Golden Gate Capital Strikes Gold in Diamond Deal

Tickers in this article: SIG ZLC

NEW YORK (TheStreet) --  Golden Gate Capital  struck gold in a merger of diamond and jewelry retailers. The private-equity firm's $150 million rescue of Zale is in for a big payoff after the Dallas-based jewelry retailer agreed on Wednesday to be purchased by Signet Jewelers for $21 a share in cash, in a merger that will put Jared Galleria of Jewelry, Kay's and Zales under a single owner.

In 2010, Golden Gate Capital provided Zale Corp. a lifeline after a sharp downturn in the U.S. and global economy cut at the jeweler's earnings and tight credit markets put the company in a vulnerable financial position as its debts came to maturity. The PE firm, in May 2010, loaned Zale $150 million for five years and agreed to receive warrants for a 25% equity stake in the company on a fully diluted basis. That deal allowed Zale to avert a liquidity crisis and presaged Wednesday's merger with Signet Jewelers.

On both the loan and the warrants, Golden Gate appears to have struck a highly attractive deal and one reminiscent of the types of emergency investments that have been made famous by Warren Buffett of Berkshire Hathaway .

Golden Gate's $150 million loan carried interest costs of 15% per annum, 10% paid in cash and 5% eligible to be paid-in-kind. The loan was secured by a first lien claim to Zale's inventory and receivables, and gave the company the right to redeem the loan with a call premium of 10% in year one, 7.5% in year two, 5% in year three, 2.5% in year four and 0% in year five. On any measure, Golden Gate's loan now looks like a savvy deal for the PE fund.

But warrants Golden Gate asked for in the deal may prove to be the biggest money maker for the private-equity firm.

Golden Gate's warrants in Zale shares carried an exercise price of $2 a share, meaning the firm had the right to purchase $11.1 million shares of common stock. After Signet's $21 a share cash offer, those warrants are now in the money by more than $200 million.

Golden Gate also asked for two seats on Zale's board. Currently, Neale Attenborough and Josh Olshansky are representatives of the firm on Zale's board.

The deal allowed Zale to repay some of its debts and revise the company's outside financing and extend the duration of its debts. Zale used Golden Gate's loan to repay its outstanding bank debt at the time and open a new facility due in April 2014 instead of August 2011. GE Capital and Wells Fargo participated in Zale's new bank debt facility and the company also signed on TD Financing Services to offer a retail partner card with the company, replacing a relationship the company had with Citigroup.