Twinkies: Trick or Treat?
Twinkies may not turn out to be as much of a golden treat for public investors as they have become for their private-equity owners.
Apollo Global Management and investor Dean Metropoulos bought the bulk of Hostess Brands' snack-cake business, including the spongy cream-filled confections, for a mere $410 million in 2013 after the company's second bankruptcy forced it to liquidate.
Just three years later, an affiliate of private equity firm Gores Group and other associated investors are putting up $725 million to buy a majority stake in Hostess, which also makes Ho Hos, Ding Dongs and Sno Balls, with the goal of taking it public. Apollo and Metropoulos will retain a 42 percent position, meaning they could reap even more profit down the road. That's on top of the $905 million dividend that the private equity owners paid themselves in 2015 after loading the cupcake maker up with debt. Talk about a sweet deal.
Hostess's owners have done what private equity owners do best: They've taken a sledge hammer to costs and invested in efficiency upgrades like an auto-bake system that can churn out more than 1 million Twinkies a day with a fraction of the workforce and manufacturing footprint. Hostess is now much better-run than it was pre-bankruptcy. Meantime, marketing campaigns and a focus on convenience stores have helped rebuild sales after a bankruptcy-induced hiatus (which was preceded by a panic-induced Twinkie feeding frenzy, but that's another story).
Hostess's market share is still below its pre-bankruptcy levels and it ranks second in U.S. sweet-baked goods behind Little Debbie snackmaker McKee Foods, according to S&P analysts Amanda Cusumano and Bea Chiem. That gives it some room to grow from its current sales base. But consumers' shift to healthier products means there's a limit to how many Twinkies and Ho Hos they're going to buy. Once the re-launch hype fades away, what is going to be left for Hostess's new public owners? Hostess itself is expecting revenue growth to slow in 2017 from this year's pace.
Hostess's anticipated initial enterprise value is about $2.3 billion, or roughly 10.4 times its projected 2016 adjusted Ebitda, according to the statement announcing Tuesday's deal. That's roughly the valuation assigned Post Holdings. Not all Post's foods are the healthiest -- Pebbles Ice Cream, anyone? -- but the company has successfully diversified into protein bars, eggs, cheese, potatoes and healthier hot cereal.
What's Hostess doing to diversify? It's new products include brownies topped with M&Ms or Milky Way candy bars -- not quite the start of a good, healthy diet. According to a Washington Post article last year, one of the changes Apollo and Metropoulos implemented is making chemical tweaks to the Twinkie recipe so that the treats can sit on shelves for 65 days before going stale -- yum.
Even for food companies focused on healthier fare, the case for future value creation is a tough sell. The Brexit-fueled hunt for safety stocks has already pushed the S&P 500 Packaged Food Index to its highest multiple of projected Ebitda in at least a decade.
There's clearly still an appetite for -- yes, we can say it -- junk food. Hershey last week rejected a $23 billion bid from Mondelez ($25 billion including net debt) that valued the candy company at about 15 times its projected Ebitda. Who knows, maybe a buyer could come along for Hostess and hand shareholders a rich premium. But strategic bidders such as Flowers Foods and Grupo Bimbo had a chance to buy Hostess's snack brands out of bankruptcy and reap all the profitability gains for themselves. It seems unlikely they would want to do a deal today at a much higher valuation. Shareholders should be wary of paying up for Hostess as well.
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