Why Hostess Had To Die

11/21/2012 @ 4:31PM |21,047 views
Susan Adams, Forbes Staff

Were outmoded products responsible for Hostess' demise?

Hostess Brands has now shut down and is going into final bankruptcy liquidation, killing 18,500 jobs and selling off its factories, brands and other assets. Yesterday bankruptcy judge Robert Drain had management and labor join him for a last mediation session aimed at brokering a new contract, but the session was abandoned last night.

What drove Hostess to this point?

 

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End For Bakers Union

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Forbes Leadership ForumContributor

As the popularity of junk food faded a decade ago, the company, which stretches back 82 years, struggled with rising labor and commodity costs. It filed for bankruptcy for the first time in 2004.

In 2009, it came out of bankruptcy under the name Hostess Brands, named for its most popular division. Hostess made an effort to adapt to changing times, introducing new products like 100-calorie Twinkie Bites. But it also had new private equity backers, which loaded the company with debt, making it tough to invest in new equipment. At the same time, the workforce was heavily unionized and had very high labor costs. Hostess had a net loss of $1.1 billion in fiscal 2012, on revenues of $2.5 billion. In January, the company filed for Chapter 11.

But who was ultimately to blame for the company failure? Here at Forbes, Leadership contributor Adam Hartung had a provocative piece on Sunday where he fingered management. In its most recent bankruptcy filing, writes Hartung, the company imposed “draconian cuts to wages and benefits.” This was unrealistic and damaging, he says, “tantamount to management saying to those who sell wheat they expect to buy flour at 2/3 the market price.” The company also kept trying to prop up its old business of obsolete products, failing to cook up more palatable foods with higher margins. Then it scapegoated the unions.

Today Forbes has a piece by Hank Cardello, a senior fellow at the Hudson Institute, and author of Stuffed: An Insider’s Look at Who’s (Really) Making America Fat. Cardello agrees with Hartung that Hostess management is to blame, for failing to alter its products amid dramatic changes in consumer tastes. Other junk food producers, including Coca-Cola and General Mills, have adapted and thrived.

Hostess should have picked up on changing consumer tastes years ago, writes Cardello, and begun reinventing its product line. The company could have even kept the iconic Twinkie, which still has its fans, if it had added more nutritional products. Cardello is a former marketing director at Coca-Cola, where he worked when the company introduced Diet Coke in 1983, so he knows of what he writes.

Other writers, including Andrew Ross Sorkin of The New York Times, Holman Jenkins of The Wall Street Journal, and John Carney of CNBC, have described the inner financial dealings at Hostess and its relationship with its unions, as the reasons for the company’s demise.

Sorkin explores the notion that Hostess was “Bained,” a new pejorative that has emerged on Twitter in conversations about Hostess. That meme stems from private equity firm Ripplewood Holdings taking control of Hostess as it came out of bankruptcy in 2009. But Sorkin maintains that Ripplewood has not been a Bain-style manager, operating with the primary objective of scoring profits. Instead Ripplewood was founded by a big Democratic donor, Timothy Collins, who was trying to invest in heavily unionized, troubled companies with the objective of turning them around.

Sorkin describes how some observers have suggested that Ripplewood didn’t get enough union concessions, and also faced rising commodity prices and pressure from competitors. The bottom line, he says, is that Ripplewood is a huge loser here, instead of walking away with big profits. “So much for being Bained,” writes Sorkin. But I have to interject that Bain has made some bad deals too. Though Ripplewood’s objective may have included goals other than profit, its goal seems to me to be similar to many Bain deals—to bring in money by making changes at an ailing company.

At the Journal, Holman Jenkins says that private equity is not to blame for Hostess’s demise. Rather, “the real story is the story of two unions, the Teamsters and the Bakery union of the AFL-CIO.” As Jenkins has it, though the Teamsters agreed to givebacks to finance the latest Hostess turnaround attempt, the Teamsters held onto work rules that would have driven the company into the ground. Examples: Drivers couldn’t help with unloading, and products like Wonder Bread and Twinkies were not allowed to ride on the same truck. Jenkins says the bakers decided to strike because bakery operations were efficient compared to the delivery process, and they didn’t want to prop up a Teamster contract that would eventually bring the company down.

Carney’s piece on CNBC.com gets more into the weeds of the financial twists and turns that resulted in Hostess’s demise. He cites an excellent, long feature by David Kaplan that appeared in the August 13 issue of Fortune magazine that describes the company’s financial unraveling. In Carney’s summary, the parties most responsible for Hostess’s decision to shut down are two hedge funds, Silver Point and Monarch, which control hundreds of millions in Hostess debt and, as Carney has it, “finally decided they won’t squeeze any more filling into the Twinkie.” The funds are distressed debt investors, which buy debt of troubled companies at steep discounts. In Hostess’ case, if the unions refused to agree to major concessions, Silver Point and Monarch could not make money.

Carney explains that after Hostess came out of bankruptcy in 2009, the unions agreed to concessions that would save the company $220 million in annual labor costs. The lenders in turn agreed to make a new loan of $360 million. But that wasn’t enough to save the company. As sales declined and new products flopped, Ripplewood put more money in, as did Silver Point and Monarch, before and after the January bankruptcy filing. But then CEO Brian Driscoll abruptly quit and relations between union and management deteriorated further. In August, as Fortune’s Kaplan reports, Hostess stopped making union pension contributions. With its investment under water, Ripplewood ceased negotiating with the unions, which left workers to deal with the hedge funds. After the bakery workers went on strike, the hedge funds concluded that Hostess wasn’t worth saving, writes Carney.

So in the end, why did Hostess die? While I think Hartung and Cardello make compelling points about product innovation, I’m convinced, as Fortune’s Kaplan wrote last summer, that “the Hostess story is a microcosm of larger economic and political issues on the national stage, including the perils of debt and the inertia of unions on workplace reform.” If Hostess had come up with a fabulous, new, healthy product line two years ago, perhaps that would have helped things shift. But the company had $2 billion in unfunded pension liabilities, unions that understandably didn’t want to make further concessions, and two hedge funds and a private equity firm with pressure to get some sort of return on their investments. As Kaplan writes, Hostess had “two root problems—a highly leveraged capital structure that had little margin of safety, and high labor costs.” A line of fabulous new products could not have solved those deep problems.

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