Sleepy’s/Mattress Firm may see extended US review, industry sources say

Provided exclusively by Mergermarket

The antitrust review of the Sleepy’s and Mattress Firm (NASDAQ:MFRM) merger is likely to have a local geographic focus and could extend into a second request if regulators find concentration issues within states, according to antitrust attorneys familiar with the industry.

The USD 780m tie-up would give the combined mattress retailers a national presence across 48 states and 21.3% share of the market for retailers specializing in mattresses, according to a Mattress Firm presentation to investors. The next largest competitor, Sleep Number, will have just 7.9% of the market, according to the presentation. The companies, two of the nation’s largest, will overlap in 10 states, according the presentation.

Overall concentration in the mattress store industry is low, with many outlets that are single-store and regional operators, according to a report provided by IBISWorld. Sleepy’s is owned by HMK Mattress Holdings.

Announced 30 November, the transaction is expected to close in August 2016, which could indicate that the companies factored in the chances of a second request, said the first antitrust attorney. A second antitrust attorney agreed that a second request for information may be forthcoming.

The first antitrust attorney said that a second request could be avoided if the companies provide regulators with enough information during the 30-day HSR period, or during the additional 30-day period if the parties pull and refile.

The Federal Trade Commission (FTC) is expected to review the transaction. The companies disclosed that they planned to file for HSR within 10 days of the deal announcement date.

Both antitrust attorneys said that the competitive analysis will largely focus on local geographies in the states where there is overlap between the two companies’ brick-and-mortar storefronts. Regulators will also likely want to separate and examine the market for specialty mattresses versus traditional mattresses, the two attorneys said.

Traditional mattresses, which comprise 49.3% of the US bed and mattress store market, “support the body with springs and are the most affordable form of mattress,” according the IBISWorld report. Specialty mattresses, which comprise 23.1% of the market, support the body with novelty features such as air, water or memory foam, according to the report.

Tempur-Pedic under Tempur Sealy International (NYSE:PSX) and Sleep Number, manufactured by Select Comfort (NASDAQ:SCSS), are the two most popular and expensive brands of specialty mattress, according to the report. Specialty mattresses comprised 43.3% of Mattress Firm’s total net sales in 2014, while conventional mattresses comprised 47.2%, according to the company’s most recent 10-K filing.

Consumers are likely willing to travel further to examine and buy more expensive specialty mattresses, the first antitrust attorney said. Most people will not buy such mattresses without testing them first, the second antitrust attorney said. How far the retailers are willing to deliver also could factor into the geographic analysis, that attorney said.

Regulators will also want to examine potential competition from home furnishing stores and department stores such as Macy’s (NYSE:M), the second antitrust attorney said.

Sleep-centric retail stores such as Mattress Firm have “gained significant market share at the expense of traditional furniture and department stores” because they “carry a wider product selection, have a more knowledgeable sales force and more dedicated floor space,” according the 10-K.

Big-box retailers also have not gained significant market share over stores such as Mattress Firm and Sleepy’s in part because they do not wish to carry products as bulky as mattresses, according to the 10-K. The internet, too, “has gained limited traction,” as it is difficult to compare mattresses across retailers online, the filing read.

Mattress Firm still listed among its competitors department stores, national and regional chains, local retailers and warehouse clubs such as Costco (NASDAQ:COST). Mattress manufacturers also compete by selling directly to consumers.

If regulators target the market for specialty mattresses and conclude the Sleepy’s and Mattress Firm are in a class above their competitors, “then maybe we have a larger problem than we initially thought” in geographies where there is overlap, the first antitrust attorney said.

Retail deals where there are anticompetitive overlaps between stores can typically be fixed through divestitures, both antitrust attorneys said. In the event of divestitures, the first antitrust attorney agreed that the storefronts could attract private equity.

That antitrust attorney also questioned the extent to which competition would truly be replaced in areas where divested stores could be sold to other mattress retailers. The second attorney said that the divestiture-buyer would also likely have to compete with a combined Sleepy’s and Mattress Firm in terms of distribution capability.

Regulators could also want to examine the relationships that Mattress Firm and Sleepy’s have with manufacturers, the first attorney said.

Mattress Firm currently relies on Tempur Sealy, Simmons Bedding and Serta as primary suppliers of branded mattresses, according to the 10-K. Product purchases from those three manufacturers accounted for 77% of the company’s mattress product costs for 2014, according to the filing.

“We believe that the strength of our supplier relationships enables us to source our merchandise in a more cost effective manner than our mattress specialty retailer competitors, as well as receive higher vendor incentives and advertising support,” Mattress Firm said in the 10-K.

The merger agreement filed with the US Securities and Exchange Commission (SEC) does not include specific language regarding a divestiture cap beyond a material effect on the combined companies’ revenues. Mattress Firm and Sleepy’s combined revenues from retail sales in 2014 totaled about USD 2.6b, according to the report provided by IBISWorld.

The transaction also does not carry an automatic regulatory termination fee. If the buyer fails to execute obligations considered reasonable best efforts and walks away, the seller can sue, but is limited to damages of USD 7.8m, according to the filing.

Mattress Firm and Sleepy’s did not immediately return requests for comment.

by Madeline O’Leary in New York

As seen in the mergermarket newsletter on 4/12/2015

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