Asserts the Board has Presided Over Abysmal
Shareholder Returns, Egregious Capital Allocation, Poor Corporate
Governance Practices and Questionable Compensation
Decisions
Believes the Board’s Ineffective Oversight
has Enabled Management to Escape Accountability and Let Costs Run
Out-of-Control in Pursuit of Flawed “Wellness Technology”
Strategy
Expresses Disappointment with the Board’s
Rejection of a Good Faith Offer to Collaborate on Director
Refreshment
Urges the Board to Meet with Stadium Capital
to Understand Shareholders’ Concerns and Chart a Better Path
Forward
Stadium Capital Management, LLC today sent the below letter to
Sleep Number Corporation’s (Nasdaq: SNBR) Board of Directors.
***
September 13, 2023
Board of Directors Sleep Number Corporation 1001 Third Avenue
South Minneapolis, Minnesota 55404 Members of the Board of
Directors,
Stadium Capital Management, LLC (collectively with its
affiliates, “Stadium Capital” or “we”) is the beneficial owner of
approximately 9% of the outstanding common shares of Sleep Number
Corporation (“Sleep Number” or the “Company”), making us a top five
shareholder of the Company. We are not typically activist investors
and strongly prefer to collaborate privately with those who lead
our portfolio companies. Our investment in Sleep Number was made
following several years of diligence into the Company, its customer
base and store fleet, and relevant operating markets. Given our alignment with fellow shareholders and years of
in-depth analysis, we believe Stadium Capital is ideally positioned
to (i.) diagnose the issues adversely affected by the business,
(ii.) provide value-enhancing ideas and (iii.) support the Board of
Directors (the “Board”) as it oversees management’s strategic
decisions, forecasting and operational execution.
To be clear, we believe Sleep Number is a tremendous brand with
a compelling, differentiated product set and an attractive business
model. Unfortunately, these positive attributes have been obscured
by poor execution and ineffective corporate governance from our
view. We believe the Board has failed to oversee accretive capital
allocation, effective forecasting and a culture of strong
accountability for management. Meanwhile, Sleep Number executives
and directors have received tens of millions of dollars in dilutive
compensation over the past decade. All of this has resulted in
Sleep Number producing unacceptable negative total shareholder
returns (“TSR”) over the past 10+ years.
In our view, shareholder-driven change in the boardroom is
necessary to address Sleep Number’s abysmal TSR, suspect governance
and questionable transformation strategy. As a starting point, we
believe Sleep Number needs targeted changes to the composition of
its Board to ensure the Company’s positive attributes translate
into enhanced future shareholder returns. The Board, as presently
constituted, includes long-tenured members who have been part of
questionable decisions and would likely not fare well in a
contested election next year. Given the urgent problems at Sleep
Number, we are disappointed in the Board’s tone-deaf response to
our proposal to add one Stadium Capital representative to the Board
and appoint two additional independent directors. Instead, by
suggesting we align on a “mutual director,” you offered that the
same entrenched group runs the same process used in past years to
pick a single new director, who would specifically not be a
shareholder. In return for minimal participation in this process,
we were nevertheless asked to give up our voice and our valuable
voting rights by agreeing to a “customary standstill.” Prior
Board-led “refreshes” have clearly not produced acceptable returns;
as such, we have no reason to expect that this time will be any
different. Furthermore, the Board’s characterization that a Stadium
Capital representative would only represent Stadium Capital’s
interests, not the interests of all shareholders, is preposterous
coming from a Board that has:
- Failed to follow basic corporate governance best practices,
such as maintaining a de-classified Board or separating the roles
of Chairman and CEO;
- Enriched itself at the expense of shareholders by taking
dilutive compensation during a period of massive value
destruction;
- Members who have been net sellers of Sleep Number stock and
collectively own a fraction of the stock that Stadium Capital owns,
and;
- Determined that spending investor resources on defense advisors
is preferred to adding a shareholder representative and independent
directors to the Board.
An Overview of Sleep Number’s
Unacceptably Poor TSR
The table below shows Sleep Number’s TSR on an absolute basis as
well as compared to its close peer, Tempur Sealy International,
Inc. (“Tempur Sealy”), and relevant market indices. Notably, Sleep
Number has produced negative TSR and dramatically underperformed
across every relevant time horizon.
Total Shareholder Return (as
of 8/24/2023)
Ibach
1-Year
3-Year
5-Year
10-Year
Tenure
Sleep Number
-50%
-54%
-34%
-7%
-17%
Tempur Sealy
63%
105%
211%
366%
315%
Out (under) performance
-113%
-159%
-245%
-374%
-332%
S&P 500
7%
34%
66%
218%
325%
Russell 2000
-3%
22%
14%
104%
192%
Out (under)
performance
S&P 500
-58%
-88%
-100%
-225%
-343%
Russell 2000
-47%
-76%
-48%
-111%
-209%
Note: CEO Shelly Ibach's tenure began
June 1, 2012.
Source: S&P Capital IQ; TSR runs
through the day before Stadium Capital filed its initial Schedule
13D.
While we acknowledge that mattress industry unit volumes have
fallen recently, this is not a compelling excuse for such poor
long-term performance. Sleep Number does not have a revenue
problem. In fact, its anemic returns have occurred during a period
in which it has more than doubled its revenue, increased its store
count by 50% and likely maintained or grown its share of overall
mattress industry retail sales.
Sleep Number’s Glaring Issues Are
Fixable
If a refreshed Board embraces new perspectives and pursues
stronger oversight, we believe it can understand and remedy the
issues identified herein.
Questionable Strategy
In recent years, the Company has shifted its strategy in an
attempt to become a “purpose-driven, sleep tech wellness company
that is poised to lead in the emerging connected sleep health
space.”1 This transition occurred as Sleep Number essentially
doubled its annual R&D budget to approximately $60 million
since 2019, purportedly to support “Sleep Number’s continued
prioritization in its long-term life-changing sleep innovation
initiatives.”2 Further, Sleep Number’s
Technology/Corporate/Management headcount increased by 70% from
early 2020 to early 2023, despite mattress unit deliveries planned
for the upcoming year remaining flat to 2020.3
To contextualize how significant its R&D spend has become,
Sleep Number spends 2x on R&D relative to Tempur Sealy even
though Tempur Sealy generates, by our estimates, roughly 4x the
retail sales of Sleep Number. Yet, based on our research, if Sleep
Number spent proportionally the same amount on R&D as Tempur
Sealy does, Sleep Number’s 2023 expected EPS would double.
We are skeptical that management’s efforts to increase R&D
focused on generating non-mattress revenue streams will be a
success. We would hope that the Company is aware that many fitness
wearables companies have spent multiples of what Sleep Number
spends on R&D, yet to our knowledge, none has produced a
durable, attractive business model around whatever subscription
revenues are generated. Why should Sleep Number expect to produce a
different result? The Company has not demonstrated that its
sleep-tracking technologies are substantially differentiated from
other sleep-tracking technologies. Its trading multiple is
languishing near a decade low despite R&D at an all-time high
percentage of EBITDA and industry unit volumes near record
per-capita lows.
To be clear, we are not opposed to increasing R&D
investment; to the contrary, we understand that sacrificing profit
today for more durable cash flows tomorrow is a compelling way to
build long-term shareholder value and, in our view, too few public
companies adopt this mentality. Our concern with Sleep Number is
that management has drastically increased R&D as the Company’s
valuation multiple has declined, suggesting that investors have
concluded that foregone profits today will NOT produce greater
profits in the future. In light of the fact that management has
continually failed to deliver on its long-term targets without
being held to account, and the Board’s stewardship of capital
proved so poor in its decisions around the previous buyback
program, it is no surprise that investors have lost confidence in
the Board’s ability to set the R&D budget appropriately. It is
this dynamic that we believe is destroying shareholder value.
Capital Allocation Missteps
Nearly all of Sleep Number’s cash balances and cash generated
since 2012, plus cash generated from leveraging the balance sheet,
have been deployed into share repurchases. In fact, Sleep Number’s
share count has declined by approximately 60%, since June 30,
2012.
While share repurchases can be an effective tool for creating
long-term shareholder value, the context around buybacks is
important. Buybacks only create real value when the issuer forms a
sober view of its long-term prospects, uses that outlook to
estimate the long-term return of buying back stock and
appropriately compares that return to both the issuer’s cost of
capital and alternative investment options. By contrast, buyback
programs that do not have a long-term shareholder return framework,
are premised on unrealistic views of long-term prospects, or are
followed by poor execution of a reasonable business plan can be
disastrous for shareholders. Unfortunately, the latter case applies
to Sleep Number.
Sleep Number’s buyback approach in 2020 and 2021 was
catastrophically flawed and has substantially weakened the
Company’s financial position. As context, on August 24, 2023, the
day before we filed our initial Schedule 13D, Sleep Number closed
trading at $21.48 per share. Yet, the Board authorized more than
$630 million of share repurchases at an average price of
approximately $90.00 between Q4 2020 and Q1 2022, including
spending almost $150 million at average prices above $140.00 in
March of 2021 alone. The question is, how could this have
happened?
As with most durable goods companies related to the home, Sleep
Number saw a substantial increase in demand for its products in
2020 and early 2021, and a corresponding spike in revenue and
EBITDA. Instead of acknowledging the risk that much of this could
have been pandemic-related pull-forward demand that would
eventually unwind (as Tempur Sealy regularly did on earnings
calls), management and the Board appear to have convinced
themselves that the Company was “different,” attributing the
revenue increase not to the pandemic but to Sleep Number’s new
positioning as a “wellness technology” business. We believe that
this remarkable lack of self-awareness caused leadership to project
sustained growth off of already significantly inflated revenue and
EBITDA figures.
The net result was that the Company leveraged the balance sheet
to repurchase stock at prices so high that earning an acceptable
return would require exceeding the unrealistic long-term goals that
presumably justified the buyback program and that were explicitly
communicated to shareholders in early 2022. We believe that given
management’s persistently poor track record of achieving its own
long-term objectives (as detailed below), the buyback program was
another significant and miscalculated risk for the Company to take.
This decision has now put the business in an unnecessarily
precarious financial position, as evidenced by the fact that Sleep
Number has had to seek covenant waivers from its lenders.
We believe that a Board with a more informed and objective view
of the broader markets and macro landscape would have understood
that the overall mattress industry was experiencing an
unsustainable boost – similar to countless consumer businesses
during and right after the pandemic. A more thoughtful approach to
such an enormous share repurchase program would have been to apply
a risk-management overlay through some combination of reducing the
size of the repurchases, having better price discipline and/or
hedging the term and interest rate risk of the Company’s debt. The
Board seems to have done none of these things, and shareholders are
now paying the price.
What makes these poor decisions more damning is that even with
Sleep Number’s Board lacking the requisite situational awareness we
describe above, the Company’s own history should have provided the
caution signs. In 2006-2007, as Sleep Number’s growth accelerated
concurrent with the housing boom, the Board also authorized
leveraged share repurchases that ultimately put the Company in a
precarious position. We would point out that Sleep Number’s current
Board includes two directors and a paid advisor who approved those
decisions, yet for reasons that defy explanation, the Board failed
to draw on that history and take a more cautious approach to
capital allocation in 2020 and 2021.
Poor Execution and Financial
Planning
Sleep Number has lowered its guidance nearly every quarter over
the past 18 months. In our view, these recent struggles are part of
a longer-running pattern. Sleep Number missed its 2015 targets
management laid out in 2013, missed its 2019 targets laid out in
2015 and management’s current plans are far below the long-range
targets the Company put out in early 2022. In fact, the Company
missed its stated 2022 profitability objectives by 50%.4 These
shortfalls cannot be explained away by the recent industry
conditions; as mentioned, they are part of a clear and long-running
pattern. The blame largely falls on management as a result of its
poor financial planning and weak execution against its operating
goals. But blame must also be placed on the Board for failing to
hold management accountable for these clear performance issues.
In fact, despite management’s consistent pattern of missing its
targets, the Board has nevertheless elected to pay Chief Executive
Officer Shelly Ibach more than $50 million during her tenure, while
shareholders have suffered negative TSR.5 Furthermore, to make
matters worse, certain current Directors were, remarkably, net
sellers into the ill-conceived 2020-2022 buyback program, cashing
out over $3 million during periods when Sleep Number was actively
repurchasing stock. In addition, executive accountability was
further weakened when the Board combined the Chairman and Chief
Executive Officer roles.
In Conclusion: Stadium Capital Can Help
Sleep Number Adopt a Shareholder Value Creation Mentality and
Establish a Culture of Accountability
We are strong believers in the Sleep Number brand, but we also
believe that the Company is materially undervalued and
underperforming relative to its potential. We have grave concerns
that deficiencies in the boardroom are an impediment to realizing
the true value of Sleep Number’s brand and business model.
Rather than debate the facts and work at cross purposes, we urge
you to collaborate with us on a Board refresh that includes a
Stadium Capital representative and other new directors with
relevant expertise.
As a next step, we request that the independent members of the
Board meet with us this month. We wish to share our perspectives
and demonstrate the depth of work we have conducted on the
business. We are confident that if you meaningfully engage with us,
you will realize that we can add substantial value for all Sleep
Number shareholders.
Thoughtful and genuinely collaborative Board changes can help
Sleep Number begin to regain some semblance of shareholder trust,
even as it maintains an outdated classified Board structure and
other unfriendly governance policies.
Sincerely,
The Investment Committee of Stadium Capital Management GP,
LP
###
1 March 14, 2022 press release: Sleep Number Announces Board
Leadership Changes.
2 Source: Sleep Number Form 10K for the 2022 fiscal year.
3 Source: Sleep Number Form 10Ks for the 2019 and 2022 fiscal
years and Sleep Number annual guidance.
4 Sources: Investor Presentations from January 2013, November
2015, March 2022 and July 2023.
5 Defined as cash compensation, benefits and the estimated value
of options and RSUs granted during Ibach’s tenure as CEO that have
either been sold or currently are owned by Ibach.
View source
version on businesswire.com: https://www.businesswire.com/news/home/20230913488935/en/
Longacre Square Partners Greg Marose / Aaron Rabinovich,
646-386-0091 gmarose@longacresquare.com /
arabinovich@longacresquare.com
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