Description

PRPL’s valuation is just way too low: 14x 2023 EPS (~13.5x ex net cash) for a 20%+ grower with low single digit market share, net cash, a differentiated product in a commoditized industry, and a great brand.

More background on the company can be found in the three previous write ups on VIC, but simply put, Purple makes and sells mattresses which use the company’s gel grid technology.

Valuation

At Purple’s analyst day in June, management put out 3-5 year guidance for $2 to 2.5B of revenue and 14 to 15% adjusted EBITDA margins.

The low end of guidance implies a ~20% 5-year top line CAGR and ~$2.60 of EPS. PRPL trades for less than 8x that EPS right now, and given the growth profile, that’s going to look increasingly ridiculous. I’m estimating $1.3B of revenue in 2023, and at a 12% adjusted EBITDA margin, PRPL will be earning ~$1.45 of EPS. In other words, a year from now this stock is going to be trading for 15x forward earnings while on a tremendous growth trajectory with mid-single digit market share and no net debt. And apart from domestic growth there’s optionality on international expansion (could be some licensing issues to take care of here) and products in new categories. Plus, Purple is a great millennial/Gen Z brand that some of the larger players with stodgy brand portfolios should want to own.

IMO the low end of the 3-5yr guidance is an achievable base case that leaves plenty of room for upside. Management plans to get there by expanding ASP from $1,900 to $2,400, growing non-mattress revenue from $140mm to $400-$500mm, growing company owned showrooms from 13 to 200 with each doing $2mm of annual revenue, and scaling wholesale partner doors from 2,300 to 3,500. These assumptions are all either reasonable or sandbagged:

• Expanding ASP from $1,900 to $2,400 (per mattress, not per transaction)

• Purple’s product assortment is missing products at the high end of the premium segment. Its highest priced bed, the Hybrid Premier 4, is available online for $3,149 right now in queen size. A top-of-the-line Tempur-Pedic LUXEbreeze queen runs $5,000+ while Sleep Number’s iLE 360 is $5,300 for a queen. Intellibed is the most comparable bed on the market by feel (it licenses the tech from PRPL) and it sells queens at price points up to $7,500. Given the uniqueness of Purple’s bed and the power of its brand, I doubt it will have a problem playing in the $5,000 price range.

• Purple has raised prices in the past with no problem: “We have had several price increases over the last 2 years since Joe and I started, and I'm not seeing any significant impact on volume when we do make those price increases.”

• Purple could offer the higher ASP products exclusively through wholesale partners, where demand for higher ASP products is stronger. Tempur-Pedic does this already, but Purple does not (yet).

• Growing non-mattress revenue from $140mm to $400-$500mm

• Expensive add-ons like powered bases and ultra-premium pillows are rapidly becoming standard purchases with a new bed. Purple’s first powered base had problems, but the re-released version costs $1,350 for a queen-sized unit and has 3x the attach rate of the previous model. Powered base sales add materially to average transaction amounts and should continue to increase, at the very least, in tandem with higher mattress unit sales.

• Purple’s new Purple Harmony pillow is $140 for the standard size and $180 for the king size. They’re very comfortable, although personally I don’t find the feel as distinct as PRPL’s mattresses. Regardless, they’re selling like hotcakes with pillow sales up 50% year over year in the latest quarter. The company just launched 4 new models with 3 heights each in two different sizes. Again, I expect the attach rate to at least stay consistent, and there’s also a bunch of room for more innovation here. PRPL just launched the TwinCloud pillow, which is an $80 pillow with adjustable firmness. Then there’s opportunities to grow other bedding categories like sheets, mattress protectors, pajamas, and PRPL’s seat cushion franchise.

• Growing company owned showrooms from 13 to 200, with each doing $2mm of revenue

• These are realistic goals, and probably sandbagged when you look at other mattress retailer store counts. Sleep Number is the best DTC store comp with good disclosure; it had 602 stores doing over $3mm of revenue on average at the end of 2020. 96% of those stores were doing more than Purple’s targeted $2mm of sales. A caveat is that Sleep Number is exclusively DTC, so there’s no channel dilution from wholesale partners.

• PRPL doesn’t say what its stores are doing in revenue today, but when an analyst asked whether they are doing more than an average Mattress Firm’s $1mm or so, the CEO scoffed (my interpretation) and said they were doing well north of $1mm. Newer stores are outperforming older stores, so when you layer in productivity increases from learning how to set these boxes up better, higher ASPs/increased prices, typical same-store traffic increases, and new products, $2mm a store 3-5 years from now looks more than do-able.

• Scaling wholesale partner doors from 2,300 to 3,500

• This is just sandbagged. At the end of 2020, PRPL was in 2,200 partner doors (including Canada) and guided to add 1,400-1,500 more in 2021. This was before the company’s production problems, but management was planning to exceed its 3-5 year goal in 2021.

• There are 8,500+ potential doors in the U.S. and PRPL is in less than 25% of those. The limiting factor on the wholesale rollout is production capacity, not demand. Wholesale partners want to carry Purple mattresses to the point of breaking their typical 2x wholesale markup and accepting lower margins. Purple’s brand brings in valuable foot traffic and punches way above its weight:

And just to note what management’s $2-$2.5B revenue guidance does NOT assume: 1) International expansion beyond $75 million of revenue from Sleep Country in Canada, or 2) any expansion into product areas outside of sleep. Btw, LOVE is sporting a ~$1B EV on ~$400mm of revenue from couches and bean bags...

Warby Parker has a $6B EV, or 4.5x PRPL’s EV, despite being twice as old as PRPL, generating only 2/3 of PRPL’s revenue, and also being unable (or unwilling) to generate a profit.

Risks

Why is PRPL down so much? I don’t exactly know, but there’s several things that could be seen as risks/problems:

• PRPL got a lot of Wallstreet Bets attention, so I think there’s a fair amount of retail in the stock.

• The stock has been trading like hot garbage, which might exacerbate the selling. Don’t have much to say about this.

• PRPL was perceived as a COVID play, and now we are reopening. It’s reasonable to look at the strength of the public mattress companies’ results and conclude that there was a big pull forward in demand that we’re about to lap. It makes intuitive sense too, given the strength in home spending. The reality is more complicated.

• The mattress industry grows ~5 to 6% annually. Tempur Sealy is the 800lb gorilla and it grew revenue by ~20% in 2020 while YTD ’21 revenue is up 50% from last year. Despite its high market share, TPX is not representative of the market because it has some idiosyncratic tailwinds. Mattress Firm is the largest mattress retailer by store count, and TPX launched into Mattress Firm shortly before the pandemic started; so TPX got a ton of new distribution in 2020. As TPX noted on its last conference call: “That leaves approximately 15% of our 2-year growth that can be attributed to the growth in the industry overall.” It’s true that there has been some COVID boost- check out web traffic volumes, for example- but IMO it hasn’t been as significant as you might think. Unless you were previously sleeping at work, WFH probably didn’t increase the desire to get a new mattress to the extent it impacted something like a couch, which you went from using at night to spending 6 hours a day on with your laptop.

• International Sleep Products Association (ISPA) data shows 2020 unit sales up 9% for the year, with 6.5% growth in Q1, 9.9% in Q2, 14.7% in Q3, and 3.6% in Q4. Yet trade downs to cheaper mattresses meant dollar sales were up only 5% in 2020 for the year- up 2.2% in Q1, down 9.7% in Q2, up 13.8% in Q3, and up 4.2% in Q4. None of this is all that impressive, particularly when you consider that the Q2 and Q3 unit and dollar growth rates in 2020 were comping negative growth in 2019.

• Even if I’m wrong here, I expect PRPL’s market share gains will eventually overwhelm near term industry dynamics

• PRPL’s mattresses look like a gimmick.

• It’s true, they do look like a gimmick. Unfortunately, I think this prevents investors from digging into the company. Watch this COVID winner gimmick mattress brand with a dumpster fire chart get cut in half again and won’t you look like a dope for buying it!

• That PRPL started on Kickstarter doesn’t help either. However, the Purple mattresses feel noticeably different than any other mattresses I’ve tried. There is no such thing as a good mattress. There are only different mattresses. It all depends on what a person finds comfortable (for example, my wife’s ideal mattress seems to be a sheet of plywood). I don’t know anyone that’s laid on a Purple mattress and not admitted, whether they liked the mattress or not, that it feels unique. The company doesn’t need to sell a mattress to everyone for the stock to be a home run. It just needs to be unique enough to own a niche, even though I think it can be much bigger than just a niche. 

• Purple has had production problems and, most recently, had to shut down a major portion of production due to a workplace accident, impacting production levels for 10-12 weeks.

• A recent accident in one of Purple’s manufacturing facilities resulted in the death of an employee. The company shut down all of its manufacturing to implement additional safety controls. A series of additional problems surfaced resulting in the company operating at less than full production for 10-12 weeks. However, management reported that production was back to 100% by the end of July.

• Purple has been supply constrained since its founding. The company makes its Purple grids on proprietary Mattress Max machines, which can each support $80-$100mm of revenue/year. As the only manufacturer of this kind of grid, the company has had to design/invent/scale the Mattress Max machines. So far it has not been able to build capacity fast enough to supply its demand. This is a good problem. Compare this to Casper, which can scale as rapidly as it wants because it lacks any differentiation and thus can outsource manufacturing. Purple is now putting additional machines into its new facility in Atlanta and should end the year with 11 Max machines.

• Eventually someone will build a knock off and compete with PRPL

• I do believe that someone will create a similar mattress and compete with Purple at some point, and I’m sure wholesalers will welcome the competition given their lower than typical margins on PRPL mattresses. Intellibed has launched a lower priced gel matrix brand called Gelee. The cheapest queen sized Gelee runs $1,700 and includes 1.25” of gel matrix, compared to Purple’s classic queen at $1,170 with 2” of gel matrix. Gelee’s only wholesale arrangement right now is with stores in Utah and Arkansas, but you can buy it online.

• Intellibed has a legacy licensing arrangement with Purple, specifically for an older type of gel matrix technology that, when you lay on it, feels very similar to Purple mattresses and is the only true gel matrix competitor. The gel is ‘sticker’ and when you move around you can feel a responsiveness delay and a tactile kind of tackiness as the gel seems to be unsticking from itself. Purple sued Intellibed for selling its products under the Sleepy’s brand, which is not explicitly approved of in the licensing agreement. I assume this is the Sleepy’s brand that Mattress Firm bought as Intellibed already sells its pricier models wholesale through Mattress Firm. The lawsuit was recently thrown out because Purple didn’t go through the contractual dispute resolution first. Oops.

• I believe one major reason that Intellibed has not been able to take meaningful market share is that it’s not able to manufacture efficiently or at scale, and thus requires either an extraordinarily high price point, or for comparable mattresses, needs to use a shorter matrix at a higher price. Maybe one day Intellibed represents a threat, but I don’t see it happening until and unless they can figure out manufacturing. Purple has shown that to be difficult.

• Purple’s patent on the gel matrix has expired, but the company still has a decent collection of patents that cover other aspects of the product, such as the specific gel material composition and some patents covering the Mattress Max manufacturing process (another roadblock for Intellibed). Will a competitor try to figure out how to get around the patents to manufacture/scale it out but probably still end up in litigation, or will they wait until the end of the decade when the patents start rolling off?

• PRPL continues to generate new patents, like the pending patent on gel matrix in a hybrid configuration with innersprings. As PRPL is the only company I know of working with gel matrix at scale, it’s likely to be the only one investing substantially into gel matrix R&D and generating new patent protections.

• Sleep Number has carved out a nice little niche for itself by selling air mattresses with foam on top that can be adjusted for firmness by inflating/deflating the air bladder. It’s grown to an upper single digit market share, yet you don’t see TPX or Serta Simmons trying to compete with a copycat product. My bottom line is that PRPL probably won’t face significant direct copycat competition in the intermediate term, whether it turns out to be a niche product or not.

• Major shareholders selling/CFO leaving

• In a series of offerings in mid to late 2020, PRPL’s founders Terry and Tony Pearce sold the remainder of their stock and retired from the board. Terry was 71 and Tony was 64. They are now collaborating with a former B of A banker on a new SPAC, this time from the sponsor side: https://www.bloomberg.com/news/articles/2021-03-11/purple-innovation-founders-banker-daniel-webb-said-to-plan-spac

• Tony and Terry have been selling their PRPL stock for a while- basically since it went public. I don’t read too much into their exit.

• Coliseum Capital is the largest shareholder and it sold a bit less than half of its shares in an offering in May.

• Coliseum is the largest shareholder from its investment in the SPAC PIPE and from warrants it picked up as a kicker for a loan to the company. It looks to me like what they sold were the shares from the warrants they exercised in late ‘20/early ‘21, plus another couple million shares or so which they had previously purchased from the Pearce brothers. Their sale was at $30, ~50% higher than today’s price.

• The CFO, Craig Phillips, left the company on August 31st

• Not a great look. He was the interim CFO from FTI, and when he became the permanent hire there was an agreement for him to relocate from the east coast to the HQ just south of Salt Lake within 2 years. COVID threw a temporary wrench in the plans, but ultimately he decided he didn’t want to move. Hence the CFO’s employment ended just prior to the two-year mark. I was also told that the CEO, who btw still flies back and forth from SF to Salt Lake, wants someone with more of an FP&A background rather than a big 4 accounting background. A quick look at the former CFO’s prior work history shows that he’s been a CFO at 4 different organizations (excluding his time at FTI), and his job at Purple was his longest tenure.

• Raw material inflation/weak consumer/macro

• The cost of Purple’s gel is linked to oil prices. If oil goes to the moon and consumers get crushed, it won’t be great for the oil-derivative mattress market. Of course, memory foam is also derived from petroleum products and the industry has been dealing with foam shortages. I’m guessing that TPX’s share price hasn’t suffered like PRPL’s or SNBR’s have since March because TPX is regarded as a share gainer due to its more robust supply chain and vertical integration. Maybe supply chains really are permanently ruined and we’ll all be back to sleeping on hay.

Catalyst

Growth