Tempur-Pedic: Acquisition Of Sealy Creates Short Term Distraction But Long Term Value

| About: Tempur Sealy (TPX)

Tempur-Pedic International (TPX) announced on Thursday that it will acquire Sealy Corporation (ZZ) in a deal valuing the company at $1.3 billion, including the assumption of debt.

Investors were applauding the deal sending shares from Wednesday's close of $26.78 to almost $33 in Thursday's morning session. Shares ended the week just below the $30 mark on Friday, as short term traders took their profits. Sealy's shares rose some 2% on Thursday towards the offer price, as shares have already returned some 38% over the past month.

The Deal

Tempur-Pedic announced that it will acquire Sealy Corporation, a global bedding manufacturer, founded in 1881. Sealy is a manufacturer of high quality mattresses and foundations, known from brands including Sealy, Sealy Posturepedic and Stearns & Foster.

Tempur-Pedic will pay $2.20 per share for Sealy, or roughly $230 million for the equity of the firm. Tempur will also assume and/or repay all of Sealy's outstanding convertible and non-convertible debt, valued a little over $1.0 billion.

CEO Mark Sarvary commented on the acquisition,

This is a transformational deal that brings together two great companies, each with globally recognized brands. Tempur-Pedic and Sealy together will have products for almost every consumer and price points, distribution through all key channels, in-house expertise on most bedding technologies, and a world-class research and development team. In addition, our global footprint will span over 80 countries. The shared know-how and improved efficiencies of the combined company will result in tremendous value for our consumers, retailers and shareholders.

Sealy Corporation generated annual revenues of $1.23 billion in 2011. The company net lost $10 million during the year. For the first nine months of 2012, Sealy reported revenues of $989.8 million, on which the company net earned $2.7 million.

The equity part of the deal values Sealy at 0.2 times 2011s annual revenues. The acquisition of Sealy is expected to be accretive in the first year of operations. Annual cost synergies are expected to be in excess of $40 million in three years time. Furthermore, revenue synergies are expected as well, as a result of the broader product offering and wider channel distribution.

Tempur-Pedic expects to close the deal in the first half of 2013. The deal is subject to regulatory approval and the usual closing conditions.


Tempur-Pedic ended its second quarter of 2012 with $134 million in cash and equivalents. The company operates with $682 million in short and long term debt, for a net debt position of $548 million. Tempur's net debt position will rise significantly after the $1.3 billion deal, to an expected $1.8 billion.

For the first six months of 2012, Tempur-Pedic generated revenues of $713.9 million. The company net earned $85.3 million, or $1.31 per diluted share. For the full year of 2012, the company is on track to generate revenues of $1.43 billion (excluding the acquisition of Sealy). Earnings per diluted share are expected to come in at $2.80.

Pro forma, the combination is expected to generate revenues of $2.7 billion. The press release stated that the combination generated pro-forma EBITDA of $504 million per annum. Net earnings on a pro-forma basis come in at roughly $170 million, excluding annual synergies of $40 million, expected to be achieved in three years time.

Tempur is currently valued at $1.8 billion, or 0.7 times annual revenues for the pro-forma combination. Shares are valued at 10 times annual earnings, a multiple expected to come down as a result of the synergies.

Currently, Tempur Pedic does not pay a dividend.

Investment Thesis

Year to date, shares of Tempur-Pedic have fallen some 45%. Shares steadily rose from $50 to a peak of $85 in April on the back of strong operating results and rising equity markets. Two severe profit warnings, send shares to lows of $20 in June of the year.

At the time, I argued that the shares offered value despite the dramatic cut in revenue outlook, after shares have fallen some 75% in a matter of weeks. Shares have swiftly recovered to a peak of $35 in September, but have fallen back to $26 earlier this week.

Initially, investors of Tempur were very enthusiastic about the deal sending shares 20% higher on Thursday. The fact that Tempur paid a mere $220 million for the equity of Sealy, combined with annual costs synergies of $40 million, looked very attractive. Shares have fallen back some 10% from the peak of $33 on Thursday, ending the week at $29.89 after investors realize the substantial addition of debt as a result of the deal.

Still, the acquisition of Sealy is net positive for Tempur. The strategic rationale is also favorable. Tempur's mattresses are typically focused on the high-end of the market, while Sealy focuses more on the mid- to lower end of the market. Sealy's shareholders are less happy with the deal, despite the run-up in recent weeks. Shares of Sealy have lost some 90% since 2006.

While the deal is a net positive for Tempur, it adds a lot of distraction, as the company needs to integrates Sealy's business at a time when its own business is suffering from competition in the mattress market.

Shares of Tempur offer a lot of long term upside, yet I see few triggers for shares in the short term.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.