BRING BACK THE TWINKIES! Saving an iconic American brand from bankruptcy
“What they’ve done at Hostess should be a Harvard Business School case study on how to turn around a business” – Perella Weinberg Partners
Introduction
In January 2012, Hostess Brands filed for Chapter 11 bankruptcy protection amidst rising union and overhead costs. While operations continued throughout the bankruptcy proceedings, negotiations with the company’s unions broke down in November 2012, triggering the immediate closure of Hostess bakeries around the country. As the company positioned itself for liquidation, private equity firms Apollo Global Management and Metropoulos & Co. (backed by billionaire food brands investor Dean Metropoulos) spent $410 million to cherry-pick the profitable bakeries and product lines for what would become the new Hostess. Over the course of the next three years, Hostess implemented several operational changes that complemented the existing Hostess business strategy, dramatically increased profitability, and ultimately saved the business.
Business Model
Hostess Brands is one of the largest wholesale bakers and distributors of snack cakes in the United States. The company’s cake products sell under brand names such as Twinkies, Mini Muffins, Cup Cakes, Ding Dongs and Ho Hos. Hostess’s roots in American manufacturing go back 150 years, and few brands have as high consumer awareness within the fresh baked sweet goods category.
Hostess’s key business mission is to sell indulgent snack products to the masses. While the healthy snack segment has received the most press and experienced the most growth in recent years, Hostess targets a very different market. Males aged 18-34, who crave flavor with little regard for nutrition, are the company’s “sweet” spot. And while “you wouldn’t find Twinkies on Whole Foods’ shelves…Hostess had something you can’t find in a locally sourced, chia–seed snack – millions of nostalgic fans.”
New Operating Model
In order to sell snack cakes post-bankruptcy, Hostess had to shed the burdensome cost structure that weighed the company down for years. As part of the purchase, Apollo and Metropoulos bought only five of the ~40 factories up for sale, believing that these five were strategically located and had sufficient capacity to produce a new Hostess cakes line with reduced SKUs. The owners then instituted several other key operational changes that allowed Hostess to re-launch as a profitable enterprise.
Reduction of Union and Legacy Costs
Hostess’s workforce was historically dominated by two unions: the Teamsters and the Bakery, Confectionery, Tobacco Workers and Grain Millers (BCT). The union structure at Hostess was atypically complex (350 separate CBAs), and the unionized workforce placed several burdens on operations. The unions were also wary of new snack formulations that might increase shelf-life and profitability, given they also might reduce working hours and re-stocking trips. Lastly, the unions had large pension obligations on the company’s balance sheet.
When Apollo and Metropoulos acquired the Hostess bakeries out of bankruptcy, they did so without needing to also purchase the union cost structure. The company was able to shed all of its union obligations and fired all 18,000 members of the union workforce. Hostess then re-organized in a more lean, and un-unionized fashion, greatly reducing costs.
Changes in Distribution
Hostess had previously used a complex and inefficient product delivery system called the “Direct Store Delivery Model,” whereby the company used ~5,000 trucking routes and 5,000 Hostess owned trucks to deliver products directly to the thousands of stores that carried Hostess items. The cost of unionized truck drivers, capital costs and accountability from production to delivery eliminated much of the profits of the business.
Instead of delivering Twinkies directly to stores, new Hostess implemented a “Hostess Direct Model,” shipping products to customers’ warehouses instead of individual stores. Through this new model, Hostess’s five factories only had to deliver products to a few central locations around the country. Hostess also chose to outsource its transportation and logistics to a third party, further lowering the capital intensive nature of distribution. After switching to the warehouse delivery system, delivery costs dropped from 36% to 16% of sales.
Hostess also gained better access to its target market. The company believed that males age 18-34 were most likely to visit convenience stores for purchases. As it turned out, convenience stores were a major end market that used central warehouses for distribution. “Whereas the company used to focus distribution mainly on grocery stores, where parents shop for items to put into school lunches, the company now plans to sell Twinkies through some 110,000 convenience stores, up from 50,000 under the previous owners.” This allowed the company to better serve its key young male demographic.
Product Chemistry Changes
A common misconception is that Twinkies have an infinite shelf–life. In fact, the average Twinkie could historically only sit on the shelf for 28 days. Given the switch to a warehouse model, the new company wanted to find a way to keep Twinkies at warehouses for longer periods of time before expiring. The company chose to invest heavily in R&D to extend the life of its products. “Metropoulos spent millions on R&D, working with food lab Corbion to tweak the formula of starches, oils and gums in Twinkies, finally arriving at an acidity level that would prevent staleness and discoloration.”
The result of the R&D was a Twinkie that could sit on the shelves for 65 days and be indistinguishable from current products. The reformulation allowed Hostess to store Twinkies longer and eliminate waste, thereby reducing costs even further.
Results
The turnaround was a huge success. Twinkies hit shelves again in July 2013, operating performance in 2014 exceeded expectations, and the company’s owners put Hostess up for sale to take advantage of the positive momentum. In July 2015, the company rebuffed “offers from other companies and private equity firms that valued it at between $2.4 billion and $2.5 billion,” and instead issued a $900 million dividend to its owners. The company will likely IPO in the near-term at an even higher valuation. Based on the initial $410 million purchase price three years ago, it’s clear that Hostess is a winner.
Sources
http://www.forbes.com/sites/stevenbertoni/2015/04/15/twinkie-billion-dollar-comeback-hostess-metropoulos-apollo-jhawar/4/
http://business.time.com/2013/07/15/the-rebirth-of-twinkies-now-for-dudes-and-suddenly-everywhere/
http://www.reuters.com/article/us-hostessbrands-ipo-idUSKCN0PH1AP20150707#dTEDLieEmZqvoBPp.97
http://teamsternation.blogspot.com/2015/08/theres-nothing-sweet-about-hostesss.html
http://www.wsj.com/articles/no-wonder-twinkies-owner-adds-bread-1442482200
http://abcnews.go.com/Business/twinkies-return-hostess-unions/story?id=19043854
Thanks Steve – really interesting article. Definitely agree with your analysis that Hostess has done a fantastic job of aligning its business and operating model in its turnaround. A couple of interesting thoughts I had as I was reading through the article:
1) On business model – I wonder how sustainable this model really is in light of the health trends going on in the US today / dying out of the older customer base which experiences the “nostalgia” for the Twinkie’s of their childhood? Additionally, how much of the brand’s recent resurgence has been due to pent-up demand from their absence?
2) On operating model – Curious what the reaction of retailers was to the shift in distribution strategy and the impact on Hostess’s results. I’d imagine that with DSD Hostess provided additional servicing to the stores (doing re-stocking themselves) and also were able to secure preferential distribution and displays given that company employees were actually in store. I’d imagine that DSD, while costly, would be helpful for demand given the impulse-driven nature of this purchase.
No need to answer any of these questions obviously, just a few things that I’ve been chewing on reading your post.
Hey Steven, great post. I wasn’t aware of the specifics of this turnaround. I too wonder how sustainable their products are, but it sounds as if they are set to be able to compete for awhile, with the huge cost reductions. I’d be curious to know more details about how they met their new capacity with so many less bakeries, and how they chose which SKUs to cut.
Hey Steven- thanks for the post.
I’d also like to better understand the sustainability and growth prospects of Twinkies considering industry trends toward healthier snacks. Given such a great cost basis compared to current valuations, I’d be curious to know if the sponsors would consider reinvesting profits into a more diverse business model including similar sweet product lines and even healthy alternatives. Is there international receptivity to Twinkies in markets where healthy foods are not yet a prime focus? Are there other chemistry modifications that could actually make the product healthier? As the company stands today, the operating and business models are in sync, but considering an aging demographic and unfavorable trends, I have doubts about the long-term business strategy.