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TEXT-S&P assigns Tempur-Pedic 'BB-' rating
Overview -- Tempur-Pedic International Inc. recently signed an agreement to acquire Sealy Corp. (B/Watch Pos/--) in a transaction valued at about $1.3 billion. -- We are assigning our 'BB-' corporate credit rating to Tempur-Pedic. We are also assigning a 'BB' issue-level rating to Tempur-Pedic's proposed $1.77 billion senior secured credit facilities, and a 'B+' issue-level rating to Tempur-Pedic's proposed $350 million senior unsecured notes due 2020. -- We expect the proceeds to fund the acquisition of Sealy, repay existing debt at both companies, and cover transaction fees and expenses. We will withdraw the ratings on Sealy Corp. following the close of the transaction. -- The outlook for Tempur-Pedic is stable, reflecting our expectation that the company will maintain adequate liquidity and improve credit measures over the next year. Rating Action On Nov. 6, 2012, Standard & Poor's Rating Services assigned its 'BB-' corporate credit rating to Lexington, Ky.-based Tempur-Pedic International Inc. The outlook is stable. At the same time, we assigned a 'BB' issue-level rating to Tempur-Pedic's proposed $1.77 senior secured credit facilities, consisting of a $350 million revolving credit facility and a $650 million term loan A due 2017, and a $770 million term loan B due 2019. The recovery rating is '2', indicating our expectation for substantial (70% to 90%) recovery for lenders in the event of a payment default. We also assigned a 'B+' issue-level rating to Tempur-Pedic's proposed $350 million senior unsecured notes due 2020, with a recovery rating of '5', indicating our expectation for modest (10% to 30%) recovery in the event of default. All ratings are subject to review upon receipt of final documentation. At the close of the transaction, we estimate Tempur-Pedic will have about $1.95 billion in total debt outstanding. Rationale The ratings on Tempur-Pedic International Inc. reflect our view that the company will have a "fair" business risk profile and an "aggressive" financial risk profile following the pending acquisition of Sealy Corp. Key credit factors in our assessment of Tempur-Pedic's fair business risk profile include its portfolio of well-recognized brands, its geographic diversification, and its strong market position in the North American mattress industry. Other key credit factors include its narrow business focus in a highly competitive industry, exposure to raw material cost volatility, and vulnerability to reduced discretionary spending in an economic downturn. Our view of Tempur-Pedic's financial profile reflects credit measures following the transaction that we estimate will be in line with the indicative ratios for an aggressive financial risk profile, which includes adjusted leverage of 4x to 5x and funds from operations (FFO) to total debt of 12% to 20%. We estimate that pro forma for the proposed transaction, credit measures will weaken given the substantial increase in debt, with adjusted leverage of about 4.4x and FFO to total debt of about 10%. We estimate leverage for Tempur-Pedic before this transaction was close to 1.5x and FFO to total debt was more than 40% for the 12 months ended Sept. 30, 2012. On a combined basis, Tempur-Pedic and Sealy have grown revenues over the past year as the companies have benefited from new products, distribution gains, and strong consumer demand in the specialty bedding segment. However, sales and profitability for Tempur-Pedic have shown some weakness over the past six months, with revenues declining 6.6% as a result of increased competition in the North American market. Although we believe economic and retail conditions remain somewhat uncertain and the industry will experience some cost inflation over the near term, we believe Tempur-Pedic's credit measures will strengthen as profitability improves and the company repays debt. Our forecast assumptions include: -- Low-single-digit revenue growth for 2013, reflecting a continued recovery in consumer bedding demand and contributions from new specialty bedding products for both Tempur-Pedic and Sealy. -- EBITDA margins decline about 30 basis points in 2013, primarily reflecting spending on new products and promotions. Thereafter, we expect synergy benefits, a more favorable product mix, and volume leverage will lead to modest margin expansion starting in 2014. -- Annual capital expenditures of about $61 million for 2013. -- Discretionary free cash flow of about $145 million in 2013. -- No share repurchases, as we expect free cash flow will be used for debt reduction. Based on our forecast, we estimate that by the end of the fiscal year ending December 2013, adjusted leverage could improve closer to 4x and FFO to total debt should exceed 13%. Tempur-Pedic markets and manufactures proprietary viscoelastic foam mattresses and pillows under the TEMPUR and Tempur-Pedic brands. The acquisition of Sealy will broaden the company's product line to include both inner-spring and foam mattresses under the Sealy, Sealy Posturepedic, Stearns & Foster, and Optimum brands. We believe the U.S. mattress industry, with an estimated $6.8 billion of wholesale sales as of June 2012, is highly competitive, with the top five manufacturers accounting for more than 68% of the market, and the remaining portion of the market being very fragmented. The combination of Tempur-Pedic and Sealy provides the company with an estimated 30% share of the overall wholesale bedding market, and close to 50% share of the specialty bedding segment, which we believe improves its competitive position and enhances its ability to secure floor space for new products over the next year. In addition, we believe the combined company has good international diversification, with close to a third of revenue generated outside of the U.S. While the bedding industry has historically demonstrated stability in various economic environments, the most recent recession and weakness in the housing industry caused unit declines for the industry overall during 2009 and 2010. Industry growth resumed as the economy began to recover in 2011, and has continued to improve during the first nine months of 2012. Input cost inflation, especially for foam and steel, has been a headwind for the industry over the past two years, but we expect some moderation going forward due to a slowing global economy. Liquidity We believe Tempur-Pedic will have "adequate" sources of liquidity to meet its needs during the next 12 months. We expect Tempur-Pedic's sources of liquidity during this period will exceed uses by more than 1.2x and that net sources will be positive, even with a 15% drop in EBITDA. This is based on the following information and assumptions: -- We estimate that immediately following the transaction the company will have close to $40 million in cash on its balance sheet. -- We believe availability on its new $350 million revolving credit facility expiring 2017 and cash flow will be sufficient to meet working capital needs. -- We expect financial maintenance covenants in the proposed credit facility will include maximum net leverage and minimum interest coverage ratio tests, with at least 20% EBITDA cushion over the next year. -- The company will not have any significant debt maturities until 2017. -- We believe Tempur-Pedic will generate more than $230 million of FFO over the next 12 months, more than sufficient to cover an estimated $61 million of annual capital spending. -- We believe Tempur-Pedic has sound relationships with its banks and a satisfactory standing in the credit markets. Recovery analysis The issue-level ratings on Tempur-Pedic's proposed $1.77 senior secured credit facilities is 'BB', with a recovery rating of '2', indicating our expectation for substantial (70% to 90%) recovery for lenders in the event of a payment default. The senior secured credit facilities include a $350 million revolving credit facility due 2017, a $650 million term loan A due 2017, and a $770 million term loan B due 2019. The issue-level rating on Tempur-Pedic's proposed $350 million of senior unsecured notes due 2020 is 'B+', with a recovery rating of '5', indicating our expectation for modest (10% to 30%) recovery in the event of default. Outlook The outlook for Tempur-Pedic is stable, reflecting our expectation that the company will maintain adequate liquidity and improve operating performance and cash flows over the near term, while strengthening credit measures over the next year as profitability improves and the company repays debt. We could consider raising the ratings if the company is able to strengthen its operating performance, repay debt, and improve credit measures, including reducing leverage to below 3.5x and FFO to total debt close to 20%. We estimate the company could achieve these metrics by the end of 2014 in a scenario where sales increased close to 10% while EBITDA margins improved about 100 basis points from the end of 2012, reflecting growth for new higher-margin products and the realization of cost savings and synergy benefits. Alternatively, we could consider a lower rating if the company experiences operating difficulties such that credit measures deteriorate, resulting in leverage of more than 5x. We could also consider a lower rating if the company's liquidity is materially pressured or if the company pursues a more aggressive financial policy, including debt-financed share repurchases. Related Research And Criteria -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 Ratings List Ratings assigned Tempur-Pedic International Inc. Corporate credit rating BB-/Stable/-- Senior secured $350 mil. revolver due 2017 BB Recovery rating 2 $650 mil. term loan A due 2017 BB Recovery rating 2 $770 mil. term loan B due 2019 BB Recovery rating 2 Senior unsecured $350 mil. notes due 2020 B+ Recovery rating 5 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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