Description

One of the less appreciated global trends for a growing middle class is the conversion to higher priced mattresses. An ongoing awareness of the health benefits of a good night's sleep has led to shorter purchase cycles for new mattresses.

TPX is an attractively priced play with a best in class brand, strong management team and proved performance after a highly tumultuous beginning to the year.

On January 30, 2017, Mattress Firm who was recently acquired by Steinoff (rough short squeeze 8/16), announced that they were terminating their relationship with TPX. The stock fell 32% that day, and the company was forced to recognize that it had a void to fill as MFRM had represented 21% of 2016 sales. TPX has shown resilience and Mr. Market has rewarded it with returning pricing to pre-announcement levels. Though we have at this point missed out on a strong rebound, we remain convinced that this is now a better business in a healthy market with improving margins for an investor that has patience through 2018.

Forgive the lack of detailed financial analysis below, but given what we view as a strong margin of safety with 11X EV/ EBITDA for a best in class brand, we view the analysis to be more valuable with a prospective towards the overall situation rather than a focus at the granular level.

Industry

Mattress Firm is by far the largest retailer among bedding retailers. Dollars in 000’s:

Mattress Firm - $3,000

Sleep Number - $1,100

Ashley - $560

Macy’s $390

Nebraska Furniture Mart - $365

Sam’s - $360

Source: FurnitureToday

TPX is the number 2 player in a highly consolidated US Wholesale Bedding market where the top 2 players (TPX and Serta Simmons account for north of 60% of the market share).

This divorce was a major shock to both companies with TPX accounting for 35% of MFRM’s 2016 revenues pre-acquisition.

That being said, we believe the worst is behind us. There has been a natural reshuffling of the landscape with Serta Simmons absorbing the MFRM volume and TPX’s retailer partners scrambling to try and grab as much as they can. TPX has also had fairly strong successes in growing their direct to consumer channel through their website (NA Direct channel up 137% in the quarter).

Non-MFRM sales grew at 10% in the most recent quarter, and with MFRM inventory liquidation affecting market TPX pricing (reported 70% discounts), we are optimistic towards the upcoming quarters. Tempur pedic is one of the few names that people know by name and will continue to find ways to purchase. We see this market realignment as a temporary blip that has negatively impacted sales and profitability in the short term only.

MFRM was a large customer, but we believe without MFRM, TPX is now a better business with limited reliance on a single customer while still maintaining a best in market brand. MFRM demanded discounts and co-op advertising. It is tough to see incrementally exactly what margins will look like over the next 6 quarters or so as TPX starts to build back their top line. But with the operational cost cutting measures they are making coupled with overall higher margin on non-MFRM orders, it is highly likely that they will surpass the $522 MM that company performed in 2016.

EBITDA guidance provided in Q1 was $400 - $450 MM; in Q2 the bottom guidance was raised and new outlook was given for $425 - $450 MM for 2017.

Management team is led by experienced executives that are highly incentivized to perform:

Thompson, CEO, (58) – CEO of Dollar Thrifty until sale to Hertz, cofounder of Group 1 Automotive, joined 9/15. 285k shares beneficially owned and 125% - 250% of salary ($1.1 MM) to be paid in stock.

Hytinen, CFO, (42) – been with company in various finance roles since 6/05. 60K beneficially shares owned, 70% - 140% of salary ($460K) to be paid in stock.

With TPX sitting at 11.6X EV / EBITDA (2017), the company has been well shepherded through a very risky past 9 months. Bottom line is that revenue will be back and margin will be higher for what will be a stronger business pre-MFRM.

Q2 CC:

We believe that this liquidation activity had significant adverse impact on our performance in April. This is the subject of litigation in federal court, so I therefore will not be making any more comments on this subject. As this liquidation activity eased in May, we observed a significant improvement in the second half of the quarter, with orders in May and June growing 17%.

Orders for Tempur-Pedic branded products grew 29%, and Sealy branded products grew 10%. These early green shoots could not have happened without, first and foremost, our salesforce doing a great job supporting our world-class retail partners. 

Catalyst

Quarterly Performance