Tempur Sealy International: Not Sleeping Well With The Mattress Firm Deal

In the summer of last year, I concluded that there was no soft landing for shares of Tempur Sealy International, Inc. (NYSE:TPX). This came after the company was early and aggressive in buying back stock following the pandemic-related boom in 2021.

The increase in leverage was worrying to me, following a reversal in the operating performance of the business, making me both cautious and disappointed last summer.

A Recap

Given the huge impact of the pandemic, I first go back to the 2019 results, the "last" normal year in recent times. For the year, the company grew sales some 15% to $3.1 billion, which looks better than it is, but it is virtually on par with the revenues reported all the way back to 2012.

The company posted operating profits of $347 million, translating into earnings of $3.50 per share (based on GAAP accounting). With shares trading at $20 (or $80 pre a four-for-one stock split), share traded at 20 times earnings. Net debt of $1.5 billion came in close to around 3 times EBITDA.

With the pandemic unleashing massive consumer spending on housing, discretionary and luxury items, and thus mattresses, the company did see a huge benefit from the pandemic. Full year sales for 2020 rose 18% to $3.7 billion, EBITDA rose to $780 million and adjusted earnings rose to $7.64 per share (pre stock-split). This momentum caused shares to rally to $30 (or $120 pre-split).

With the company originally guiding for 2021 results to improve further, and the company announcing a $475 million deal for UK-based Dreams, investors got a bit carried away. The company hiked the full year earnings guidance to $3 per share (equal to more than $12 per share on a pre-split basis) causing shares to rise toward the $50 mark in 2021. This made that multiples expanded to 17 times earnings, all while the earnings of the business have seen a big and non-sustainable boom of course.

Resetting

Between the peak at $50 in 2021 and the summer of last year, shares had lost nearly half their value to $27 per share. In the end, the company ended up generating $4.9 billion in sales in 2021 on which it posted operating profits of $912 million and earnings of $3.19 per share. The company originally guided for 15-20% sales growth in 2022 and earnings are set to rise further to $3.75 per share, badly needed as net debt rose to $2.3 billion amidst the Dream deal and more share buybacks.

After a tough first quarter, the company cut the guidance again alongside the release of the second quarter results. At the time the company saw earnings at just $2.70 per share for the year, a dollar reduction from just six months before! Moreover, net debt rose to $2.8 billion, pushing up leverage ratios to 2.7 times based on an expected $1.05 billion in EBITDA.

While the resulting 10 times earnings multiple looked low, earnings momentum was turning negative as net debt was substantial. Having held a position since the mid-teens from 2018 onwards, I was sitting on a decent gain, but was looking to sell on rips as I did end up selling my shares in the low-thirties later in the fall.

And Now?

Since my too-cautious tone last summer, and myself selling shares in the lower thirties in December, Tempur Sealy International, Inc. shares even rallied to a high of $45 in February, since which shares have consolidated in the higher thirties again.

In the meantime, the softening trends were more visible in the results. 2022 revenues came in at flat at $4.92 billion, but fourth quarter revenues fell more than 12% to $1.19 billion. In the end, adjusted earnings fell some 19% to $2.60 per share, softer than previously anticipated. Net debt was stable at $2.74 billion, but with trailing adjusted EBITDA being down to $892 million, leverage ratios increased to 3.1 times.

It was comforting that the company guided for flattish results in 2023 with adjusted earnings seen rather flat between $2.60 and $2.80 per share, based on an outlook which called for mid-single-digit sales growth.

A share count of 177 million shares valued equity at $7.1 billion at the $40 mark, translating into an enterprise valuation of around $9.8 billion, equal to about 2 times sales and just over 10 times EBITDA.

Big News

Early in May, the company announced its first quarter results, as well as it announced a big deal, yet shares have hardly reacted to the news. In fact, shares rose from $37 to a high of $40 intraday, to end the day flattish around the $37 mark.

Let's start with the results. First quarter sales fell 2% to $1.21 billion and while adjusted earnings only came in at $0.53 per share, the company reiterated the full year guidance. Trialing adjusted EBITDA fell to $855 million (and trends around $800 million) pushing up leverage to 3.2 times based on nearly $2.8 billion in net debt.

The bigger news is that the company reached a deal to acquire Mattress Firm Group Inc. (MFRM), the largest specialty mattress retailer in a $4 billion deal, equal to roughly 40% of the enterprise valuation of Tempur! Tempur will pay $2.7 billion for the company in cash, essentially doubling its net debt load to $5.5 billion, while issuing 34 million shares at $37 and change to finance the remainder of the deal. This transition will add more than 2,000 retail locations as well as e-commerce operations.

The $4 billion deal is largely equal to the $4.2 billion revenue number of Mattress firm as the 1 times sales multiple comes in at just half the 2 times sales multiple at which Tempur trades. Adjusted EBITDA of $432 million translates into margins of just around 10%, much lower than Tempur, as about 9 times EBITDA has been paid here (in line with the own valuation). That said, Tempur expects $100 million in synergies in year four post-closing.

Based on standalone EBITDA of $855 million as of the first quarter and this deal, pro forma EBITDA comes in at nearly $1.3 billion on a combined basis, or $1.4 billion if we factor in anticipated synergies. With pro forma net debt of $5.5 billion, I peg leverage at 3.9-4.2 times, while the company communicated just a 3.00-3.25 times leverage ratio upon closing, as I cannot reconcile this gap.

Holding Off

Given the added uncertainty and leverage from the latest Mattress Firm deal, while shares have done quite as well, I can only conclude that I am growing more cautious here, seeing no reason to get involved with Tempur Sealy International, Inc. here.

Given the set of circumstances, I see no reason to get involved again with Tempur Sealy International, Inc. shares. Quite frankly, I would lose some sleep over the latest deal, making me a patient watcher from the sides.

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