It sounded like such a simple deal when it started. After months of watching their sales sag and their stock price gyrate with every takeover rumor, executives at Kay Jewelers Inc. of Alexandria had decided to sell their company to Britain's largest jewelry company, Ratners Group PLC.

Kay's common stock holders would get $17 a share and the junk bond holders would get 75 cents on the dollar.

A simple deal? Hardly. Barely a week after the acquisition was announced, the junk bond holders were crying foul and organizing a campaign to prevent fellow investors from selling their bonds to Ratners.

That was crucial because the way the deal was designed, Ratners has to get 51 percent of those bonds or, as Ratners officials said, the whole deal is off.

So what might have seemed simple at first has turned into a nasty fight between Ratners and some of the nation's largest mutual funds, pension funds and insurance companies, who own the Kay bonds.

Consequently, the merger, at least for the moment, hangs in the balance.

If it does take place, the deal would merge Kay, which operates 494 stores in 32 states, with Ratners's 473 stores, making it one of the major players in the U.S. jewelry market. Ratners has about 1,200 stores in Britain.

But if the deal evaporates, this will be why it failed.

About a year ago, Kay sold $100 million of 12.875 percent junk bonds through Drexel Burnham Lambert Group Inc. The natural investors for those bonds were the major financial institutions. And some of the institutional investors, aware of Kay's financial problems and the buyout rumors, told Drexel they would not buy the bonds unless they got a special guarantee.

The investors wanted a guarantee that if Kay Jewelers were sold, they would be allowed to sell the bonds back to the company for what they paid, or 100 cents on the dollar.

Kay Jewelers agreed.

At the same time, the general terms of the bond agreement included a fairly standard clause that said the agreement could be modified by anyone who owned more than half of the bonds.

The clause lists the things that can't be changed, such as the interest payments and the payment schedule. But it doesn't say anything about doing away with the guarantee to buy back the bonds if Kay Jewelers were sold.

As a result, Ratners is trying to buy more than half of the bonds and thus obtain the right to do away with the money-back guarantee. Ratners has offered the bondholders 75 cents on the dollar.

What frosts the bondholders, said Deborah Pederson, the high-yield bond analyst at IDS Financial Services Inc. in Minneapolis, are two things:

First, the stockholders appear to be making out better than the bondholders, when it is normally clear that the claims of the bondholders should supersede those of the common stock holders.

And second, the change-of-control, money-back provision was put in at the specific request of investors, who bought the bonds believing they were protected from just the sort of thing that is happening.

As a result, Pederson predicted, Ratners will not get approval from 50 percent of the bondholders.

Pederson herself controls more than 14,000 of the 100,000 outstanding bonds in two IDS mutual funds. Other institutional investors, who together hold more than 50,000 of the bonds, have no intention of going along with Ratners, Pederson said.

"They are not going to get 50 percent," she declared after several days of talking to her colleagues at other institutions.

Pederson claimed it was "absurd" for Kay's common share holders to be bought out for a "significant premium" at $17 a share while the bondholders are taking "a 25-cent haircut."

Well, replied Richard Miller, the chief financial officer at Sterling Inc., a subsidiary of Ratners Group, the bondholders really don't have much to complain about.

Because Kay Jewelers has been in financial hot water, the bonds have been trading for only 45 to 50 cents on the dollar. And Ratners is offering 75 cents.

"We feel it is a fair offer," he said, stressing that the buyout of Kay Jewelers, which he figured would cost $400 million, was a "difficult and expensive" transaction.

"It is contingent on getting 51 percent of the bonds and if we fail to achieve it, we will not have a transaction," he said.

Watching the two sides digging in, Charles T. Akre Jr., head of Akre Capital Management of Alexandria, a longtime investor in Kay Jewelers, said the argument looked to him like an "arm-wrestling match."

Although neither side will admit it at this point, Akre suggested that Ratners eventually might have to sweeten its 75-cent offer to get closer to the dollar guarantee, while the institutional investors might be willing to take less than a dollar to get out of a junk bond that didn't look too healthy a few weeks ago.

Meanwhile, what is going to happen to the holders of the common stock?

Akre, who doesn't care much for Ratners's plan to abrogate the money-back guarantee, thinks common stock holders are getting a pretty good deal at $17 a share.

But, like the rest of this arrangement, there is nothing simple about it.

To begin with, when Ratners buys Kay Jewelers, the common stock holders will not get cash. The deal is a stock swap and the Kay shareholders will get Ratners stock in exchange.

And this is how it will work.

For each share of Kay Jewelers, the Kay's stockholder will get one convertible preferred share of Ratners. The Ratners shares will come in the form of American Depository Receipts, or ADRs. The ADR is a commonly used method for trading foreign stocks in this country without hassle.

The new Ratners convertible preferred ADRs are expected to trade on the Nasdaq over-the-counter market. Since there are 12.4 million Kay common shares, there will be an equal number of the Ratners ADRs, which means there should be good liquidity.

Once the new Ratners preferred ADRs are issued, each ADR will be convertible into three of Ratners ordinary (common) shares, the ones traded in London, if anyone should want to convert.

And what will the new preferred ADRs be worth?

Well, Ratners's ordinary shares recently were trading at 236 pence, or about $4.20 a share. Three shares would be worth about $12.60, although Ratners says the three shares are worth $17. The market here says Kay stock is now worth about $14 a share.

One other way to gauge the price of Ratners's London shares is to watch the price of a Ratners common stock ADR already trading on Nasdaq. Each one of those ADRs also is equivalent to three shares of the Ratners London shares, although currency fluctuations will affect the price. That common ADR closed Friday on Nasdaq at $12.50.

When, and if, Ratners gets the chance to issue the new convertible preferred ADRs to Kay shareholders, they will come with several sweeteners. The first is an annual dividend of $1.06 a share. If the preferred was worth $17, that would be a yield of 6.2 percent. At $14, the yield would be 7.6 percent.

But there's more.

Akre estimates that because of the way British ADRs work, and especially because of tax considerations, each Ratners preferred ADR will pay an additional 14-cent-a-share dividend, for a total of $1.20 a share. That would, of course, boost the yield.

In addition, shareholders will be able to take a foreign tax credit of 21 or 22 cents a share on their tax returns, he said.

The theory of convertible stocks, of course, is that the yield helps to put a floor under the stock and thus protects an investor on the downside. But at the same time, it allows for unlimited upside as the common stock appreciates.

Like most investment rules, the convertible rule sometimes works as advertised and sometimes doesn't. But it appears that if business is good at Ratners, the Kay-turned-Ratners stockholders could profit.

Of course, whether they will ever get the chance to do so depends right now on the bondholders. And as far as they are concerned, 75 cents on a dollar isn't good enough to take to the bank.