Stevie Cohen’s Bed of Nails

05/08/2012 12:47 pm EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

The hedge-fund legend recently stuffed $77 million into a mattress stock that has continued to sag. He’s likely to come out ahead sooner than later, writes senior editor Igor Greenwald.

Spare some sympathy for billionaire hedge-fund manager Steven Cohen. First, the founder of SAC Capital Advisors failed in his bid to buy the Los Angeles Dodgers. Then rival mastermind David Einhorn stole the spotlight. And now a prescient small bet of Cohen’s has suddenly turned into a much bigger loser.

Until the end of last month, SAC held fewer than 200,000 shares of Select Comfort (SCSS), the maker of high-end Sleep Number adjustable mattresses. According to GuruFocus, he initiated the position in the second half of 2010, paying $6.90 a share. That was well off the stock’s March 2009 low of 20 cents a share, but well timed in light of its record close above $35 three weeks ago.

Cohen could have slept easy on a mattress laced with remotely controlled air chambers after quadrupling his money. Instead, with the stock already down 18% from its cushiest close ever, he bought in big time, spending $77.5 million on an additional 2.7 million shares at an average price of $29, boosting his stake to 5% of the company.

That was eight days ago. As of this morning, assuming SAC still owns all those shares, what had been a 320% gain on Select Comfort has turned into a double-digit loss. The intra-day low was below $25, down more than 30% from that record three weeks ago.

So what happened? Is the mattress-buying frenzy dead? Or is Europe distracting everyone from Select Comfort’s pledge to grow earnings at least 20% a year indefinitely? Is Cohen tossing and turning after stuffing his cash into a broken stock, or is he instead dreaming about the next rally?

The earnings that followed that record share price last month were certainly dreamy enough. Sales and earnings were up more than 35% in a year’s time, comfortably exceeding expectations.

But gross margin slipped year-over-year, and the company kept its prior annual guidance in place. A day later, rival Tempur-Pedic (TPX) provided disappointing profit guidance, and it’s been all downhill for both stocks ever since.

This week, the selling picked up steam after Tempur-Pedic owned up to planning near-term discounts of up to 17% on a key mattress model, a tactic it has previously eschewed.

At least today, the mattress makers have plenty of company in their misery. Other high-end discretionary consumer stocks are seeing red after a disappointing report by designer watch marketer Fossil (FOSL), which is down 38% in the wake of disappointing sales in Europe. Fashion trend setters like Lululemon (LULU), Michael Kors (KORS), Polo Ralph Lauren (RL), and Coach (COH) are all seeing red as a result.

The fashionable thing to do would be to predict that Europe will burn while luxury buyers in the US go into hiding to escape rising taxes and general ennui with the good life. With stocks seemingly reverting to the bearish form of the past two summers, there is temptation to stuff cash into a mattress or else into Treasury bonds earning less than the rate of inflation. Hey, everyone else is doing it.

But I think the temptation is wrong, and in fact today’s sell-off presents…wait for it…a buying opportunity.

I know that’s not fashionably skeptical at all. I realize the only thing that matters for the moment is the market flush below the 50-day moving average. But I believe that this short-term concern will be proved wrong as consumers stay the course, and as institutional investors hungry for growth snap up the freshly discounted outperformers.

Sales of mattresses are likely to stay strong, and the premium category led by Select Comfort has been gaining market share from its inner-spring competitors. The company enjoys an enviable growth momentum that will outlast Tempur-Pedic’s summer sale, and its current 2% unit market share leaves plenty of runway.

The stock is priced at 17 times 2012 earnings estimates that have continued to rise in the wake of last month’s results, but may yet prove conservative. Yet those earnings are likely to increase at least 20% and likely closer to 25% next year. Investors have recently been willing to pay much more for consistent high growers.

Today’s sell-off seems likelier to punctuate the recent bout of market weakness than to initiate another downturn. As of yesterday, Raymond James strategist Jeff Saut was looking for one more downside flush to leave stocks heavily oversold “as well as finally raise my daily and weekly stock market internal energy indicators back to levels that would register a full load of energy, something I have been waiting for the past eight weeks.”

It looks like we might have gotten that flush this morning. And I would bet that Stevie Cohen’s sleeping pretty soundly.

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