In a previous article, I outlined my thesis on Tempur-Pedic (TPX) and how I believe the shares could get to $50. Comments posted by readers made me realize that investors' concerns over Tempur-Pedic's debt position, post-Sealy (ZZ) acquisition, was much greater than I had initially thought. While I addressed the Sealy acquisition, it was from a strategic perspective and not a financial one. After digging into the numbers, I believe that investor's concerns are largely overblown and misplaced.
A Clearer Picture…
As I mentioned in my previous article, I assume that Tempur-Pedic will have upwards of $2 billion in debt after the Sealy acquisition. Over the last few days, investors were given a clearer picture on what the composition of the debt will look like.
Specifically, Tempur-Pedic was able to place $375 million in 144A securities due in 2020 at 6.875%. They also entered into a new $1.3 billion revolving credit facility where Tempur-Pedic will pay in between 300-400bps over LIBOR (See latest Tempur-Pedic 8-K filing). Sealy meanwhile has about $750 million in total debt which they are paying in between 10-12% (See latest Sealy 10-Q).
How will Tempur-Pedic use this debt?
Tempur-Pedic will likely use the first $375 million to pay for the equity in Sealy, and use a good portion of their revolver to retire the majority of the Sealy debt they are assuming. After all, it does not make sense for Tempur-Pedic to pay 10% on Sealy's debt when they are only paying 300-400bps over LIBOR on their credit facility.
When it is all said and done, Tempur-Pedic will likely be paying, on average, 6% on about $2 billion in debt. This results in $120 million in interest payments per annum. Over the last twelve month period, Sealy has generated about $117 million in EBITDA and $50 million in free cash flow. So while investors are correct in saying that Sealy is barely profitable, it is really more of a cash flow story than anything else.
Over the last twelve month period, Tempur-Pedic has generated about $320 million in EBITDA. Assuming no growth for either company, the combined firm should generate EBITDA of approximately $437 million next year. This equates to a 3.6x EBITDA/Interest coverage, which leaves plenty of cash available for reinvestment and equity holders. Even if synergies do not materialize as anticipated, the combined company still should generate more cash than either company could on a stand-alone basis.
The Great Misconception
Investors have been viewing the increase in debt, and pricing the stock as though Tempur-Pedic is not going to receive any incremental EBITDA or cash flow from Sealy. This is likely due to investors focusing on Sealy's lack of earnings and assuming this also means a lack of cash flow. This is a misconception.
In fact, Sealy's $117 million in EBITDA is almost enough to cover the annual interest payment of the combined firm. Put another way, when looking at EBITDA, Sealy will pay for its own equity value in three-years and the combined firm's interest payments through 2020. This is a great deal for Tempur-Pedic and at $30/per share, a great buying opportunity for investors.