Please ensure Javascript is enabled for purposes of website accessibility

Is Signet's Decision to Tie the Knot with Zale All it's Cracked Up to Be?

By Daniel Jones – Feb 22, 2014 at 11:00AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Signet announced that it will be acquiring Zale for $21 per share. However, is this a move of desperation for the business or a decision that will allow it to catch up to Tiffany & Company?


Source: Wikimedia Commons

On Feb. 19, 2014, shares of Zale (NYSE: ZLC), one of the largest jewelry stores in the U.S., soared over 40% in response to news that it was being acquired by Signet Jewelers (SIG 0.85%) for $21 per share. At that price, it implies a market capitalization of $690 million, quite small compared to Signet's $7.5 billion or Tiffany & Company's (TIF) $11.3 billion, but nothing to scoff at. Given this move by Signet, is the company an attractive opportunity for the Foolish investor or is its strategic decision a harbinger of bad times ahead?

What's in it for investors?
In exchange for the high price of the acquisition, shareholders who own a piece of Signet will receive a business that made $1.9 billion in revenue in 2013. In aggregate, management expects that the sales of the two businesses will amount to $6.2 billion.

On top of seeing its sales rise significantly, Signet believes that the Zale acquisition will result in a great deal of synergies. Within three years of the completion of the transaction, the company expects to see $100 million worth of synergies per year. What this means is that this is the expected cost savings that will develop as a result of the company's ability to greater utilize its market position with suppliers, combined with reduced corporate costs.

Is the deal too rich for Signet?
Given the premium that Signet placed on Zale, shareholders might think they are getting a strong and attractive company in return. However, this doesn't appear to be the case. Over the past four years, Zale has significantly lagged both Signet and Tiffany in terms of revenue growth and net income growth.

Between 2010 and 2013, Zale reported revenue growth of 17% from $1.6 billion to $1.9 billion. Although this may appear strong, it actually falls quite short of the 22% rise in revenue experienced by Signet, which rose from $3.3 billion to $4 billion. While Signet's revenue growth was strong, even it pales in comparison to the 40% jump in sales reported by Tiffany. Over the past four years, Tiffany saw its revenue rise from $2.7 billion to $3.8 billion.

In terms of profitability, Zale has been at the bottom of the barrel but has seen some improvement over time. Between 2010 and 2013, the company's net income turned from a loss of $93.7 million to a gain of $10 million. On top of benefiting from rising revenue, the company saw its cost of goods sold decline from 49.6% of sales to 47.9%, while its selling, general and administrative expenses fell from 52.4% of sales to 48.5%. A four-year picture of each company's cost of goods sold and selling, general and administrative expenses in relation to sales can be seen in the two tables below:

Source: MSN Money

Source: MSN Money

In contrast to this, both Signet and Tiffany performed immensely better over this timeframe. Between 2010 and 2013, Signet saw its net income jump an impressive 129.1% from $157.1 million to $359.9 million. Despite seeing a slight uptick in its selling, general and administrative expenses, Signet's management reported that its cost of goods sold declined drastically, from 67.4% of sales to 61.4%.

When it comes to revenue, Tiffany took the cake but this wasn't the case when looking at profitability. Between 2010 and 2013, the company saw its net income rise 57% from $264.8 million to $416.2 million. Over this four-year period, the company saw most of its improvement come from higher sales, but also enjoyed a slight decline in its cost structure.

Foolish takeaway
Right now, Zale's financial performance looks to be less-than-ideal. Not only was the company the slowest growing of its peer group; it was also the least profitable. Typically, this combination might raise some eyebrows among shareholders, but Signet's plan moving forward is quite clear. By taking a business that will significantly increase its size, Signet's management is hoping to further leverage its resources to reduce costs in relation to sales, just as it has done with itself over the past four years.

While the risks are great, the rewards are tremendous. In the event that management can make Zale as profitable as the rest of its business was at the end of its 2013 fiscal year, then both a revenue multiple and a net income multiple suggest the purchase could be worth $3.6 billion. The real question is whether or not this will come to fruition. For the Foolish investor who believes in the future of Signet and in its ability to make Zale a stronger business, the acquisition could create a great deal of value. However, if you don't think Signet is up for the challenge, now might be an opportune moment to consider investing in Tiffany.

Daniel Jones has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Nearly 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Tiffany & Co. Stock Quote
Tiffany & Co.
Signet Jewelers Stock Quote
Signet Jewelers
$65.00 (0.85%) $0.55

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 11/30/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.