Description

We are recommending buying GRSH, which is spac owned by private equity Gores Group.  GRSH will be purchasing  Hostess Brands at a purchase price of $11/GRSH share or 10.3x 2017E ev/ebitda.  In addition to paying $375MM in cash (from GRSH), another $350MM will be raised in a private placement, of which $50MM will come from the current executive chairman to delever the b/s.  Post restructuring by Apollo and Metropoulos out of bankruptcy in 2013, the Company has 30%+ ebitda margins and 85% fcf conversion with nice growth prospects to regain share it lost during bankruptcy – trough market share of 10.6% and peak of 22.3%.  We have a price target of $15-16/share based on 12x our estimate of 2017E ebitda or about 40% upside from current prices.

Background

There is a lot of history here – we won’t go through it all.  The basic was that it was just a business that never had much of a margin of safety given the debt, labor costs and inefficient distribution, which are all now fixed.  The Company is now investing, re-gaining lost market share (now at 16% versus previously at 22%) and focused on growth.  The operations are fixed and optimized and they now have a platform to extend existing brands, increase white-space in the bakery, frozen retail and international.  Interestingly, management is participating in the private placement and will have significant proforma ownership so we think there is still upside even after the dramatic turnaround post bankruptcy from just 3 years ago.

History

Hostess brands is owner of lunchbox snacks like Twinkies, Ding Dongs, Susy Q’s, Ho Hos, Donettes, etc. mainly sold at grocery stores around the county.  Some of the brands have been around since 1930 but the Company got into trouble in 2012/2013 – filing for bankruptcy again after filing in 2004.  The significant pension costs, debt and national trend to healthier foods led to this second bankruptcy. 

They sold the Company to Apollo and Metropoulos – who were able to restructure the pension obligations, debt and labor.  The new owners invested in R&D, marketing and distribution (now in dollar stores and vending machines).  They were able to expand the shelf life to average 65 days and spent $130MM to upgrade production lines and industrial ovens.  In addition they have roughly 1200 employees down from 8k just five years ago when 75% was unionized.

It’s amazing what automation can do.  A new factory using robots and automation with 500 people produces 1MM Twinkies/day – 80% of the total output versus the old regime that would require 14 plants and 9000 employees.  The new Hostess got rid of 36 factories, 5600 delivery routes (they no longer deliver to the bakeries) and 19k jobs. 

The Company now does $1bn in sales at retail.  They are positioned in the premium segment of the sweet baked goods category in the US with 16% market share.  The Company clearly has momentum – in the last 52 weeks, they have been able to achieve 71% of the category growth, which was 10% in the last 52 weeks!  

Management will have significant proforma ownership

The Company was taken over by Apollo and C. Dean Metropoulos (who was a specialist in turning around food brands – having done this before dozens of times over the last 35 years – Pam, Premier foods, Ghiraradelli, etc.).  They basically took the cake business (which had the most recognized brands described above) and built a new business plan around those brands.  The proforma ownership will have C. Dean Metropoulos at 25%, Apollo at 17%, Gores at 8%, Pipe investors – 21%, Spac shareholders at 29%.

Numerous Growth Opportunities – could more than double ebitda

Market share/brand extensions/Recapture shelf space

• If they regain share to the 22% from current 16%, we estimate that could be $1.5bn of retail sales, or $500MM in company sales and at 30% ebitda margins (assuming no operating leverage), is worth $150MM in ebitda (on top of a base of $250MM ebitda); we think this is conservative because they are running at only 80% capacity utilization so to the extent they can produce more, they will continue to improve ebitda margins; in addition 40% of SG&A is fixed with no legacy costs so they should be able to leverage this base
• Their plan is to add more items/stores (shelf space), ecommerce focus, add seasonal items, and customized exclusive offerings – in June they rolled out pre-packaged deep-fried twinkies in walmart to name a few

New Aisles & Channels

• Another $500MM in retail sales (which could be much higher) could be achieved through licensing, testing frozen treats, and international that is largely untapped
• This would add another potential $150MM of ebitda to the base

M&A

• They acquired Superior cake products in May 2016; Adds $8MM to ebitda next year
• Given the free cash flow is $200-$225MM next year, they can acquire brands to run through their platform in a very accretive way

Catalyst

• Expect final proxies and shareholder vote; closing of the transaction in Late Sept/early October
• Analyst will begin to cover the stock highlighting the growth and major operational changes that have structurally changed the platform – no one covers it now