Description

Purple represents an interesting long-term opportunity. After overexpanding during COVID, new management has rightsized the cost structure over the past year. The balance sheet has been cleaned up, and PRPL now has $55mm in cash and another $55mm in undrawn revolver capacity. This should be enough liquidity even if demand does not rebound in the near term. 

The mattress industry is in the midst of its worse downturn ever. While too soon to call a bottom on the demand environment, we think the impact of COVID-related pull-forward has more than fully unwound already. For PRPL, we think Q2 will be the trough as the company rolls out its new product line in 2H. The macro outlook remains uncertain, but looking at past cycles, consumer spend in this category is truly deferred, and the industry always turbocharges coming out of a recession. Coming out the other side, PRPL will also find itself in a much more favorable operating environment, no longer competing with 150+ unprofitable DTC mattress brands. 

Downside for the equity should be limited by the Coliseum Put. Earlier this year, PRPL rejected an offer by Coliseum Capital (44% owner) to take the company private at $4.35/sh. After a very public spat, the two parties have come to a temporary standstill.  

There are lots of moving parts here, but ultimately, you have a strong brand with a differentiated product in a largely undifferentiated category, in an industry that is historically stable and growing. At $285mm TEV, we think there is a higher chance of a multi-bagger than an impairment. 

Business Overview 

Purple designs, manufactures and distributes mattresses and bedding products. Products are centered around PRPL’s patented gel grid technology, the Hyper-Elastic Polymer. The gel grid represents the first real innovation in the industry since memory foam mattresses were introduced in the 1990s. 

PRPL started as a digitally native bed-in-a-box (“BiB”) brand but has since moved to an omnichannel strategy. 80% of shoppers say they want to lay on a mattress before buying. This is particularly true for the higher price points PRPL competes in. PRPL competes in the mid ($1-$2k) and premium (>$2k) segments of the market. These segments are faster growing and shielded from low-cost imports. The company operates 55 owned stores that offer an exceptional buying experience. The company has also grown its wholesale presence, increasing from 700 doors in 2018 to 3,450 today. This contrasts with other BiB brands that have been unable to win wholesale distribution due to an undifferentiated product.

BiB brands exploded onto the scene circa 2015. Backed by significant VC money, companies chased growth at all cost, bidding up keywords and affiliated marketing rates. At the peak, there were over 175 BiB companies all bidding on the same keywords. Take rates for affiliated marketing (e.g. sleep-related blogs) went from the standard 5% to as high as 25%. 

Most of these BiB brands were essentially performance marketing companies. There was no real innovation other than delivery method. They all outsourced manufacturing to the same suppliers. Products had little differentiation. DTC unit economics quickly broke down, and wholesalers weren’t interested in carrying the products. Most of these brands have gone away and should clear the way for a much more rational marketing environment when demand rebounds. 

PRPL has built a strong brand in an industry that historically has not had strong brand affinity. The company consistently ranks among the top of DTC brands in search volume and organic traffic. They punch well above their weight when compared to the large incumbents in metrics such as brand awareness and mattress satisfaction. Management claims that 30% of their customers found PRPL through word of mouth. The strength of the brand is a huge intangible asset, and should allow PRPL to scale down marketing spend over time. There is some evidence of this already. PRPL’s eCommerce revenue in 2022 was higher than 2019, despite drastically reduced ad spending ($117mm in 2019, vs $67mm in 2022). This is even more impressive when you take into account the terrible demand environment in 2022 (volumes -14% vs 2019). 

Industry Overview

We want to briefly touch on the industry situation as it answers the question “why now?”

Our two main points on the mattress industry are 1) we think the COVID demand pull-forward has fully unwound already and 2) the mattress industry historically has performed quite well in normal economic recessions. If you believe the coming recession will be a GFC-esque housing recession, then this idea might not be interesting to you. 

The mattress industry is historically a stable, 4-5% growth industry without extreme peaks and troughs. Growth has been primarily driven by premiumization as consumers place more importance on sleep quality. Unit growth has been ~1%, in line with population growth. 

We believe the demand pull-forward from COVID has fully unwound already (see below). A theoretical return to “normalized” volumes of ~31 million units would represent a 17% increase over 2022 figures.  

Of course, we still have a potential recession ahead of us. Investors might be surprised to learn that the mattress industry has historically performed quite well during recessions. Other than during the GFC, which was a housing recession, industry sales have been flat to slightly up during recessionary periods. Furthermore, spending in this category appears to be truly deferred, and the industry always turbocharges out of a recession.

We are currently in the worst drawdown the industry has ever seen, exceeding the -19% cumulative unit decline from 2007-2009. LTM unit sales are trending -14% below 2019 levels. Sure, things can always get incrementally worse, but I would venture to say we’re closer to the end than the beginning.

Current Situation / Outlook

PRPL was a huge COVID beneficiary as the pandemic pulled forward demand for mattresses. The previous management team doubled production capacity which came online just as demand for mattresses fell of cliff in Q3 2021.

Under new management, PRPL has subsequently undergone a painful process of rightsizing its cost structure. Capacity has been idled and headcount has been drastically reduced. Various productivity initiatives have been implemented.

The cost rationalization is near completion. YoY gross margins have improved despite significantly lower volumes, unfavorable channel mix, and higher promotional intensity (see below).

PRPL should exit the year with gross margins in the low 40s as volumes pick up. In addition to seasonality that is more 2H weighted, management is planning a big marketing push to support the new product line. Ad spend had essentially been embargoed ahead of the May product launch which contributed to Q1 softness. eCommerce sales have a strong correlation to ad spend. 

As a caveat - Q2 margin numbers will likely be noisy. In addition to clearing out old models, PRPL will need to sell new floor models to 3,400 retail doors. Floor models are sold at half price (as is industry standard). 

For the rest of the year, PRPL should see an added benefit from lower raw material costs. For reference, TPX expects the commodity benefit to be about +150bps in gross margin this year. 

In the near term, gross margin trends give us more confidence in PRPL’s ability to make it through the downturn. Looking further out, the excess capacity should provide torque to the upside when volumes eventually return. 

PRPL currently has $110mm in liquidity ($55mm in net cash + $55mm in undrawn revolver capacity). 

For FY2023, management has guided to revenue of $590mm to $615mm (3% growth at midpoint) and Adj. EBITDA of $13mm to $17mm. 

Our base case (posted at the end of writeup) is slightly more punitive, but we arrive at similar numbers. We are assuming HSD industry declines in 1H and MSD declines in 2H, in line with TPX management commentary. Offsetting macro weakness, sales will benefit from a 15% slot expansion in wholesale, higher marketing spend in 2H, and a full year contribution from the Intellibed acquisition. 

Under our base case, we estimate cash burn to be ($25mm) for the remainder of the year ($5mm OCF less $30mm capex). Capex is elevated as management is building out previously contracted showrooms. This number can be scaled down next year if the industry remains in the doldrums. 

There is definitely some hair to this idea but a $110mm liquidity cushion should allow PRPL to weather some pretty bad scenarios the next couple years. Timing of the industry recovery remains uncertain. However, when demand does inevitably snap back, we think PRPL will have the production capacity (currently operating at <50% capacity) to really see some upside torque.  

The Coliseum Put should also effectively limit downside. As mentioned, Coliseum Capital (44% owner) previously made an offer to acquire PRPL at $4.35/sh. After a very public spat earlier this year, the two parties came to a temporary standstill agreement which also gave Coliseum 4 of 8 board seats including the chair. The new board should provide additional check on corporate governance. 

I will not spend much time on upside scenarios but it is quite easy to model out $80mm+ EBITDA in an environment where volumes return to trend. A 10x multiple gets us to north of $8/sh. Looking further out, there are all sorts of possibilities for PRPL to leverage its strong brand and IP to enter into new categories (e.g. couches) or new geographies (either direct or through licensing its IP). There is also a long runway to increase store count, which have very attractive box economics. 

Lastly, we are quite constructive on the mattress industry as a whole (and are bullish TPX). We think the industry is a lot better than investors are giving it credit for. Granted the past 15 years have been abnormally turbulent with the housing crisis, threat from Asian imports, BiB brands, and the COVID boom then bust. The next decade should be a lot smoother sailing. As previously mentioned, we think the DTC marketing environment will be far more rational/favorable going forward. The industry will also benefit from a demographic bulge of millennials reaching household formation age. 

We also think promotional intensity will be lower. Historically, advertising in industry as a whole has been a lose-lose prisoners dilemma focused on price competition. Interestingly, survey data shows most Americans place a high importance on sleep, yet a better mattress does not rank among the top 10 things a consumer would do to improve their health. 70% of Americans sleep on a mattress that cost <$1,000. Marketing has begun to change as the industry consolidates. Since the Serta/Simmons and Tempur/Sealy mergers, advertising is more and more focusing on benefits of sleep quality. This shift in messaging, combined with the continued trend of health and wellness, should support healthy growth in the category going forward.

Risks

Prolonged and continued industry deterioration

This remains the main risk and one to monitor. After an unprecedented 8 quarters of decline, we think there is pent up demand for a new replacement cycle. There are green shoots in recent months (foot traffic, search volumes, surveys on purchase intent) but the timing of recovery remains uncertain.

Product Launch

PRPL launched a new line of products in May. This is an added variable that is hard to handicap. We cannot point to any analogues in the industry of a “failed” product launch. Nonetheless, resetting its product line across 3,400+ doors is a heavy lift and likely comes with some amount of friction in the near term. 

Mattress Firm Acquisition

Mattress Firm is a $90-$100mm account for PRPL, representing ~15% of overall revenue and ~40% of wholesale.

TPX’s acquisition of Mattress Firm is expected to close in Q4 2024, so this is not an immediate risk in any case. By then, the industry will have likely snapped back (if not, we’ll have bigger problems). 

This is a fascinating acquisition to think about. It will have all kinds of reverberations up and down the industry. This will be a huge win for TPX hands down. SSB is a clear loser. Our initial take is that the acquisition will be a marginal negative for PRPL. PRPL’s differentiated product should allow it to retain slots better than other brands directly competing with TPX’s foam mattresses. Still, sales reps will obviously have a strong incentive to prioritize selling TPX’s brands, which will impact door productivity for all competitors including PRPL.

Catalyst

Industry volumes getting "less bad"