Sleepy Merger Appears to Be on Track

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Trinity, North Carolina-based bedding manufacturer Sealy Mattress Company (NYSE: ZZ) has announced its intention to merge with its Lexington, Kentucky-based rival Tempur-Pedic International (NYSE: TPX). The $1.3 billion cash-and-debt deal will require Tempur-Pedic to buy out Sealy's current shareholders and assume a substantial amount of the company's outstanding debt. Although the deal has been subject to several legal and regulatory delays, it appears likely that it will close as planned by the end of the second quarter of 2013.

About Sealy and Tempur-Pedic

Sealy has operated in the bedding manufacturing industry for more than a century. The company sells its beds, mattresses and other bedding-related products in North America, South America, Europe and Asia under a variety of brand names. In the United States, Canada and Latin America, these include Sealy, Sealy Posturepedic, Basset and Stearns & Foster. Internationally, its most popular bedding brands include Carrington Chase and Embody. Although its products encompass a wide range of styles and price points, most are comprised of traditional bedding materials. Sealy markets its products directly to consumers as well as through a number of bedding stores and discount retailers. The company employs about 4,000 people and earned about $2 million on revenues of $1.4 billion in 2012.

Founded in 2002, Tempur-Pedic International is a far more dynamic company that continues to experience growth in sales of its namesake memory-foam bedding products. The company makes mattresses, pillows, adjustable beds and body cushions. With a streamlined sales process that involves a great deal of direct-to-consumer marketing, the company has a lean cost structure and appears poised to experience further growth. In addition to its consumer bedding division, it operates a smaller business that focuses on selling memory-foam products and adjustable beds to hospitals, at-home care services and other medical businesses. Tempur-Pedic earned $106.8 million on gross revenues of $1.4 billion in 2012.

How the Deal Is Structured

Under the terms of the deal, current Sealy shareholders will receive cash payouts of $2.20 per share. In addition, the entity that forms as a result of the merger will assume the bulk of Sealy's $750 million debt load. Relative to Sealy's current closing price of $2.16 per share, this merger represents a premium of less than 2 percent. Relative to the company's pre-announcement closing price of $2.14, the deal represents a premium of about 3 percent. 

However, rumors that a deal was in the works had prompted a run-up in Sealy's share price during the two-week period before the merger's September 27, 2012 announcement date. Investors who purchased Sealy shares near $1.60 per share in early September will receive a premium of 37.5 percent as a result of this deal. It remains to be seen how this deal will affect Tempur-Pedic's share price in the long term. However, news of the merger caused the more profitable company's shares to jump by nearly 15 percent.

Complications and Legal Challenges

This merger faces several unresolved legal hurdles. First, it is the subject of a potential lawsuit. Although it is still in the "investigation" stages, the suit attacks the deal on a couple of different fronts. Since New York-based private equity firm Kohlberg Kravis & Roberts (NYSE: KKR) is Sealy's largest shareholder as well as a major stakeholder in its convertible debt notes, it appears that there may be a conflict of interest inherent in its acceptance of the deal. In fact, several other Sealy stakeholders of significance have publicly opposed the merger on the grounds that it values the company unfairly.

Kohlberg Kravis & Roberts's ownership of Sealy's convertible notes gives it a tremendous advantage over rank-and-file shareholders. In fact, it stands to earn substantially more than the 2 percent premium that current Sealy shareholders will receive from the merger. While the suit's prospects are unclear, it may force Tempur-Pedic to reevaluate its offer.

In addition, the U.S. Justice Department recently extended this deal's customary antitrust waiting period. Given the deal's size and scope, it appears unlikely that antitrust-related issues will scuttle it. However, further delays could wear down investors' patience and reduce the apparent benefits of the merger.

Long-Term Prospects and Outlook

Although the bedding industry  is notoriously competitive, Tempur-Pedic appears well-positioned to deliver growth and value in the coming years. It has been credited with popularizing memory-foam bedding and continues to ride the momentum of its early successes. However, the company has seen its revenue decline over the past several quarters. While this trend is not yet worrisome, it bears watching. Since the industry's barriers to entry are relatively low, it might not take much for a smaller competitor to begin to eat into Tempur-Pedic's market share.

Although the Sealy deal does not currently offer an exceptional premium, the uncertainty that continues to hang over the merger may provide investors with momentary buying opportunities. Since the company's stock is not particularly liquid, it is subject to momentary volatility. Quick-footed arbitrage investors may yet benefit from sudden dips in its share price before the deal's closure.


mthiessen has no position in any stocks mentioned. The Motley Fool owns shares of Tempur-Pedic International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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