Zayre Losing Money on HomeClub Acquisition

A year after its $151-million purchase of HomeClub Inc., the Zayre Corp. is losing money with the home-improvement chain, and some industry analysts are saying that the acquisition was a big mistake.

Herb Zarkin, 48, who last August succeeded HomeClub founder Robert J. McNulty as the Fullerton-based company’s chief executive officer and president, blamed unexpectedly fierce competition, the costs of establishing new stores and inadequate inventory and financial controls for HomeClub’s poor results for the 1987 fiscal year, which ends Saturday. He also predicted that HomeClub will make a profit in its fiscal 1988.

Exactly how badly the once-publicly traded chain of warehouse-style home centers is doing is unknown because Zayre does not report financial data on the individual businesses it owns. But while Zarkin would describe HomeClub’s loss only as “marginal,” an analyst with the investment firm of Adams Harkness & Hill estimated it at about $5 million for the year.

Zarkin denied reports from some retail industry analysts that Zayre was sold “a bill of goods” when it bought HomeClub and that the giant retailer is waking up to the fact that it will never realize an adequate return on its investment.

HomeClub hasn’t been profitable since it was founded in October, 1983--a situation caused in part by the costs of expanding from two to 28 locations and building a work force of about 3,600 employees in just three years .

But Zarkin said Zayre will have a “very acceptable return” on its investment in HomeClub over the next several years, starting with a profitable 1987.

“We are going to be profitable this (coming fiscal) year, no matter what, barring an act of God,” Zarkin said.

But Zarkin’s optimism about HomeClub’s future is not unanimous in the retailing industry.

“My view is that it is not going to work,” said Terry McEvoy, specialty retailing analyst with the New York investment firm of Smith Barney, Harris Upham & Co.

He said that while he expects HomeClub to make some money in the coming year, the company never will reap the 20% to 25% returns on investment that Zayre gets from its other operations, which include a discount department store chain with 365 outlets east of the Mississippi.

Predicting that HomeClub will never achieve a return of more than 10%, McEvoy said he believes that Zayre eventually will convert its HomeClub stores to general merchandise operations similar to Price Club or will sell them to other retailers.

Likewise, Dan Wewer, an analyst for Robinson Humphrey in Atlanta, said he believes that if HomeClub still exists in four years, it will exist as a chain with the general merchandise format with which Zayre has more experience.

Rock-Bottom Prices

Wewer said he believes that HomeClub must change because it has lost the leadership of its founder, McNulty, who designed the company to sell a wide variety of home repair and improvement items at rock-bottom prices, utilizing bare-bones warehouse sales outlets and high sales volume, and charging customers a membership fee.

Other analysts, however, say that McNulty--however innovative his plan for the company--jeopardized HomeClub’s survival by failing to install the sophisticated inventory and financial controls needed by such a rapidly growing enterprise.

“Had HomeClub stayed independent, they would have had some very rude surprises for their shareholders,” said Harry E. Wells, analyst with the Boston-based firm of Adams Harkness & Hill.

Under terms of Zayre’s acquisition of HomeClub, McNulty agreed to stay on as HomeClub’s president for three years. But some industry observers say that McNulty began neglecting HomeClub as he became involved in establishing new enterprises.

Zarkin said he understood that McNulty was released from his contract obligations at Zayre by mutual agreement. Ultimately McNulty went to work as chairman and chief executive officer of SportsClub, a Long Beach-based, warehouse-style sports equipment retail business that he founded.

“I left because I wanted to do something else,” McNulty said.

‘Got to Be Something Good’

Denying that HomeClub lacks potential, he asserted that because Zayre “paid 3 1/2 times book (value) for the company . . . there has got to be something good about it.” He estimated that HomeClub’s revenues for its 1988 fiscal year will be “close to $1 billion.”

Zarkin, who previously worked in Boston as executive vice president and director of marketing and real estate for Zayre’s discount department stores, said he learned soon after taking the helm at HomeClub that major changes were needed in the company’s financial and inventory controls.

He said HomeClub’s growth plans for 1986 were pared back while the company spent $10 million to begin revamping a computerized management accounting system that keeps track of sales and determines which merchandise should be reordered and in what quantities. Another $10 million will be spent on perfecting and expanding the system over the next few years, he added.

Despite a conscious slowdown, Zarkin said, HomeClub kept opening new stores and entering new markets in 1986. While the company originally planned to open up to 18 new stores in its fiscal 1987, he said, it settled for 10, including seven new stores in California, two in the Denver area and one in Seattle.

‘Big Bang Theory’

Zarkin said HomeClub’s profits last year were hurt by the initial costs of opening several stores in Southland areas that overlapped the service areas of other, better established HomeClub outlets. Under the “big bang theory,” he said, HomeClub ultimately expects to benefit by increasing its name recognition in areas where its stores are concentrated.

Moreover, Zarkin said that last year two competitors, Builders Square and Home Depot, pushed aggressively into HomeClub’s core market in Southern California and sparked a profit-eroding price war. Only in the last few months, he said, has the price cutting started to abate. “I don’t know who blinked,” Zarkin said.

Because of the heated competition among warehouse home improvement operations in Southern California, “it is highly unlikely that anybody will make money out there,” said Smith Barney’s McEvoy.

In retort to such dire predictions, Zarkin said HomeClub will proceed apace with plans to expand throughout the West and eventually nationwide. In 1987, he said, more HomeClub warehouses are scheduled to open in Washington, Colorado, Arizona and Southern California. “Contrary to some reports, we are not dead,” he said.

HOMECLUB AT A GLANCE

October, 1983--HomeClub Inc. is founded by Robert J. McNulty and George Handgis. Company begins business using $4.5 million in venture capital to open two retail warehouses in Fountain Valley and Norwalk.

October, 1984--HomeClub raises $30 million in a private stock offering and turns down $15 million more in proffered investment funds because it has no use for the extra money.

October, 1985--HomeClub launches initial public offering to raise capital for expansion, but is unable to sell the stock at hoped-for price of $14 to $16 a share. Instead, the price is cut to $9 per share and 2.3 million shares are sold,, raising a total of $20.7 million.

November, 1985--Zayre Corp., one of the nation’s fastest-growing retail firms with stores mainly in the East, agrees to acquire HomeClub, now grown to 15 units, for Zayre stock valued at approximately $151 million. McNulty stands to make $6.5 million profit on his stock and options.

August, 1986--McNulty leaves HomeClub and Herb Zarkin becomes president and chief executive officer.

January, 1987--HomeClub numbers 28 units and 3,600 employees in California, Colorado, Nevada and Washington.