BUSINESS WATCH

Seduced down a treacherous path

Irving Gerstein, who led his family into this fiasco, is the latest victim of the 1980s foolishness that replaced common sense

Peter C. Newman December 9 1991
BUSINESS WATCH

Seduced down a treacherous path

Irving Gerstein, who led his family into this fiasco, is the latest victim of the 1980s foolishness that replaced common sense

Peter C. Newman December 9 1991

Seduced down a treacherous path

BUSINESS WATCH

PETER C. NEWMAN

Dreams die. And no dreams die more cruelly than those of Canadian retailers trying to penetrate the U.S. market. The latest and most dramatic example is the impending fate of Toronto’s Gerstein family, which with a Swiss partner in 1986 purchased Dallas-based Zale Corp., the world’s largest jeweller, which last week faced the prospect of filing for Chapter 11 bankruptcy protection. The move, if it happens, would be serious enough to drag down Zale’s Canadian parent company, the 72-year-old Peoples Jewellers Ltd., one of this country’s finest and most venerable family firms.

The portents are not encouraging. After Zale announced a two-quarter loss of $120 million on revenues of $593 million, Standard & Poor’s slashed the company’s debt ratings, placing it in the low end of its non-investmentgrade spectrum. (Peoples simultaneously reported a $44-million loss on revenues of $88 million, a direct result of its 47-per-cent ownership of Zale.)

Zale’s dismal earnings record is important because the company seems already at risk since a $59-million interest instalment is outstanding on its junk bonds, and in June it faces further obligations totalling $188 million. On top of that, Zale’s suppliers are owed more than $100 million, though they have temporarily extended their due dates. To try and save their company, Zale employees shelled out $45 million in return for their six-per-cent share of its stock.

Whether any of this will help stave off insolvency remains doubtful, and it is still an open question whether Peoples, which owns equity in Zale worth $133 million, can survive. The bankruptcy of Zale could shake Peoples’ hitherto solid equity base.

Irving Gerstein, 50, the third-generation Canadian jeweller who led his family into this fiasco, is the latest victim of the riptide of foolishness that replaced common sense in the 1980s. That his dream of becoming the world’s largest jeweller has now turned into a night-

Irving Gerstein, who led his family into this fiasco, is the latest victim of the 1980s foolishness that replaced common sense

mare is bad enough. That it threatens the existence of his family business and may end the Gerstein dynasty is a personal tragedy of rare dimensions.

The Gerstein family’s current operating head is a handsome, fun-loving entrepreneur who genuinely believed in himself and, under the current difficulties, has demonstrated grace under pressure rare for his class. A graduate of the University of Pennsylvania’s prestigious Wharton School of Finance, he sits on the boards of a dozen important Canadian companies and is a past governor of such distinguished institutions as the Albany Club, Upper Canada College and Bishop Strachan School. He has always lived well, keeping a Swedish-built Swan-50—one of the world’s most luxurious yachts—at the ready for quick holidays in either Antigua in the Caribbean or somewhere in the Mediterranean, as well as maintaining one of the most luxurious mansions on Toronto’s exclusive Bridle Path.

When I interviewed Gerstein in the spring of 1987, just after he had taken over Zale, he was still impressed by his chutzpah in having captured control of a company 10 times the size of his own. “We had a net worth of $50 million and Zale was about worth $550 million,” he told

me. “It seemed unthinkable that we could take it over, but a change had taken place in the financial markets that allowed some unthinkable things to come about.”

That change was the introduction of junk bonds, and no one was more enthusiastic about that dubious invention than Gerstein. In 1986, Gerstein relied on junk bonds to engineer the $750-million leveraged buyout of Zale. Then, in 1989, long before the Zale deal was fully assimilated, Gerstein returned to the financial trough for another $375-million shot of highyield securities to buy out Gordon Jewelry Corp., the second-largest jewelry chain in the United States. By the end of the decade, Gerstein had realized his dream of becoming the world’s largest jeweller. But Zale was also an incredible $1.62 billion in debt.

There had been plenty of warnings. Peoples, which had been run with loving care and creative conservatism from the day in 1919 when Gerstein’s grandfather started selling silver flatware door-to-door for 50 cents down and 50 cents a week, had already tried penetrating the U.S. market in 1978 with the purchase of the 14-store White jewelry chain of Salt Lake City. But the investment turned sour almost immediately, and the family switched its attention to Zale in 1980. It took six years for the Gersteins to capture control, and they ended up paying $65 a share—twice Zale’s book value. Even at the time of purchase, analysts claimed that the Dallas company was not throwing off enough cash to pay the interest on Gerstein’s financing package. The leveraged buyout was bound to fail.

Several Canadian banks backed out of the financing at the last minute, having noted that unlike most jewelry retailers, Zale rented all its stores, so that there was no real estate value to back up its cyclical retail revenues. “I don’t understand the deal. I don’t know what Gerstein has in mind,” Arthur Lichtendorf, an authoritative retail analyst with E. F. Hutton in New York City, commented at the time. Opined another veteran Wall Streeter: “Nothing in the historical performance of Zale would seem to justify the price.”

Among the motivating incentives for Zale’s acceptance of the takeover were the unprecedentedly generous golden parachutes Gerstein offered Zale executives. Some were paid as much as $2,600 an hour as consultants; others received stock options worth a total of $29 million. On Dec. 30,1986, Gerstein called in all of Zale’s executives to give them a pep talk. “We see the retail jewelry business as one that is focused on the two feet of counter space between the sales personnel and the customer,” he said. “That’s where this company must succeed—beat out its competition!”

At first, the U.S. expansion seemed to be working, and as late as 1990 Zale and Peoples were still in the black. But the extra cost of the Gordon acquisition had added so much debt to an already awesome overload of obligations that the ratings services placed the whole operation under credit surveillance. By mid1989, Zale’s total debt ratio was approaching 72 per cent of its capital structure.

Now, it is close to collapse.