A 13G filed with the SEC has reported that Senator Investment Group, an event driven hedge fund managed by Doug Silverman, owns over 5 million shares of Tempur-Pedic International Inc. (NYSE:TPX). The most recent 13F filing shows that the fund had not owned any shares of Tempur-Pedic at the beginning of 2013 (see Silverman’s stock picks). We use 13F filings in order to develop investment strategies (for example, we have found that the most popular small cap stocks among hedge funds outperform the S&P 500 by an average of 18 percentage points per year) but they are also useful for checking what a fund owned at the end of the last quarter- here we can see that Silverman and his team added all 5 million shares in a little over two months. The fund now owns over 8% of the total shares outstanding.
The FTC recently approved Tempur-Pedic’s acquisition of competing mattress firm Sealy Corporation (NYSE:ZZ). Market trends have not been good for Sealy; its stock price is down 70% in the last five years even after the takeover premium being paid by its acquirer, bringing it to a market capitalization of only about $230 million. Tempur-Pedic’s stock price rose 6% on the news. While Tempur-Pedic International Inc. itself is up 170% in the last five years as Sealy has crashed, this turns out to be an oversimplification: the stock price reached a peak of over $80 per share in early 2012 before plunging to about $22 last June, and has since doubled from those lows (note that this leaves the stock price down quite a bit from a year ago). Last quarter revenue slipped 7% compared to the fourth quarter of 2011, which helped drive earnings down by over 50%.
At its current price Tempur-Pedic International Inc. trades at 27 times trailing earnings, so the market is pricing in earnings growth. Sealy should not add much earnings to the company (unless Tempur-Pedic is able to realize substantial synergies), so the acquisition’s effects on growth will be limited unless consolidation allows the company (and others in the mattress industry) to push up prices. As a result it appears that the recent financial trends in the core business would have to reverse in order to justify the current valuation. Wall Street analyst expectations imply a forward P/E of 16, a more moderate figure, while 15% of the outstanding shares are held short. John Shapiro’s Chieftain Capital owned 7.5 million shares of Tempur-Pedic at the end of the fourth quarter of 2012 (find Shapiro’s favorite stocks), while billionaire Steve Cohen’s SAC Capital Advisors was buying shares and closed December with a little over 700,000 shares in its portfolio (check out more stocks Cohen was buying).
We can compare Tempur-Pedic to Select Comfort Corp. (NASDAQ:SCSS), Mattress Firm Holding Corp (NASDAQ:MFRM), and La-Z-Boy Incorporated (NYSE:LZB). We’d note that Select Comfort and Mattress Firm Holding were both up 4% on the day the FTC approved Tempur-Pedic’s takeover of Sealy, so clearly there is some expectation that reduced competition will help all parties. Select Comfort trades at only 13 times trailing earnings and 10 times forward earnings estimates, and even though its earnings have been down it might be a more value-oriented alternative in mattresses. Mattress Firm, a retailer, actually managed to hold its net income steady in its most recent quarterly report versus a year earlier and revenue was up strongly. However, at a trailing earnings multiple of 20 it is an even more popular short target than Tempur-Pedic with 20% of the outstanding shares held short. La-Z-Boy reported double-digit growth rates on both top and bottom lines in the fiscal quarter ending in January 2013 compared to the same period in the previous fiscal year, and even though its trailing P/E is 21 it might be worth looking into how sustainable that growth is.
Between the general observation that M&A activity tends to destroy shareholder value at Tempur-Pedic’s premium compared to similar companies, we’d actually avoid the stock. Select Comfort seems like a good starting point for value investors, and would also benefit from industry consolidation.
Disclosure: I own no shares of any stocks mentioned in this article.
