April 30, 2006, 3:09 pm

Week of 5/1

As always pre-ipo analysis for every offering available:


CPX - Complete Production Services

CPX - Complete Production Services plans on offering 25 million shares (11 million by insiders) at a range of $22-$24. Credit Suisse and UBS are lead managing the deal. Post-offering CPX will have 70.5 million shares outstanding for a market cap mid-range of $1.622 billion. Roughly 1/3 of the IPO proceeds will be utilized to repay debt, the remainder for general corporate purposes.

As currently structured, CPX is a rather new entity commencing operations in 9/05. CPX is a merge of 3 separate oil/ natural gas services companies all bought in the 2001-2003 period by private equity firm SCF Partners. SCF Partners has been around since 1989 and focuses exclusively on the energy and energy equipment sector. Looking at the structure of CPX and how it was formed, it takes on a lot of the characteristics of classic 'roll-up' companies. SCF Partners has essentially been buying up small oil services companies the past 5 years and in 9/05 combined these entities into CPX.

As is typical in private equity deals SCF Partners did pay themselves a dividend of $147 million upon the merge that created CPX. Also SCF will be selling roughly 11 million shares in the offering, assuming over-allotment is exercised. Post-offering SCF will own 41% of the public CPX.

From the S-1:

“We provide specialized services and products focused on helping oil and gas companies develop hydrocarbon reserves, reduce costs and enhance production.”

CPX falls into the broad category of 'oil services’. While they do have a small offshore component, for the most part CPX business is onshore, in the US Rocky Mountain region, Canadian Rockies, and the Oklahoma/ Texas region. As is often indicative of roll-ups, CPX has their fingers in a lot of different niches. To compare to recent IPOs, they're almost a combination of BAS/ SWSI/ BRNC with a little HERO thrown in for good measure. HAL is probably the most similar currently public company, although HAL is much larger with a market cap 25 X's greater than CPX projected initial cap.

Obviously oil/ natural gas services has been a great spot to be the past few years. Driven by high underlying commodity costs, exploration and production capacity has ramped up, leading to a boom period for those companies involved in servicing said exploration and production. Historically this has been a cyclical sector as strong demand leads higher prices brings on higher capacity, leading to more supply and lessening demand from high prices eventually....leading to lower prices. Currently the group is in a massive bull run, fueled in large part by global energy demand, fueled in large part by demand from India/ China. I often liken what is occurring in India/ China to what transpired in the United States in the years following World War II. Yes, at some point there will be a turn, whoever can predict such is an analyst with psychic gifts. Continued high oil/ gas/ natural gas prices will continue to lead to a very strong exploration and production environment and it appears that will be the case throughout 2006.

The number of drilling rigs in North America has doubled in the past 3 years and the number of well service rigs has grown by 60% the past 3 years. Easier to reach wells have been drilled over the years, the trend has become tapping tougher to reach fields. This combination of increased drilling in harder to drill fields/ reserves has been that boom cycle for the oil/ natural gas services companies.

CPX services pretty much cover the entire life-cycle of a well. The business breaks down into 3 distinct services:

1 - Completion and Production Services which accounted for 67% of 2005 revenue. Essentially this entails establishing, maintaining, and enhancing the flow of product through the entire life-cycle of a well. This includes; intervention services, downhole & wellsite services, and fluid handling. CPX intervention services are specialized equipment used to increase flow and include coiled tubing units, pressure pumping units, nitrogen units, and well service rigs. Fluid handling for the most part includes a fleet of disposal vehicles to assist in elimination of used/ waste fluid used in E&P. Direct competitors in the Completion and Production space include Haliburton, Basic Energy Services, Baker Hughes and Key Energy Services.

2 - Drilling Services which accounted for 17% of 2005 revenue. This segment entails drilling equipment/ rigs and the actual drilling itself. All of the CPX actually contract drilling revenue was derived in the North Texas region. Competitors here include Bronco Drilling, Nabors, and Patterson-UTI Energy.

3 - Product Sales which accounted for 16% of 2005 revenue. Oil and gas services equipment sold to exploration and production entities through retail stores and distributors. Competitors here are similar to those in the Completion and Production Services segment.

As a roll-up type business and to compete in each locale they operate, CPX has kept an operating structure akin to that of many smaller locally managed companies.

Top 10 customers accounted for 33% of revenue, with no single customer accounting for more than 10%. As is typical in this business, all revenue other than 'Product Sales' segment is derived on a contract basis for relatively short time-frames. This has really helped these type companies ramp revenues as demand has increased, historically for this reason they've also suffered during the cyclical downturns.

US operations accounted for 86% of '05 revenue, Canadian operation 14%.


There is some debt here. Some was brought on through the dividend payout to SCF, the rest through the roll-up acquisitions. $426 million post-IPO is not enough to impede operations or really cause much of an issue, especially when one factors in the $200 million in cash on hand post- offering. I would expect SCF to utilized cash on hand for acquisitions, which should enable them to pay down debt levels rather swiftly from cash flow. I do fully expect CPX to continue to grow, either by adding equipment such as rig/ workover rig counts, or more likely by picking up smaller regional oil/ gas services companies. That has been CPX 'mo" and it has also been the characteristics of the sector which is rapidly consolidating.

7 1/2 X's book value post-offering. CPX does not intend to pay dividends.

Approximate 2.1 X's trailing revenue assuming mid-range pricing.

Revenue comparisons year to year are not really comparable due to the roll-up nature also, CPX did not exist in its current form until 9/05. They have included consolidated numbers for 2005 as if the entire entity existed 1/1/05 so we can look at full year 2005.

Revenues in 2005 were $760 million with 37% gross margins. Operating margins of 15%. Taking into account debt servicing and taxes, net margins for 2005 of 7%. CPX earned 77 cents a share in 2005. At a mid-range pricing CPX will be trading 30 X's trailing revenue.

Looking into 2006, there is no doubt CPX will add services capacity. How much? Really difficult to discern due to the complete lack of operating history as currently structured. My estimates for CPX in 2006 are much more guesswork than usual [for me within this industry]. The sector itself looks to expand 10-15% in 2006, I think CPX will do a little better than overall sector. Why? First they're still a relatively small player so during another strong demand year they should be able to outperform sector growth on a % basis. Second I think they'll put IPO proceeds to work expanding business which should result in increased revenue back 1/2 of 2006. Gross margins should be in similar ballpark, but I do think operating margins can improve slightly due to all segments now being under one umbrella. Better operating margins should positively impact net margins, coupled with a stable debt servicing number.

So at a $900 million revenue run rate for 2006, I think CPX could book post net margins of 9% , resulting in $1.10-$1.20 in net earnings. At mid-range, CPX would be trading at 20 X's 2006 earnings.

A look at a few others in similar sectors:

Haliburton (HAL) - $39 billion cap, currently 19 X's '06 earnings, 6 X's book, 2 X's trailing revenue 5-10% top-line growth.

Baker Hughes (BHI) - $24 billion cap, currently 20 X's '06 estimates, 5 X's book, 3 X's trailing revenue10-15% top-line growth.

Basic Energy Services (BAS) - $1.1 billion cap, currently 15 X's '06 estimates, 4 X's book, 2 X's trailing revenue, 10-15% top-line growth.

Superior Well Services (SWSI) - $0.66 billion cap, currently 30 X's '06 estimates, 7 X's book, 5 X's trailing revenue, 20-25% top-line growth.

Complete Production Services (CPX) - $1.6 billion cap at $23, 20 X's '06 estimates, 7 X's book, 2 X's trailing revenue, 15-20% top-line growth.

Risks-- Big risk here is CPX continuing to spend money to grow capacity and acquire business when a cyclical turn hits. That doesn't appear to be much of a short or mid-term risk but something to keep in mind. These oil/ gas servicing companies are spending quite a bit of money annually to keep up with E&P demand. It has been paying off very nicely for them and looks as if that is going to be the case at least through 2006. If and when the E&P environment changes and slows every one of these oil/ gas services companies will be sitting on a lot of excess inventory/ employees they'll need to idle and/ or write down. It happens over and over again in this industry and it will again someday. When? I've no idea, doesn't appear to be an imminent danger.

I don't like to see debt during boom periods, although debt is a characteristic of a roll-up type operation. I'd like to see CPX utilize cash flow to pay down debt, something I think they will do. The fact they've $200 million in IPO proceeds to devote to growing the business, should allow cash flow to go towards lowering debt.

Conclusion - Solid offering. This is one you definitely take shares on offering in range and probably $1-$2 above range. I do think since the sector is so hot here that CPX will most likely price above range and open higher from there. Should that occur I doubt we'll see CPX outperform the sector. In fact if it opens too high initially this could be a case in which CPX underperforms the group.

Late '05 we saw 2 IPOs in HERO/ BAS actually price/ open at a significant discount to the sector really giving IPO players an opportunity for appreciation on not only the sector but also the 'multiple catch-up.'. I don't see that 'multiple catch-up' being in play here with CPX as I do believe it's opening prints will definitely not be at a forward discount to the sector as a whole. Good offering in a great performing sector, one though to be careful of paying any price for in aftermarket. I would anticipate a pricing of $26 and an open around $30, at which there may be better opportunity elsewhere in the group. I do like CPX aftermarket under $27 (which is $4 above mid-range) or so and would take any allocations especially if able to flip on a lofty open.

April 23, 2006, 1:46 pm

Week of 4/24

The ipo calendar seems to be picking up a little. We've 4 shceduled for the week, with another 4-5 expected the first week of May.

IPO reporter Grace Wong of cnnmoney.com was kind enough to quote me in her recent article on the Corel ipo. That article can be found here:


This week's blog past analysis piece is Nextest, a small but promising little semiconductor testing outfit. As always pre-ipo analysis on every offering can be found at http://www.tradingipos.com

NEXT - Nextest Systems

NEXT - Nextest Systems plans on offering 6.2 million shares(assuming over-allotment) with 1.6 million coming from insiders. Projected offering range for the deal is $14-$16 a share. Merrill Lynch is lead managing the offering with Cowen and Company co-managing. Post-offering NEXT will have 17.5 million shares outstanding(again assuming over-allotment is exercised) for a market cap mid-range of $263 million.

From the s-1:

'We design, develop, manufacture, sell and service low-cost, high throughput automated test equipment, or ATE, systems for the semiconductor industry. We address rapidly growing, high volume segments within the semiconductor industry such as the flash memory and flash-based system-on-chip markets.'

Our 2nd semiconductor testing ipo in the month of March. The big difference between recent ipo EGLT and NEXT is that EGLT does not provide test equipment for consumer flash memory semiconductors, while it is the focus for NEXT. EGLT focus is mixed signal semiconductor testing, NEXT is digital specifically digital flash memory. Flash memory has taken hold the past couple of years as the key internal component in many consumer digital products. Reason being flash memory maintains its data without any external power source and can be easily erased and reprogrammed. Ideal for consumer digital devices and most estimates continue to call for strong growth in consumer related flash memory the next few years. Pricing tends to be very competitive. These flash memory chips/components need to be tested whether that be the design, fabrication and/or manufacturing stage and that is where NEXT comes in. NEXT believes their Magnum systems offer the high throughput low cost scalable solution that gives them an advantage in the flash memory testing niche. Highlights of Magnum include the ability to run independent multi-speed parallel tests on flash memory semiconductors and components. Additionally NEXT claims Magnum offers higher speed testing and lower cost per pin. The 5,120 pin configuration of the Magnum can test 640 NAND flash devices in parallel. The 5,120 pin configuration can also simultaneously test 160 NOR flash devices. NEXT claims they have the equipment that offers the lowest cost flash memory tests.

Along with flash memory semiconductor testing NEXT products also test flash memory components such as integrated circuits, or ICs, such as microcontrollers, smart cards, and field programmable logic devices, or FPGAs. End products for NEXT semiconductor customers include portable music players, cellular phones, digital cameras, computer notebooks and USB flash drives.

Of note NEXT test products are designed to test both the stagnant NOR flash memory and the much faster growing NAND flash memory. NEXT believes their recent strong quarterly growth rates are directly attributable to testing NAND flash memory.

In the past 18 months 75% of revenue has been derived from Asia, 25% from the US. NEXT is still relatively small having shipped over 1,500 systems to 60 semiconductor companies since inception. Much like EGLT, the bulk of NEXT's revenue has come from a few customers. Amkor Technology, Atmel Corp., SanDisk, Hynix and Sansung have accounted for the bulk of NEXT revenue the past 3 years. Financials

$4+ per share in cash post-offering, no debt.

2 3/4 X's book value at mid-range pricing.

Revenue troughed in 2002 and 2003. Since than NEXT has ridden the wave of flash memory boom avoiding the steep revenue drop-offs of non-flash semi test equipment makers such as recent ipo EGLT. In FY 2004 revenue tripled, while FY 2005(ending 6/30/05) saw revenue climb 10% to $48 million. Fueled by the 2 strongest quarters in NEXT history, revenues for FY '06 are off to a good start. Thus far through first 1/2 of FY '06, revenue is on pace for a 40%+ increase to $70 million. Seasonally the first 1/2 of each fiscal year is stronger for NEXT, the $70 million estimate actually forecasts lower revenues the 2nd half of FY '06 for NEXT.

Gross margins quarterly have remained in the 45%-50% range.

Operating expenses really jumped up in FY '05 as NEXT rolled out their new Magnum product. This led to roughly 25 cents per share loss, coming off a small net gain in FY '04. For FY '06 NEXT has managed to keep SGA in line with FY '05 while growing revenue rapidly as note above. This has led to operating margins through the first 6 months of FY '06 of 13%. I imagine that will contract a little going forward as seasonality kicks in, but I do think NEXT can book net margins for FY '06 of 8%. That would lead to net earnings for FY '06(ending 6/30/06) of 30-35 cents for NEXT. At mid-range pricing of $15, NEXT would be trading at 45 X's 2006 earnings. This is roughly the current fiscal year valuation EGLT priced their ipo.

Risks - The big risk here is the cyclical nature of the semi/semi component test business. While NEXT was able to weather the most recent testing niche downturn in 2004, revenues did take a nosedive in the early 2000's. I don't see this as a near term risk for NEXT as they are focused on the sweetest spot in the semi test niche, flash memory. Robust backlog backs this assessment. However the downturns in this sector are severe and often come with little warning. Much like most of the small technology companies coming public this decade, NEXT will not be debuting cheap. A strong initial valuation definitely leaves NEXT share price very vulnerable to a change in cycle. This is something that needs to be watched closely, because when these cycles turn they turn hard and ugly. SNDK has been a consistently large customer for NEXT test equipment since FY 2003. A good tell going forward for NEXT may be be SNDK's outlook on the strength of their flash end-market. As long as SNDK continues to see strong demand, NEXT should be alright.

Conclusion - I like this NEXT ipo much more than EGLT. It is not coming cheap by any means, but NEXT equipment is focused on testing the fastest growing semiconductor sector of the past few years, consumer flash memory. One too which is forecast to continue strong growth the next 3-4 years. For this reason I like this one in range and even $1-2 above. This is a deal that should work much better than similar EGLT. Yes there are risks here, the topmost being one of initial valuation. However I think demand will exist for this one, I'd take allocations and will be looking to enter on a reasonable aftermarket print.

April 16, 2006, 7:13 pm

weel of 4/17

Only one ipo on the calendar this week, but we should be seeing 4-5 a week for a bit beginning the week of 4/24

this week's piece is Clayton Holdings(CLAY). As always in-depth analysis for every offering is available at:


CLAY - Clayton Holdings

CLAY - Clayton Holdings plans on offering 6.25 million shares at a range of $15- $17. William Blair and Piper Jaffray are lead underwriting the deal. Post-offering CLAY will have 18.1 million shares outstanding for a market cap mid-range of $290 million. IPO proceeds are being utilized to redeem preferred shares and repay debt.

CLAY is structured as a roll-up by TA Associates of 3 separate companies in 2004, Clayton Services, First Madison, and CFIS. TA Associates laid debt onto the company to not only complete the acquisitions but give themselves a payout. Post-offering CLAY will be carrying around a bit of debt, $114 million. Post-offering TA Associates will own 46% of CLAY.

From the S-1:

“We provide a full suite of outsourced services, mortgage-related analytics and specialized consulting services for buyers and sellers of, and investors in, mortgage-related loans and securities and other debt instruments. Our services include transaction management, which consists of due diligence, mortgage processing services for buyers of mortgage loans (conduit support services), professional staffing, and compliance products and services, as well as monitoring of mortgage-backed securities (credit risk management and surveillance), and specialized loan servicing services (special servicing).”

CLAY believes its entities founded the non-conforming loan expertise market 15 years ago.

Essentially CLAY provides mortgage loan and mortgage backed securities expertise with focus being analytics/ consulting/ outsourcing. Most of CLAY's services are provided to participants in the non-agency segment of the mortgage backed securities (MBS) market and the non-conforming mortgage loan market. Non-agency MBS are comprised primarily of mortgage loans that do not conform to the underwriting guidelines of Ginnie Mae, Fannie Mae or Freddie Mac. This catagory of loans/ securitizations has exploded this decade. Securitization rates for non-conforming mortgage loans have increased from 34.6% in 2000 to 60.1% in 2005. Growth in this class of securities has exploded, so has the demand for specialization in this arena.

Due diligence(analysis) on closed non-conforming loans is the leading revenue driver here. CLAY's business can appear a bit complicated, however CLAY is essentially an offering whose primary business is due diligence with the rest of their services stemming from there. With the heavy growth in these type of loans, expertise in this area has been in strong demand.

Customers of CLAY's services include capital markets firms, banks and lending institutions, MBS issuers/ dealers, mortgage and bond insurance companies and fixed income investors. CLAY's parts have been providing these services for 15 years now and CLAY believes they are the leading player in all of their service areas. During 2005, CLAY performed detailed analysis on over 930,000 loans totaling over $175.0 billion in principal value, which represented 9.0% of the total principal balance of U.S. non-conforming mortgage loan originations over such period. As of December 31, 2005, CLAY was monitoring over $308.0 billion in loans underlying MBS, which represented 19.4% of the total outstanding U.S. non-agency MBS at such date.

CLAY makes the point numerous times that their products and services cover the entire lifecycle of non-conforming mortgage loans.

The 3 largest clients Bear Stearns, Lehman Brothers and Morgan Stanley accounted for approximately 33% of 2005 revenue. With due diligence being the revenue driver here, the fact that the largest players in the sector rely on CLAY for analysis of non-conforming mortgage backed securities products is a testament to CLAY's expertise in this arena. A very good sign.


After paying down $36 million in debt on offering, CLAY post-offering will be carrying approximately $114 million in debt. This is not at a level that will impede operations but debt servicing did eat up roughly 30% of operating earnings in 2005. I would expect CLAY to continue to look for acquisitions and don't see debt levels dropping significantly in the mid-term.

Since the formation in 2004, CLAY has experienced 5 straight sequential quarterly revenue increases booking strongest revenue quarter in 12/05.

Due to CLAY's recent formation combining 3 existing entities revenue data is not comparable going backward. It appears CLAY has enjoyed strong organic growth the past few years though as their niche has seen tremendous growth. In 2005 CLAY booked $207.5 in top-line revenue. Gross profit came in at 65%. Operating expenses appear well contained even with relatively high amortization expenses resulting from the 3 company roll-up. Operating expenses came in at 25% in 2005.

Factoring in debt-servicing on the $114 million post-offering debt and folding out one-time charges, net margins for 2005 came in at 4%. Earnings per share came in at 45 cents putting CLAY's trailing PE of 36 at a mid-range pricing.

Going forward into 2006, CLAY's results will depend on the continued strength of the non-conforming mortgage loan market. I think this is an area in which we need to forecast quite a bit more muted growth in 2006 than we've seen past 2- 3 years. This type of mortgage loans (and subsequent MBS securitizations) have seen their strongest period in at least the past 20+ years. I feel a little uneasy simply assuming this sector will continue to boom in the face of rising shorter term rates, of which many ARM mortgages are based. Plus one can run into quite a bit of trouble assuming a strong cyclical market will continue at record high levels.

Amortization/ debt servicing are really impacting CLAY's net margins and that isn't going to change anytime in the near future. I think these factors coupled with the probable unsustainability of recent strong growth will keep CLAY from really being able to grow the bottom line substantially in 2006. CLAY is a fairly difficult offering to project for 2006 because they are also really the only public pure-play in their sector. I think we can be safe in assuming a 10-15% top-line growth rate here for '06. Along with that growth I think CLAY may be able to bump net margins to the 5-6% levels as well. If both come to pass I would expect CLAY to earn approximately 70-75 cents in 2006. If the housing market remains strong in '06 this number could prove to be low, conversely if the housing market sees a precipitous drop-off this 70-75 cent number could prove to be aggressive.

At 70-75 cents earnings in '06 CLAY would be coming public mid-range at 22 X's 2006 earnings. Due to the factors mentioned above I've a little less confidence in this projection than usual. I wouldn't be shocked to see any '06 number from 40 cents to $1, although to see that high end revenue would really need to ramp in 2006. CLAY simply has too large an amortization/ debt service number to easily grow the bottom line without a substantial increase in revenue.

Risks: A slowdown in the housing market, particularly the higher risk mortgage loan market. This is a very real risk and one reason to be cautious paying up too much for CLAY. There is a chance here that CLAY is coming public right at a sector peak for its market. Sector peaks are always easy to see in hindsight, very difficult at the time though. CLAY's focus is on the segment of mortgage loans that have benefited the most from the low interest rates and home price appreciation. It would be a reasonable assumption that CLAY's targeted niche would also be the area of the home mortgage market to be most affected from a slowdown.

Also the recent resignation of founder and President, Stephen M. Lamando, effective December 31, 2005, may impact the business going forward. Mr. Lamando will continue to serve on the Board of Directors so this looks more like a normal retirement than anything else. Still worth mentioning.

Conclusion - Expertise type IPOs tend to do rather well overall through good and bad markets alike. The one thing to be wary of here is the possibility CLAY is IPOing right at the peak of its niche. Also keep in mind that CLAY's top customers are the leading houses on 'the street'. Often when this is the case with an IPO, price will tend to move well ahead of numbers. CLAY's customers will know if business is continuing strong well ahead of CLAY's reports. Stock price here could very well be a leading indicator of CLAY's underlying future business strength. This has often been the case when investment banking houses are leading clients: MKTX was sold off for months ahead of the company taking down numbers and conversely CME priced/ opened strong a few years back and was able to sustain a bid in a tough market environment forecasting correctly very strong underlying trends for CME.

I do think CLAY offers pretty solid risk/ reward in range. I tend to like niche/ sector leaders in growth arenas and CLAY fits that bill to a 'T'. I wouldn't pay up here substantially though due to 1) the amortization/ debt service drag on margins and 2) the possibility of this IPO coming right at a sector peak. However CLAY is a leader in what has been a strong growing niche which makes it worth the risk in range and $1-$2 above. I've no real good feel for how this will do initially in the aftermarket, but I will be looking to enter on a reasonable open with of course a stop-out on pricing break. This is definitely one in which to follow the lead of CLAY's client base -- if the likes of Bear Stearns/ Morgan Stanley/ Lehman Brothers accumulate this stock it could be a good mid-longer term play, if there is continued supply here on any blip up than be very very careful.

April 7, 2006, 2:43 pm

ZZzzzzzzzzz - Sealy

For the 2nd week in a row I'm going to post on the blog an ipo that debuted in the just closed week. Why? Well I think it is important that readers realize I do put these pieces together before these offerings price/open.

There were 5 offerings this past week and as always the membership section has full analysis pieces available for each. 3 day free trial, the site has analysis pieces for essentially every ipo of the past 13 months available plus an active forum in which we discuss offerings and other market activities:


My pre-ipo thoughts on ZZ. Note that the eventual offering was approximately 28 million shares at $16, the extra shares predominantly coming from KKR. The 11.3 million shares from insiders in the final pricing of the deal does drop KKR's present ownership stake below the 55% noted below.

ZZ - Sealy Corporation

ZZ - Sealy Corporation plans on offering 23.3 million shares(3.3 million from insiders) at a range of $14-$16. Citigroup, Goldman Sachs, JP Morgan, and B of A are all lead underwriting the deal. Post offering ZZ will have 101 million shares outstanding for a market cap mid-range of $1.515 million. Approximately 1/2 the ipo proceeds are going to pay off insiders as a dividend, the other 1/2 to pay down debt.

ZZ is another leveraged buy-out quick flip ipo. In April, 2004 KKR purchased ZZ for what appears to be considerations of $1.2 billion. This transaction was funded in large part with a $1.05 billion loan put on the back of ZZ. Roughly 400 million of this loan did go toward replacing older higher interest debt, it appears though that the remaining $600 million was utilized to fund acquisition. Post-offering KKR will retain a 55% stake in the public ZZ.

From the s-1:

'We believe we are the largest bedding manufacturer in the world and the leading bedding manufacturer in the United States, based on our wholesale domestic market share of approximately 20.7% in 2004, approximately 38% greater than that of our next largest competitor.'

ZZ believes they retained that 21% leading domestic market share in 2005. ZZ has had the leading domestic bedding market share for 25 years. 79% of revenue is derived domestically, 21% internationally. Customer base is broad with 2900 customers and over 7000 retail outlets in the US alone.

The US bedding industry has seen 6-7% annual revenue growth the past 20 years. Revenues in the industry declined in only one year of the past 20(2001). The industry is characterized by a few large domestic manufacturers with few Asian imports. ZZ's top competitors are Serta, Simmons, and Spring Air all private companies.

Conventional bedding products are manufactured and marketed under the Sealy, Sealy Posturepedic, Stearns & Foster and Bassett brand names, while non-innerspring products are market/manufactured under the TrueForm, SpringFree, Stearns & Foster, reflexions, Carrington Chase, MirrorForm and Pirelli brand names. Innerspring products sell from $300 - $5000, with 68% of sales from products costing $750+. ZZ is seeing strong growth in the non-innerspring product group with sales increasing 130% in 2005 fueled by the Sealy Posturepedic 'True Form' line. This line is aimed at competing with the likes of Tempur Pedic.

The Sealy brand accounted for 80% of 2005 revenues, while Stearns & Foster accounted for 17%.

ZZ anticipates that higher end conventional and non-conventional bedding products will continue to grow at a faster than industry pace. ZZ has an even higher market share than overall in the premium bedding group($1000+) and foresees this segment as being their #1 growth driver going forward.


There is debt here. Post-offering ZZ will have approximately $842 million in debt. While the debt is slightly higher than I would like to see debt servicing does eat up 'only' 4% or so of revenue.

ZZ expects to pay an annual dividend of 2% of the initial offering price. At $15 that would mean an annual payout of 30 cents a share.

After a stagnant 2001, 2002 and 2003, revenues have grown steadily the past 2 years. In '04 top-line increased 10% and in '05 top-line grew another 12% to $1.47 billion. Gross margins for 2005 were a strong 44.3%, a slight increase over 2004/2003. Operating margins were 14%, a strong increase over '03/'03 as ZZ has been able to keep SGA expenses at similar levels while increasing revenue.

Net margins are impacted by the debt servicing. Debt payments ate up 30% of operating income in 2005. Net after tax margins in 2005 were just over 5%. Earnings per share were 77 cents per share giving ZZ a PE at a mid-range pricing of 19.

Looking into 2006, it appears after Q1(ending 2/28/06) that ZZ is on track for another 10% top-line gain. Gross margins ticked up again in Q1, operating margins were stable. ZZ notes that operating margins in Q1 were impacted negatively by new-product roll-outs and they anticipate margins to increase the 2nd half of FY 2006. I think ZZ can book another 10% top-line growth year in 2006 giving them $1.62 billion in FY '06 revenue. At slightly better gross and operating margins, I would anticipate net margins to come in roughly between 6-7%. Earnings per share for 2006 should be than approximately $1.05 per share. At a mid-range pricing ZZ would be trading 14 X's 2006 earnings.

Conclusion - I rarely recommend one of these leveraged buy-out quick-flip ipos as too often the leveraged buy-out company has sucked out an awful lot of cash/equity from the entity coming public. I'm making an exception here with ZZ. Yes KKR has put a bit more debt onto the backs of ZZ, but current debt levels post-offering are quite similar to ZZ pre-buyout as ZZ has been paying down debt from cash flows. With ZZ we've a worldwide sector leader with strong market position, proven growth trends of 10%, yielding 2% annually, and coming at an attractive multiple. Factor in the anticipated growth of non-traditional/premium bedding and the future looks bright for ZZ. I like this deal and think it works in range and $1-$2 above. Yes the debt is something to keep an eye on and should prevent one from paying up too high for ZZ, but this appears to be a solid deal all the way round.

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