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Rating Action:

MOODY'S ASSIGNS B3 RATINGS TO SR SUBORDINATED NOTES OF SEALY MATTRESS COMPANY AND ASSIGNS Ba3 RATINGS TO ITS SR SECURED CREDIT FACILITIES

04 Dec 1997
MOODY'S ASSIGNS B3 RATINGS TO SR SUBORDINATED NOTES OF SEALY MATTRESS COMPANY AND ASSIGNS Ba3 RATINGS TO ITS SR SECURED CREDIT FACILITIES New York, 12-04-97 -- Moody's Investors Service assigned B3 ratings to Sealy Mattress Company's proposed $155 million senior subordinated notes and $75 million senior subordinated discount notes, both due 2007. Moody's also assigned Ba3 ratings to its $100 million secured revolving credit facility and its $420 million in term loans. In addition, Moody's withdrew its two debt ratings on Sealy Corporation, the parent of Sealy Mattress Company. Specifically, the ratings withdrawn include the B1 rating on the $200 million senior subordinated notes, due 2003; and the Ba1 rating on the $275 million secured revolving credit facility, due 2002. The proposed notes issued by Sealy Mattress Company are part of a buyout of Sealy Corporation by Bain Capital, Inc. and management. Following the buyout and recapitalization, the debt of Sealy Corporation will be repaid. This is the first time Moody's has rated the debt of Sealy Mattress Company.
The new ratings reflect the high leverage associated with the $833 million buyout of Sealy Corporation by Bain Capital, Inc., the risk that the company may take on additional debt to fund future acquisitions, and the thin interest coverage. In addition, Sealy operates in a mature and increasingly competitive industry, with potentially volatile market share. In recent years, the Sealy has reported declining gross margins. However, the ratings are supported by the company's position as the clear leader in the fragmented US bedding industry and its highly recognizable brand names, including Sealy, Sealy Posturepedic, and Stearns & Foster. In addition, over the past two years the company has reversed a trend of declining market share largely by improving its dealer relationships and focusing on its core business. Sealy's strong vertical integration should enable the company to better serve its retail customers who require just-in-time inventory.
The B3 ratings on the senior subordinated notes and the senior subordinated discount notes reflect their contractual subordination to the borrowings under the secured revolving credit and term loan facilities. These notes are both are unsecured, mature in 2007 and rank pari passu with other senior subordinated debt. The notes are guaranteed on a subordinated basis by Sealy Corporation as well as most of the subsidiaries of Sealy Mattress Company. Non-guarantor subsidiaries comprised 9.5% of net sales for the nine months ended August 31, 1997. All the liabilities of the non-guarantor subsidiaries are considered to be senior to the subordinated notes.
The Ba3 ratings on the revolving credit and term loans reflect the benefits of the collateral package. The facilities are guaranteed by Sealy Corporation and most US subsidiaries of Sealy Mattress Company, and are secured by a perfected first priority interest in substantially all of the tangible and intangible assets of Sealy Mattress, as well as those of its guarantor subsidiaries, including intellectual property and all the capital stock of all the guarantor subsidiaries (65% of the stock of foreign subsidiaries).
Bain Capital, Sealy management, and certain other investors, have purchased a 90% interest in Sealy Corporation, with the current shareholders, the Zell / Chilmark Fund, retaining 10% ownership. The purchase price of $833 million was equal to 8.1 times LTM August 31, 1997 EBITDA of $103 million or 9.1 times LTM EBITA of $92 million, adjusted to exclude $10.6 million in losses incurred on recent asset sales, a $4.8 million charge for certain 1997 stock based compensation, and a $3.5 million charge related to the write-off of Montgomery Ward receivables. The purchase price was financed with bank loans of $434 million ($420 million in term loans and an initial draw of $14 million under a $100 million revolving credit facility), senior subordinated notes of $155 million, senior subordinated discount notes of $75 million, and equity of $169 million. The equity includes a $130 million investment by Bain Capital, a $14 million equity rollover by Zell / Chilmark, and a $25 million junior subordinated note at Sealy Corporation. This junior note is structurally subordinated to the senior subordinated notes, including the subordinated discount notes, and has a longer maturity.
Pro forma for the buyout, total debt increased to $664 million from $340 million at August 31, 1997. In addition, under recapitalization accounting, book equity fell from $206 million to negative $101 million. The ratio of pro forma debt to market capitalization is 80%. Based on LTM EBITDA of $103 million, the ratio of total debt to EBITDA is high at 6.4 times (7.2 times EBITA). The terms of the senior secured credit facilities allow for usage up to $50 million under the revolving credit to finance future acquisitions. Thus, there could be an additional increase in leverage if the company uses this facility to support external growth.
Competition within the conventional bedding industry is intense and is largely based on pricing, new product innovation, brand awareness, and the ability to capture retail floor space. From 1994 to 1995, Sealy's market share declined from 20.1% to 18.0% largely due to competitive pricing strategies employed by other mattress companies, the loss of the Sears private label business, and a movement away from promotional products. During this same period, Sealy's gross margin dropped from 49% to 47%, mainly due to the decrease in sales volume. Over the past two years, the company's market share has rebounded - reaching an estimated 22% in 1997. However, the gross margin has deteriorated further to 44% for the nine months ended August 31, 1997 partly due to overtime costs, training expenditures and shipping cost inefficiencies. Moody's believes that Sealy may be challenged to maintain both its current market share and its historical gross margin levels given the intense competition and its high percentage of sales to mass merchants and the specialty sleep shops. Also, in the past, by taking advantage of the strong demand for premium priced mattresses, Sealy enjoyed operating margins which were typically higher than its competitors. But as the battle for market share intensifies, the long term sustainability of these margins becomes questionable. Finally, like most mature industries, any significant price increases in order to increase margins will require a certain level of costly product innovation.
Pro Forma LTM August 31, 1997 results include sales of $738 million and EBITDA of $103 million. As a percentage of sales, EBITDA declined from 14.8% for the fiscal year 1996 to 13.9%. This decrease was partly due to some unplanned costs associated with an increase in sales volume as well as certain promotional initiatives such as increased cooperative advertising expenses. Based on pro forma interest expense of $64 million, EBITDA interest coverage is thin at 1.6 times. Depreciation expense is approximately $14 million versus capital expenditures of $25 million. The 1997 capital expenditure figure was higher than normal due to $11 million in costs related to an upgrade of the company's computer system. Additional costs are expected to be incurred in 1998. Given the high level of capital requirements, the ratio of EBITDA minus capex to interest expense more accurately measures debt service coverage and is initially low at 1.2 times. EBITA of $92 million produces a strong 20% return on tangible assets.
The note indenture permits up to $15 million of additional foreign subsidiary debt and up to $30 million of US subsidiary debt. Thereafter, additional indebtedness can only be incurred if the fixed charge coverage ratio on a pro forma basis is at least 2.0 times. Principal covenants include limitations on indebtedness, restricted payments, and sales of assets.
As indicated, up to $50 million in borrowings under the revolving credit facility may be used to finance acquisitions. Total indebtedness to finance such acquisitions are limited to 5.5 times LTM EBITDA for the businesses acquired. The bank facilities' tangible asset coverage is only 66% given intangibles of $451 million (total assets of $737 million). However, this coverage improves once consideration is given to the value of the company's intellectual property and the enterprise as a whole. This value is largely based on the strength of the Sealy brand names.
Headquartered in Cleveland, Ohio, Sealy Corporation is the largest manufacturer of bedding in North America. Through its subsidiaries, it operates in North America, Canada, Puerto Rico and Mexico and has licensees worldwide. It manufactures and sells complete line of mattresses and box springs, including those sold under the Sealy, Sealy Posturepedic, and Stearns & Foster brand names.




No Related Data.
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