Unlike Twinkies, Hostess Proves Very Perishable

By Stephen D. Simpson, CFA | November 16, 2012 AAA

For many companies, bankruptcy is an opportunity to gain some breathing space, refinance debt and move on. Most airlines have been through bankruptcy at least once, and many other companies in operation today once had to seek protection from their creditors. It's not often that major companies choose the route of liquidation, but on Thursday, Hostess, the maker of well-known baked goods like Wonder Bread and Twinkies, announced that it was doing precisely that.

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How Did We Get Here?
In January of this year, Hostess sought bankruptcy for the second time in less than eight years, as it owed more than $1.4 billion in various debts and obligations, including almost $1 billion in pension obligations to the Bakery & Confectionery Union & Industry International Pension fund. While the company reported nearly $1 billion in various plant assets, the company had long struggled to make sustained profits and cash flow from those assets, and the company struggled through numerous leadership changes over the years.

Certainly, management deserves some of the blame here. Hostess had numerous changes in its senior management, and lacked a strong roster of talented baking industry veterans. While the company had much-loved brands and the second-largest share in the U.S. market (after Grupo Bimbo), management couldn't find a way to make sustained profits with that. What's more, companies like Bimbo, Flowers (NYSE:FLO), Mondelez (Nasdaq:MDLZ) and Campbell Soup (NYSE:CPB) were outmaneuvering the company with new product development and in-store promotion activities.

Nevertheless, the final straw would seem to be an unsustainable employee cost structure. Hostess got a bankruptcy judge to sign off an adjustments to union contracts that would cut wages and benefits by about 30%, but the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union (BCTGM) refused to go along and went on strike. In response, management warned that if the strike continued, they would be forced to liquidate the company. While the Teamsters Union warned the BCTGM that the company's management was not bluffing (and was indeed in an untenable state), the BCTGM refused to budge and Hostess management opted for liquidation.

SEE: Distressed Debt An Avenue To Profit In Corporate Bankruptcy

What Happens Now?

With Hostess electing to go into liquidation, what happens next is basically an auction process, where the company's hard assets (such as plants and machinery) and brands/recipes will go to the highest bidder(s).

Successful bidders are not required to take on the employees, so a bidder could acquire brands like Twinkies and HoHos and manufacture them in existing plants - offering no relief for the 18,000 or so workers who will now be out of work.

Although there would seem to be a lot of overlap between Bimbo's products and Hostess, I'm not sure Bimbo will make a bid. Bimbo tried to acquire Hostess during the prior bankruptcy and ultimately ended up acquiring Sara Lee's bakery operations. Adding Hostess would boost its market share to around one-third to 40%, and that may be problematic for some regulators (and retailers like Wal-Mart (NYSE:WMT) couldn't be too happy about it either).

Flowers, Mondelez and Campbell Soup could also be options, and I could perhaps see Kellogg (NYSE:K) having some interest in adding the snack cake brands to its existing Keebler operations. Similarly, I wouldn't be surprised to see the Hostess brands broken up - it would surprise me if Kellogg or Mondelez wanted the fresh bread operations, for instance.

SEE: An Overview Of Corporate Bankruptcy

Did This Have to Happen?
Looking through some of the details of this announcement, I really have to question whether this whole situation was necessary. In particular, I have to wonder about the agenda of the BCTGM union.

What may not be commonly appreciated is that the large pension fund obligation is not at risk; Hostess was part of a multi-party pension plan where others must take on the liability if a member goes bankrupt. As a result, Bimbo will be on the hook for roughly one-quarter of the pension liability, with Mondelez responsible for 15%, and Safeway (NYSE:SWY) and Kroger ( NYSE:KR) collectively responsible for another 15% or so.

So at least insofar as the pension was concerned, the union knew that money wasn't at risk. What's more, while I appreciate the anger and frustration of workers asked to take another 30% hit to wages and benefits due to management's mistakes, I have to ask whether it's better for these 18,000+ workers to have a job that pays 70% of what it paid before or no job at all and lose 100% of their pay (particularly right before Christmas). After all, this isn't an economy where 18,000 workers can easily be reabsorbed. In any case, the workers had their chance to vote and they made their decision.

The Bottom Line
Here again we see an example where even great brands cannot protect a company indefinitely. While it's almost impossible to think that Twinkies and other popular snack cakes won't re-emerge under somebody else's umbrella, the Hostess saga is a painful lesson in how changing industry dynamics along with uncompetitive cost structures and incompetent management can destroy even an otherwise strong collection of brands.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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