his first book that he really didn’t pay much attention to macroeconomics.  He just picked good companies.

continental Europe?

When I began to manage a global portfolio at a small firm in 1986, I was faced with the problem of continental Europe.  I had limited resources.  There were lots of countries, all with different customs, different politics and different attitudes toward investing.  But together they only made up 10% or so of my benchmark index.   I’d spend all my time looking at just them if I adopted the European approach.  So I decided to do what Americans do, just pick stocks, on a pan-European basis and hope I didn’t get hurt too badly.

Ten years of European integration–and stellar portfolio performance along the way–later, my “accidental” approach had become the new norm.  It has stayed that way since.

…or so I thought.

macro-driven analysis

I’ve been surprised over the past couple of weeks to be seeing reports that harken back to an earlier day when analysts drew conclusions about individual stocks from general economic analysis, and nothing much else.

Two stick out.

1.  According to press reports, Goldman cut its price target on TIF a few days ago by 13%, from $77 to $67.  2013 eps were clipped by 4%, from $4.60 to $4.40.  Why?  Slowdown in the overall US economy.  That’s it.  Macroeconomic weakness will translate into lower jewelry purchases.

We’ll get some new evidence when TIF reports a little later this morning.   But judging from last night’s results from more down-market jewelry company SIG (which you’d expect to be hurt more severely than TIF if consumers were pulling in their horns),  however, there’s no sign of slowdown yet.  SIG said same store sales in the US were up 12% year on year in each month of the July quarter, and up 12% as well for the first three weeks of August.

I’m not saying GS is particularly insightful about TIF, nor that what I’ve read (I haven’t seen the actual report) is internally consistent.  What strikes me is the methodology–that there’s no apparent attempt to find a metric more subtle than that GDP growth is slowing.

2.  Deutsche Bank recently declared that the growth days for the casino gambling market in Macau are over.  Why?  Imports of German luxury cars into China, which had been growing at close to a 50% annual clip in the first half of 2011, slowed to +22% in July.  Deutsche believes this means wealthy Chinese citizens are seeing their income squeezed by global slowdown and are cutting back on spending (again, I haven’t seen the actual report, but it has been widely covered by the Asian press).

But July was a blowout month for the Macau gaming market.

According to Deutsche, that doesn’t matter.  We’re already seeing now is a reduction in high-roller participation in the market, but it’s being disguised for now by a boost in visits by less affluent Chinese gamblers.  By yearend, Deutsche thinks the Macau market will only be growing by 20%.  Growth of a mere 10% is possible for next year.  Evidence for any of this??

That’s an awful lot of inference from a one-month dropoff in sales of imported automobiles.   Who knows?  …maybe this year’s models are ugly.  …or customers have run out of garage space and will pick up the spending pace when their new garage additions are finished.

This report really struck a nerve in Hong Kong, however.  The entire gambling sector fell, with some stocks off as much as 10%.  It hasn’t recovered to date.

premises and conclusions

It’s always possible that your conclusions end up being correct even though your reasons are crazy–or non-existent. I happen to think that both reports will end up being too negative.  But that’s not my point.

In my experience, good analysts visit stores, interview/survey customers, talk with suppliers and with competitors to build a bottom-up model of a company or an industry.  They have detailed factual knowledge of a set of companies that they then integrate into an industry view.  Then maybe they knock on the door of their firm’s economist to give empirical feedback about the house macroeconomic view.

In these cases, the flow seems to have been reversed.  An economist who deals at the highest level of abstraction seems to be dictating what analysts are “supposed” to be seeing.  There’s a risk that the house macroeconomic view acts as a set of blinders that certainly make the analyst’s job easier, but makes the results less valuable at the same time.  I hope this isn’t the start of a trend.

We’ll know more about TIF later on today.  And Macau gambling numbers for August will be out in a week or so.