Analysis of Recent IPO Sealy Corp. (ZZ)

Sealy Corporation (ZZ) is another leveraged buy-out quick flip IPO. In April, 2004 KKR purchased ZZ for what appears to be considerations of $1.2 billion. This transaction was funded in large part with a $1.05 billion loan put on the back of ZZ. Roughly 400 million of this loan did go toward replacing older higher interest debt, it appears though that the remaining $600 million was utilized to fund acquisition. Post-offering KKR will retain a 55% stake in the public ZZ.

From the s-1:

'We believe we are the largest bedding manufacturer in the world and the leading bedding manufacturer in the United States, based on our wholesale domestic market share of approximately 20.7% in 2004, approximately 38% greater than that of our next largest competitor.'

ZZ believes they retained that 21% leading domestic market share in 2005. ZZ has had the leading domestic bedding market share for 25 years. 79% of revenue is derived domestically, 21% internationally. Customer base is broad with 2900 customers and over 7000 retail outlets in the US alone.

The US bedding industry has seen 6-7% annual revenue growth the past 20 years. Revenues in the industry declined in only one year of the past 20(2001). The industry is characterized by a few large domestic manufacturers with few Asian imports. ZZ's top competitors are Serta, Simmons, and Spring Air all private companies.

Conventional bedding products are manufactured and marketed under the Sealy, Sealy Posturepedic, Stearns & Foster and Bassett brand names, while non-innerspring products are market/manufactured under the TrueForm, SpringFree, Stearns & Foster, reflexions, Carrington Chase, MirrorForm and Pirelli brand names. Innerspring products sell from $300 - $5000, with 68% of sales from products costing $750+. ZZ is seeing strong growth in the non-innerspring product group with sales increasing 130% in 2005 fueled by the Sealy Posturepedic 'True Form' line. This line is aimed at competing with the likes of Tempur Pedic.

The Sealy brand accounted for 80% of 2005 revenues, while Stearns & Foster accounted for 17%.

ZZ anticipates that higher end conventional and non-conventional bedding products will continue to grow at a faster than industry pace. ZZ has an even higher market share than overall in the premium bedding group($1000+) and foresees this segment as being their #1 growth driver going forward.

Financials

There is debt here. Post-offering ZZ will have approximately $842 million in debt. While the debt is slightly higher than I would like to see debt servicing does eat up 'only' 4% or so of revenue.

ZZ expects to pay an annual dividend of 2% of the initial offering price. At $15 that would mean an annual payout of 30 cents a share.

After a stagnant 2001, 2002 and 2003, revenues have grown steadily the past 2 years. In '04 top-line increased 10% and in '05 top-line grew another 12% to $1.47 billion. Gross margins for 2005 were a strong 44.3%, a slight increase over 2004/2003. Operating margins were 14%, a strong increase over '03/'03 as ZZ has been able to keep SGA expenses at similar levels while increasing revenue.

Net margins are impacted by the debt servicing. Debt payments ate up 30% of operating income in 2005. Net after tax margins in 2005 were just over 5%. Earnings per share were 77 cents per share giving ZZ a PE at a mid-range pricing of 19.

Looking into 2006, it appears after Q1(ending 2/28/06) that ZZ is on track for another 10% top-line gain. Gross margins ticked up again in Q1, operating margins were stable. ZZ notes that operating margins in Q1 were impacted negatively by new-product roll-outs and they anticipate margins to increase the 2nd half of FY 2006. I think ZZ can book another 10% top-line growth year in 2006 giving them $1.62 billion in FY '06 revenue. At slightly better gross and operating margins, I would anticipate net margins to come in roughly between 6-7%. Earnings per share for 2006 should be than approximately $1.05 per share. At a mid-range pricing ZZ would be trading 14 X's 2006 earnings.

Conclusion

I rarely recommend one of these leveraged buy-out quick-flip ipos as too often the leveraged buy-out company has sucked out an awful lot of cash/equity from the entity coming public. I'm making an exception here with ZZ. Yes KKR has put a bit more debt onto the backs of ZZ, but current debt levels post-offering are quite similar to ZZ pre-buyout as ZZ has been paying down debt from cash flows. With ZZ we've a worldwide sector leader with strong market position, proven growth trends of 10%, yielding 2% annually, and coming at an attractive multiple. Factor in the anticipated growth of non-traditional/premium bedding and the future looks bright for ZZ. I like this deal and think it works in range and $1-$2 above. Yes the debt is something to keep an eye on and should prevent one from paying up too high for ZZ, but this appears to be a solid deal all the way round.