Who Wins, Who Loses With Smucker’s Hostess Buy?

Will Ashworth - Barchart - Tue Sep 12, 2023

Hostess Brands (TWNK), the maker of snack classics Twinkie and Ho Hos, got an offer it couldn’t refuse on Monday. J.M. Smucker (SJM), whose brands include Folgers, Meow Mix, Milk-Bone, Smucker’s, and Jif, has agreed to pay $5.6 billion in cash and stock to acquire Hostess.

Hostess stock jumped on the news while Smucker’s fell. Clearly, Wall Street is not united about the transaction. Some believe the acquisition makes sense; others don’t.

While it will take a few years to determine this deal's ultimate winners and losers, the early indications are that Hostess hit a home run for its shareholders.

Let’s break things down.

Hostess Goes Bankrupt Twice

Smucker’s is paying Hostess $30 a share in cash and issuing 0.03002 shares ($4.25) of its stock for every share held in TWNK. The $34.25 price per share paid and the assumption of $900 million in debt work out to an enterprise value of $5.6 billion, 17.2x Hostess Brands’ estimated 2023 adjusted EBITDA. If $100 million in projected synergies are included, Smucker’s paid 13.2x adjusted EBITDA.

Either way, that’s a significant multiple to pay for a company that’s gone bankrupt twice (2004 and 2012) in the past 20 years.

In the second bankruptcy, investment firms Apollo Global Management (APO) and Metropoulos & Co. rescued the company, acquiring the brands and five Hostess bakeries in January 2013 for $410 million, only $186 million of which was cash, with the rest financed.

The two firms took the company public in 2016 by merging with Gores Holdings, a special purpose acquisition company (SPAC). Hostess received $725 million in capital from the Gores Group, while retaining 42% in Hostess.

At the time of the merger, Hostess’ enterprise value was estimated to be $2.3 billion. Apollo and Metropoulos had made 13x their original cash purchase in less than four years. Apollo sold out the remainder of their stake in 2017. Metropoulos sold out in 2019.

Apollo and Metropoulos won with Hostess, regardless of Monday’s deal.

As for the Gores Group, it sold down its holdings over the five years between the 2016 merger and 2021. It, too, won with Hostess, although it would have done even better if it held on another 24 months until the Smucker’s deal.

However, hindsight is 20/20.

Smucker’s Largest Acquisition Since 2015

Unless I’m mistaken, Smucker’s biggest deal was its 2015 purchase of Big Heart Pet Brands for $6.0 billion, including the assumption of $2.5 billion in debt. Not only was it the jam maker’s largest deal to date, it moved the Ohio-based company into the pet food business.

“It’s not uncommon at all for leaders in the industry to be in human food and pet food,” The New York Times reported CEO Richard Smucker’s comments at the time. “Pet food is one of the fastest-growing areas in the center of the store.”

As part of the transaction, Big Heart shareholders got 17.9 million shares of SJM stock and $1.3 billion in cash. If the Big Heart shareholders kept their shares through today, they would have achieved a miserable compound annual growth rate of 2.4%, considerably less than the S&P 500.

Smucker’s shareholders haven’t benefited nearly as much from the Big Hearts acquisition as management suggested.

Is history about to repeat itself? Maybe.

Here’s what CEO Mark Smucker had to say about the Hostess buy:

“With this acquisition, we are adding an iconic sweet snacking platform; enhancing our ability to deliver brands consumers love and convenient solutions they desire; and leveraging the attributes Hostess Brands offers, including its strong convenience store distribution and leading innovation pipeline, combined with our strong commercial organization and consistent retail execution across channels to drive continued growth,” Smucker stated in its press release.

It believes that Hostess can deliver mid-single-digit revenue growth. Based on $1.5 billion today, it will get to $2 billion by 2029. Smucker’s expects to generate $100 million in annual synergies within 24 months of closing.

The split between cash and stock is approximately 88%/12%. Based on $4.6 billion in equity, Smucker’s will issue nearly 3.9 million shares to satisfy the terms of the agreement. That’s a 4% increase in SJM shares outstanding.

From this perspective, it’s not diluting shareholders by much. However, the net debt increased to $8.6 billion, 4.4x its EBITDA. At the end of the second quarter, the company’s net debt was $3.8 billion, 2.2x EBITDA.

Most of the company’s current debt is between 2.13% and 4.38%, with $1 billion (3.5% interest rate) due in March 2025. Should interest rates remain stubbornly high, its interest expense will increase considerably over the mid-term.

Hostess clearly balked at getting more of the deal in stock, knowing it’s badly underperformed over the past decade.

The Bottom Line

While this acquisition may turn out better than the Big Hearts buy, an argument can be made that the Big Hearts purchase was a winner that Smucker’s management let slide through its fingers.

JPMorgan analyst Ken Goldman believes the acquisition is a head-scratcher.

“All in, we can’t say we love this transaction from SJM’s perspective,” Yahoo Finance reported the analyst’s comments. “We are very surprised that SJM (or anyone) is paying this amount.”

I have to agree with the analyst.

Paying between 13-17x EBITDA to access the convenience store market looks steep. Kudos to Hostess management for obtaining such a favorable price.

SJM stock could be dead money for another decade if its management isn’t careful. I’d think twice about buying SJM stock on the dip.

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On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.