KANSAS CITY – Calling Hostess Brands L.L.C. “one of the most profitable consumer businesses in the United States,” C. Dean Metropoulos, executive chairman, said the business will be positioned going forward to expand both through organic growth and strategic acquisitions.
In the wake an announcement that Gores Group Holdings will acquire a majority stake of the sweet goods business, Hostess executives celebrated success achieved since 2013, when the Hostess Brands cake assets were acquired in a bankruptcy liquidation, and flexed their corporate muscle in describing how the company’s structural advantages over competitors will enable future growth.
The executives, together with leaders of Gores, offered their thoughts on the acquisition during a July 5 conference call.
Under terms of the transaction, the current owners of Hostess, funds managed by affiliates of Apollo Global Management, L.L.C. and C. Dean Metropoulos and family, will receive approximately $522 million in cash. The payment will come from $375 million in cash from Gores Holdings Inc., a publicly traded affiliate of Gores Group, and another $350 million to be raised in a private placement. The private placement will be led by Alec Gores, chairman and c.e.o. of the Gores Group, and will include $50 million in a rollover contribution from C. Dean Metropoulos, executive chairman of Hostess.
The Metropoulos and Apollo groups are expected to retain a 42% stake in Hostess when the transaction is completed.
In the nine months since Gores Holdings, Inc.’s initial public offering raised $375 million, Gores Holdings evaluated dozens of businesses as acquisitions candidates, Mr. Gores said.
|Alec Gores, chairman and c.e.o. of the Gores Group|
“We were ultimately, unanimously impressed by Hostess Brands,” he said, citing the company’s business fundamentals, its management team and the involvement of C. Dean Metropoulos as an investor.
“The company will benefit significantly from our sponsorship and access to public equity markets. Prospects for Hostess Brands look bright, and we look forward to being a part of it.”
Mark R. Stone, chief executive officer of The Gores Group, said that he would be joining the Hostess Brands board together with Mr. Metropoulos; Andy Jhawar, senior partner and head of the consumer and retail group at Apollo; and four independent directors.
Mr. Metropoulos described the transaction as a continuation of a “journey” that began in 2013 when the Hostess snack cake business was acquired from bankruptcy by Apollo and Metropoulos and Co.
He expressed considerable pride in progress that has been achieved to date.
|C. Dean Metropolous, executive chairman of Hostess|
“From the beginning three years ago, this incredible business has responded extremely well to the Americana brand under our investment and our hands-on efforts,” he said. He described current management as “very performance-driven and very results-oriented.”
“In addition we have executed a strong investment plan to build efficiencies, automation, systems and product innovations,” he said. “These efforts have made new Hostess one of the most profitable consumer businesses in the U.S. with an excellent growth rate. Our pipeline innovation should continue to drive this strong organic growth for the foreseeable future.”
Going forward, Hostess will need to sustain its momentum with a focus on strategic acquisitions, Mr. Metropoulos said. These additions will help the company generate synergies and leverage its performance culture, he said. As an example, Mr. Metropoulos cited the company’s recent purchase of Superior on Main, letting Hostess tap into the $7 billion in-store baking market.
“Our new partnership with Alec Gores as well as access to the public markets will provide Hostess with a flexibility and support to continue, not only the strong growth plans and financial performance, but reaching out to a much broader array of consumers for many, many years to come,” Mr. Metropoulos said.
Delving deeper into the profitability of Hostess was William D. Toler, president and chief executive officer of Hostess Brands L.L.C. Mr. Toler will continue to lead Hostess following the completion of the Gores transaction.
Underpinning the company’s financial success has been a strength of the Hostess brand, which he said enjoys “an amazing emotional connection with consumers.”
|William D. Toler, president and c.e.o. of Hostess|
“Combine that with the extended shelf life technology we’ve put into the products, up to 65 days from making the product shelf life compares favorably to our Old Co. (Hostess prior to the bankruptcy sale) and competitors who are more in the 15- to 25-day range,” he said. “Put that with our business model, which is now not direct store but is instead direct to our retailers’ warehouse, enables us to have the leading combination of the best brand, the longest shelf life and the direct to warehouse model that really complements our ability to go to market.”
Since the cake assets were acquired in bankruptcy, $130 million of information technology and automation investments essentially allowed a recapitalization of the business, Mr. Toler said, leaving the company’s manufacturing footprint highly automated and efficient.
Brand awareness above 90% allows Hostess to charge a price premium for its products, Mr. Toler said – nearly 80% above Little Debbie because of the company’s strength in single-serve sales. As a result, the objectives of Hostess Brands are well aligned with customers’, he said.
“It strengthens the customers’ desire for Hostess to grow,” Mr. Toler said. “When we left the market in 2012, the category declined. We came back, behind all the investments we made, the category has grown. So customers know that to grow this $6.8 billion sweet baked goods category, we need to be strong with Hostess. Today they work very collaboratively with us to build displays, to take our innovations, to take our new products, because growing with Hostess means growing the category.”
In addition to the pricing strength, Mr. Toler directly tied Hostess gross margins topping 30% to the company’s new business model.
“We have three bakeries operating at 80-plus per cent utilization,” he said. “Compare that to the Old Co. model and many of our competitors’ models of regional bakeries with small inefficient distribution lines. At Old Co. they had 11 legacy Hostess bakeries operating at about 54% capacity utilization. When we want to make a Twinkie or we want to run a Twinkie event or Twinkie flavor, we make that nationally in one plant, primarily on one line and ship it all over the country to all of our customers. Our competitors and Old Co. are a very different, very inefficient regional model they have to pursue. And since we brought back the brand, we’ve been able to extend that shelf life up to 65 days, importantly doing now without compromising quality. Our recent surveys show that about 90% think that the quality was good or better than it was in Old Co.”
Looking forward, Mr. Toler said margins enjoyed by Hostess are sustainable because of the company’s brand strength and structural differences with competitors.
“Little Debbie, Flowers and Bimbo are all D.S.D. and have a higher cost transportation and distribution network,” he said. “That makes it difficult for them to compete on cost basis, so our margins sustainability is very strong. They also have plant and bakery inefficiencies, and our lowest G.&A. (general and administrative) cost as a centralized organization give us other structural advantages to allow us to sustain and expand on our margin base as well.”
Mr. Toler characterized the snack cake category as an attractive one, growing about twice the rate of packaged foods overall. He also acknowledged Hostess has yet to fully regain its pre-bankruptcy market share.
“Importantly the categories of products that we compete in are also growing fast, like the brownie, the muffins, the pies, the bars, snack cakes,” he said. “All of these areas have tremendous growth opportunity. Today we have about a 16% market share, Old Co. was just under 22%, so we have room to go and space to grow, to go, to get back to our Old Co. levels. But importantly we’re going to continue to expand our depth and breadth because of the strength of our model. We are able to go further and farther because of our strength in direct to warehouse. It gets us into more stores, more opportunities and it really ties in well with the small-format retailers like dollar stores, like drug stores, like c-stores and our unique partnership at Wal-Mart, where we’ve essentially had a higher share market now than we did in Old Co. They understand that they need to grow with us to be able to grow their category, and they’ve really jumped on as a lead partner in this effort over the last few years.”
Hostess Brands EBITDA in fiscal year 2016 was $220 million, and for 2017 the company is projecting $235 million, Mr. Toler said. Sales had been growing in double digits, but he said high single digits are likely in fiscal 2016 and 2017.
Like Mr. Metropoulos, Mr. Toler also was upbeat about the Superior Cake Products, Inc. acquisition and the access it gives Hostess to in-store bakeries.
“That’s a separate $7 million business growing at an even a faster rate than the bakery aisle market we operate in today,” he said. “While Superior is a relatively small business, it introduces us to the frozen format through I.S.B. and introduces their brand. And we’ve got lots of ideas on how to bring Hostess into that segment.
“Other frontiers for us include getting into frozen retail. This summer we are going to be launching frozen fried Twinkies into retail starting with a lead customer in a couple of weeks at Wal-Mart and later on this year in a broader grocery format. We’ve also got plans to expand into food service starting later this quarter, and we’re continuing to expand in grow international business, again because of our model, our code and our brands.“
Growth has been propelled by new product launches, including moves into Danish and brownies, Mr. Toler said. Strategic moves have included offering whole grain muffins.
“We’ve partnered with the Mars Co. and launched the M&M’s brownie and Milky Way brownies, and later this year we hope to expand that even further.” He also described a tie-in to the movie “Ghostbusters” later this year that will feature the introduction of a Key Lime Slime Twinkie.
Mr. Toler wrapped up his comments speaking briefly about the company’s foray into extended shelf life bread. He said the product has done “extremely well,” elevating Hostess to the No. 1 seller of bread in small-format stores, including drug stores, dollar stores and convenience stores, “where they need a supply solution for bread and they don’t get good service or D.S.D. support.”“All of these things lead to a wealth of choices, a wealth of opportunities for us to continue to grow, expand our presence and footprint, both in stores, in number of items and platforms in which we compete,” he said.