* $21-per-share price is 41 percent premium to Tuesday's close * Signet shares rise more than 16 percent * Deal would mean big payday for Zale shareholder Golden Gate Capital By Phil Wahba Feb 19 (Reuters) - Signet Jewelers Ltd is buying smaller rival Zale Corp for about $690 million, an acquisition it said would strengthen its place in the U.S. jewelry sector and let it tap new markets. The deal, announced on Wednesday, would combine the two largest U.S. mid-tier jewelry store chains, Zales and Signet's Kay Jewelers. The price of $21 per share is a 41 percent premium over Zale's close on the New York Stock Exchange on Tuesday. The deal caps a multiyear turnaround for Zale, which last July reported its first profitable fiscal year since the 2008 financial crisis and in January posted strong holiday sales. The company's stock, which traded as low as $3.76 only 10 months ago, rose to $20.89 on Wednesday. The merger would also mean a big payday for Golden Gate Capital, which holds about 22 percent of Zale shares. The private equity firm gave Zale a $150 million lifeline in 2010, when it was running low on cash, and in return received warrants to buy 25 percent of the retailer's shares at $2 apiece. In the United States, Signet and Zale would have a combined 16 percent share of the specialty jewelry market, which is highly fragmented, according to IBISWorld data. The merger would also make Signet the biggest jeweler in Canada, where Zale operates the successful Peoples Jewellers chain. Signet would also gain a much bigger presence in the growing U.S. jewelry outlet business, where Zales Outlets is a leader. Other benefits include more leverage with diamond vendors at a time both companies are focusing on their bridal businesses, and annual savings of about $100 million from combining operations, Signet said. Investors agreed, sending Signet shares up 16.2 percent to $92.12. Signet Chief Executive Officer Michael Barnes told Reuters that the company had approached Zale about a deal in the autumn. It was not the first time the rivals discussed a combination; in 2006, Zale ended tentative, short-lived merger talks with its bigger rival. In 2010, Signet hinted that it would look at a deal to get a new nationwide U.S. jewelry chain, saying it would take too much time and money to build one. The deal is subject to Zale shareholders' approval. REVERSAL OF FORTUNES In 2009, debt-laden Zale went through a severe liquidity crisis that forced it to cancel orders right before the key holiday season, alienating vendors and customers to Signet's benefit. In the next two years, Zale made strides by closing unprofitable stores and adding exclusive brands like Vera Wang bridal jewelry, some of it costing as much as $17,000, at its now 90-year-old namesake chain. Barnes told Reuters that Signet would not combine Zales and Kay stores at malls that have both as long as each is profitable. Signet operates 1,400 U.S. stores, including its higher end Jared chain. Zale has about 800 Zales and Gordon's Jewelers stores, as well as 630 Piercing Pagoda mall kiosks. Buying Zale will also reduce Signet's reliance on its British chains, H. Samuel and Ernest Jones, which are market leaders but whose growth has been uneven in recent years. Zale will become a division of Signet. Zale CEO Theo Killion will manage that division after the deal, but will report to Signet CEO Barnes. Including debt, the all-cash deal values Zale at about $1.4 billion, the companies said. Signet said it expected the deal to increase earnings by a high single-digit percentage rate, excluding acquisition costs, in the first year after closing. The jeweler said it expected to finance the transaction through bank debt, other debt financing and converting a significant portion of its accounts receivables into cash. Signet said J.P. Morgan Chase Bank had committed to provide bridge financing for the transaction. J.P. Morgan Securities acted as financial adviser to Signet, while Weil, Gotshal & Manges was legal counsel. Bank of America Merrill Lynch was financial adviser to Zale, and Cravath, Swaine & Moore acted as legal counsel.