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Tempur-Pedic — Bouncing Back on Buyout News

Small-cap mattress maker Tempur-Pedic (NYSE:TPX) snuggled up to Sealy (NYSE:ZZ) with a buyout deal of $2.20 a share, or $228.6 million, according to reports.

So after the deal, is there cash hiding under this mattress stock? There very well could be.

I know what you’re thinking: before today’s pop, Tempur-Pedic stock was down 50% year-to-date and a whopping 70% from its peak earlier in 2012. Today’s gains are nice, but will they keep up?

But consider this as the starting point even before the Sealy buyout:

  • Valuation: Before today’s 20% pop in shares, TPX was trading at a forward P/E of 8.6 and a current P/E of 8.7, with its PEG ratio an attractive 0.76.
  • Top-Line Growth: Barring a Q2 miss, Tempur-Pedic has seen revenue increase 10 out of the last 11 quarters on a year-over-year basis. Its five-year growth rate is about 25%.
  • Brand: Tempur-Pedic is one of those brands like Band-Aid or Kleenex that stands in for a generic term like “memory foam mattress.” Don’t discount the power of brand with consumers.

There are big risks, of course. Because as the top line continues to grow, there is marked slowdown in earnings momentum — which ultimately has resulted in the stock crashing in 2012.

TPX guided down this summer and admitted it has had to cut costs and margins to keep up with rivals pushing into its specialty market of foam vs. spring mattresses.

It’s also worth noting that the demographic power of the baby boomers had fueled Tempur-Pedic to its inflated levels. Sold on the health benefits of its products, older Americans jumped in and caused TPX stock to overheat.

You might have been burned by Tempur-Pedic and think it’s foolish to bargain hunt. Maybe it is. But I remain convinced that this mattress company could see a nice bounce over the next few months after taking it on the chin.

Hear me out.

The history of Tempur-Pedic as an investment is that it was one of the post-crash momentum darlings. From Jan. 1. 2009, to Jan. 1, 2011, TPX stock was one of the highest fliers on Wall Street. In that period, Tempur-Pedic stock tallied 430% gains — right alongside other growth standouts Green Mountain (NASDAQ:GMCR) with 300% gains in the same frame and Netflix (NASDAQ:NFLX), which notched 550% growth.

Of course, traders should know by now what has happened to these red-hot stocks that have since flamed out.

I think Netflix and Green Mountain might be cooked for good, but TPX is a different story.

Consider that while Tempur-Pedic has a gimmicky mattress — as does rival Select Comfort (NASDAQ:SSCS), which makes the “Sleep Number” bed — it’s not like technological disruption is going to make bloggers start talking about “a post-mattress age.” Please. Every household needs a mattress, and no households see their bed counts wax and wane dramatically over the years based on exterior circumstances. This is a very stable business to be in, all things considered.

So while margins have slumped, Tempur-Pedic stock isn’t going under.

Now we get to the buyout: More than 70% of TPX sales came domestically in 2011, but the acquisition of Sealy gives TPX a footprint in some 80 global markets. That’s a huge way to push its memory foam products into new international locations — and since the products are different enough, it won’t cannibalize existing Sealy sales enough to lose the efficiency of scale.

Oh yeah, and Sealy also helps TPX get out of specialty mattresses and into boring old box springs. Not a growth industry, surely, but a stabilizing one to be sure.

Then there’s the perceived mismanagement of Seally by one-time private equity owners KKR & Co. (NYSE:KKR). This from Dealbook at The New York Times:

“… K.K.R.’s management of Sealy has often tested investors’ patience. Earlier this year, several investors blamed K.K.R. for Sealy’s poor financial performance and lobbied for a shake-up of the company’s board. In one March filing, H Partners, a hedge fund with a minority interest in the company, said K.K.R. held a “dominance” over the board, because the majority of the directors had current or previous ties to K.K.R. Last year, the company recorded a loss of $9.8 million.”

I’m not saying Tempur-Pedic will ever get back above $80 a share. But global growth and efficiencies of scale will help TPX counteract its shrinking margins due to some competition.

You may be thinking to yourself, “What about the debt? Tempur-Pedic just assumed $750 billion in debt on this deal!” True. And not to sound like I don’t think that matters but… I don’t think that matters. Interest rates are ridiculously low right now and whether you like it or not, it is a better time than ever to borrow whether your are a business or consumer.

Also consider this: Even if the Sealy deal doesn’t move the needle a penny on fiscal 2013 earnings, simply prompting TPX shares to correct to a forward P/E of 15 gives the stock a target of $38.

That’s 22% above today’s open. Not a bad trade.

Further reading:

  • Alex Rasmussen has a bunch of charts, tables and graphs for those who want more detail on Tempur-Pedic’s numbers and projections (Seeking Alpha)
  • Rich Duprey liked the low-overhead model, but was willing to take a shot on TPX and its brick-and-mortar sales plans earlier this month. Interesting to see if the Sealy deal makes him even more bullish. (Motley Fool)
  • Think memory foam is odd? Check out the 12 weirdest beds ever. (TechEBlog)

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing he did not own a position in any of the stocks named here.

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