How Private Equity Killed the Twinkie

Submitted by HankP on Sun, 11/18/2012 - 1:19am

Economics and Business

While Mitt Romney has (hopefully) moved off the national stage, despised by his erstwhile supporters, it's important not to forget what we learned during the campaign - specifically about how Bain Capital, and private equity in general, works. We have a great example of that in the bankruptcy and dissolution of Hostess (formerly known as Interstate Bakeries), maker of Twinkies and other snack foods.

According to the right wing stenographers, the whole situation is simple - Hostess failed because of greedy, stupid labor unions. It's true that the unions failing to agree to significant cuts was the proximate cause of Hostess closing down. But of course that's far from the entire story. In fact, in looking over the history of Hostess over the past ten years it seems that the union made the right decision. That is, they were faced with a no win situation - demand no reductions, or accept an agreement from ownership and a management team that had already failed to live up to previous agreements.

It all started when Hostess originally entered bankruptcy in 2004. Hostess hadn't changed its product lineup since the 1960s, unlike virtually every other snack food company (not the sign of a very good management team to begin with). In 2004 Hostess went into bankruptcy protection with $450 million in debt, where they stayed for 5 years until Ripplewood Holdings, a private equity company, bought them and brought them out of bankruptcy. At that time they had $670 million in debt, a 50% increase over 5 years. It's also important to note that the union made significant concessions in pay and benefits to get the company out of bankruptcy in return for equity in the firm. It also saw employment decrease from 32,000 to 22,000 employees during the bankruptcy.

Ripplewood took the company back into bankruptcy in 2011, having failed to lower debt - over $1 billion at the time of the second filing - and having a management team that while ridiculously compensated still couldn't run the company. They also stopped making the contributions to the employee pension plan that they had agreed to (but kept up the contributions to the management pension plan). The company saved $160 million on pension plan contributions, but that wasn't enough to keep them from sinking even deeper into debt. The company also had 6 CEOs between 2002 and the filing in 2011, with no sign that anyone in management had any idea of what to do to turn the situation around other than award themselves increasing salaries and bonuses. And management had already shown their bad faith by reneging on the agreements they had made just three years earlier. So the union members didn't have any good options

So Hostess is gone, but it's important to remember that the pattern here is the same we've seen in multiple private equity buyouts:

1. Leverage debt to buy a distressed company

2. Increase the debt on the company even further

3. Make unions take large concessions on wages and benefits

4. Take out as much money as possible in management fees and management salaries

5. When things go bad, renege on your agreements with the workers and ask for more concessions

6. When the whole thing blows up, blame the unions

It appears to work just about every time. Of course, there are plenty of people out there who are ready to say the workers (average salary $44K) are greedy but top management (average salary hundreds of thousands of dollars) are not.

Also: squeeze dividends & other distributions,

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Submitted by Jordan on Sun, 11/18/2012 - 11:17am.

starving companies of capital;

load up companies with debt based on their improved balance sheet (like you said), often in order to make further dividends & profit distributions;

collect agency fees and consult fees from investors whether the deal works or not;

sell off what remains of the company when shares are profitable, and before the debt scheme blows up, sometimes taking the company into bankruptcy.

M Aurelius was probably right.

More misplaced blame from the

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Submitted by heet on Sun, 11/18/2012 - 11:47am.

More misplaced blame from the usual cast of miscreants

-- American unions have a duty to take paycuts and benefit reductions, one after another, to save an American institution.

-- Investment companies have a duty to extract as much money and fees from American institutions to make profits for large foreign investors.

-- A revolving cast of upper managers and CEOs have a duty to demand ever increasing compensation, benefits, and golden parachutes despite declining American institutions.

CNBC would love for this BS machine to keep humming along. One of the triumphs of modern marketing is convincing Americans that shrinking and neutered unions destroy companies while enriched predatory investors and useless corporate executives are "job creators".

That's the real disconnect for me

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Submitted by HankP on Sun, 11/18/2012 - 4:40pm.

If you make less than $100K, how dare you ask for a raise. You're lucky anyone will employ you, you loser/parasite/moocher.

If you make more than$100K, you're not getting compensated enough. The company is lucky to have you, and they need to dramatically increase your compensation or you'll leave (or go Galt, depending on the situation).

I blame it all on the Internet

High powered MBAs disgust me

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Submitted by heet on Sun, 11/18/2012 - 5:01pm.

High powered MBAs disgust me in general, probably well beyond rationality. Business school is a joke and the top-end places are just very expensive and exclusive networking clubs. Why people think CEOs/upper managers are special is beyond me.

I was fortunate in my life

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Submitted by HankP on Sun, 11/18/2012 - 5:12pm.

to have been exposed to MBAs quite early in my career. I learned they were very talented at developing and measuring metrics, and pretty useless at everything else.

I blame it all on the Internet

This is a one-sided, half-story diary,

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Submitted by Bird Dog on Sun, 11/18/2012 - 2:04pm.

from a labor union perspective only. This is what left-wing stenography looks like. What a disservice. Making this even more unbalanced, your sole link was to a bakers' union press release. The Teamsters made a deal last September and they implored the bakers' union to take a deal, too, but they held out and then struck. Now its union members will get 100% pay cuts.

The truth is that there are no white or black hats. Hostess was a bankrupt company in 2004 and multiple factors led to its current state. For perspectives that are actually informative and offer a broader picture, click here, here, here, here and here.

To recap, you've got a poorly conceived reorganization from the 2004 bankruptcy that left too much debt and too many badly structured union contracts. Without Ripplewood (whose principal owner is a loyal Gephardt-supporting Democrat), Hostess would likely have been sold and dismembered. You've got a company that came out of an overly long bankruptcy at a horrible time in the business cycle, with a lousy 2009 economy, lowering sales and higher-than-usual commodity prices. You've got a society that increasingly looks down on highly processed starchy, sugary carbohydrates. You've got management that couldn't figure out a successful business plan. You've now a got private equity firm that is out of the picture, having burned up all of its equity and cash. What's left were a couple of hedge funds that ended up negotiating with various labor unions. The hedge funds will get some of their money back when the company liquidates. Depending on how much they paid for the notes, they will lose a little or a lot, but they will lose money.

The end result is that the Hostess name and the products will be liquidated today instead of three years ago. Some other corporation will produce and deliver Twinkies by its employees, who may or not may be in labor unions, but at least are working in going concerns. And Hostess employees will be no more, and who knows how their pension plans will pan out. There were no winners in this debacle.

The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, and no Warrants shall issue, but upon probable cause, supported by Oath or affirmation, and particula

Here's the perspective of one guy who worked there:

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Submitted by JKC on Sun, 11/18/2012 - 2:30pm.

Courtesy of the Great Orange Satan:

This, I think, says it all:

What was this last/best/final offer? You'd never know by watching the main stream media tell the story. So here you go...
1) 8% hourly pay cut in year 1 with additional cuts totaling 27% over 5 years. Currently, I make $16.12 an hour at TOP rate of pay in the bakery. I would drop to $11.26 in 5 years.
2) They get to keep our $3+ an hour forever. (This refers to the union's pension plan.)
3) Doubling of weekly insurance premium.
4) Lowering of overall quality of insurance plan.
5) TOTAL withdrawal from ALL pensions. If you don't have it now then you never will.

Remember how I said I made $48,000 in 2005 and $34,000 last year? I would make $25,000 in 5 years if I took their offer.
It will be hard to replace the job I had, but it will be easy to replace the job they were trying to give me.
That $3+ per hour they steal totaled $50 million last year that they never paid us. They sold $2.5 BILLION in product last year. If they can't make this profitable without stealing my money then good riddance.

I can guarantee that if the Enormous Medical Center where I work offered me such a "deal" I would be gone in a heartbeat. I bet the same would be true for you, Bird Dog, especially given this:

"As the company was preparing to file for bankruptcy earlier this year, the then CEO of Hostess was awarded a 300 percent raise (from approximately $750,000 to $2,550,000) and at least nine other top executives of the company received massive pay raises. One such executive received a pay increase from $500,000 to $900,000 and another received one taking his salary from $375,000 to $656,256."

"I've been on food stamps and welfare. Anybody help me out? No!" Craig T. Nelson (6/2/2009)

And yet,

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Submitted by Bird Dog on Sun, 11/18/2012 - 5:49pm.

the Teamsters made a deal. Now the bakers will get a 100% pay cut instead of 27%. Management will also get a 100% pay cut. Win-win!

I don't know what deal the Teamsters made.

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Submitted by JKC on Sun, 11/18/2012 - 6:01pm.

But for the bakers, the offer obviously was unacceptable. I don't blame them.

And as for senior management, I'm willing to bet they all have a golden parachute of some sort or another. Don't lose any sleep over them.

"I've been on food stamps and welfare. Anybody help me out? No!" Craig T. Nelson (6/2/2009)

Ha

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Submitted by HankP on Sun, 11/18/2012 - 4:36pm.

coming from the guy with Benghazitis that's a compliment.

It's simple, management f*&ked up so bad that the union members thought it was a better deal to find a job elsewhere. They figured it was better to take their chances in the job market than sign a contract with people who are known liars and would unilaterally abrogate any part of the contract they wanted to at any time.

I'll never understand why conservatives and Republicans can't simply say "management screwed up" without also blaming the union. It's like some kind of verbal tic.

I blame it all on the Internet

Ad hom

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Submitted by Bird Dog on Sun, 11/18/2012 - 5:57pm.

Heh. This coming from a guy who cuts and pastes labor union press releases.

Your "analysis", such as it were, is shallow and simplistic. This isn't BinaryWorld. There were problems with management and there were problems with union contracts. You should read up on the subject instead of unquestioningly believing the propaganda you're absorbing. You just might learn something.

The problem with the union contracts

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Submitted by HankP on Sun, 11/18/2012 - 6:55pm.

is that management broke the previous one unilaterally. So why sign a contract with known liars who have shown that they won't keep to the agreement? But of course that was the unions fault because ... well just because. And seriously, after the Benghazi diaries you've exposed us to you're the last person who should be talking about "shallow and simplistic".

I question the negotiating skills of anyone who gets lied to but tells themself "it will be different this time".

I blame it all on the Internet

Nope, that's not it

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Submitted by Bird Dog on Sun, 11/18/2012 - 7:00pm.

My recommendation still holds.

Of course it does, impervious to fact or reason nt

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Submitted by HankP on Sun, 11/18/2012 - 7:45pm.

I blame it all on the Internet

And now a second suggestion

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Submitted by Bird Dog on Sun, 11/18/2012 - 11:15pm.

When it comes to being impervious to fact and reason, look in a mirror.

You just don't like the facts in this case

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Submitted by HankP on Sun, 11/18/2012 - 11:36pm.

management screwed up, period. No other explanation necessary except to muddy the waters.

I blame it all on the Internet

When you bring facts, I'll consider them

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Submitted by Bird Dog on Sun, 11/18/2012 - 11:55pm.

FTR, you acknowledged that you had already looked at some of my links--all of which provided more facts than your labor union press release--and then discarded them. Go ahead with the binary. It's entertaining. Oh, and look in a mirror.

Reading through all of BD's links...

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Submitted by Jay C on Sun, 11/18/2012 - 7:29pm.

... I noticed there were a couple of common themes presented: first, that while the Bakers' Union rejection of the latest offer was probably the immediate cause of Hostess' final closure; it was also probably merely the coup de grace for a company that was fundamentally moribund. And the ultimate cause of that mortality was - what all the financial writers seem to refer to coyly as a "puzzling" situation - wherein Hostess belatedly emerged from its first (2004) bankruptcy loaded down with more debt that it had had going into it. A debt load which - despite significant previous wage-and-benefit concessions by the unions - proved the unshakeable monkey (King Kong-size) on its back, and which the repeated machinations of those ingenious "Private Equity" honchos failed to, apparently, do much about, except to increase: just before they bailed.

And Hank is right about one thing: which the linked articles also refer to (if just in passing), that there was an early rush in the press (both "mainstream" and financial) to cast the Hostess FAIL as a simplistic case of "Greedy Unions Staked the Twinkie"; which didn't hold up on further analysis, but was considered good enough to go with as a start.

I read most of them while writing this

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Submitted by HankP on Sun, 11/18/2012 - 7:47pm.

but really, is it a surprise that a bunch of magazines that target business management as their readers would downplay just how badly management screwed up?

I blame it all on the Internet

OK, Hank: for once

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Submitted by Jay C on Sun, 11/18/2012 - 9:02pm.

I'm going to have to side with Bird Dog here, since - for once - he's linked to a fairly (IMO, anyway) even-handed bunch of analyses about the Hostess BK - which don't seem to be "targeted [to] business management" as readers. Except for Tyler Durden's, which is mainly a recap, they pretty much refrain from either of the simplistic "Greedy Unions" or "Vulture Capitalists" memes as the explanation(s) for Hostess' failures. Although on a re-read, I see that they all DO tend to elide - possibly because its causes have been deliberately obscured - the circumstances of the unusual debt burden Hostess emerged from its first BK with. And of course, the general question of why, if the company had such poor prospects, lenders seem to have been quite willing (and management compliant in) to load it up with even more debt; not a lot of which was likely to be gotten back: even taken out of the hides of the workforce.

Though I did note one telling cite from the linked New Yorker piece:

Perhaps the most striking response to the Hostess news, in that sense, was the tweet from conservative John Nolte, who wrote “Hostess strikers had pension. PENSIONS! What is this 1962?”

Perhaps the most striking response to the Hostess news, in that sense, was the tweet from conservative John Nolte, who wrote “Hostess strikers had pension. PENSIONS! What is this 1962?”

Perhaps the most striking response to the Hostess news, in that sense, was the tweet from conservative John Nolte, who wrote “Hostess strikers had pension. PENSIONS! What is this 1962?” It was once taken for granted that an industrial worker who worked for a big company for many years would get a solid middle-class lifestyle, and would be taken care of in retirement. Today, that concept seems to many like a relic. Just as Wonder Bread does.

And private equity could save Hostess

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Submitted by Bird Dog on Tue, 11/20/2012 - 10:24am.

If Sun Capital has its way.

So it wasn't a union problem

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Submitted by HankP on Tue, 11/20/2012 - 12:57pm.

it was a management problem:

The proposal would be to operate Hostess as a going concern, including reopening the shuttered factories and continuing union representation of Hostess workers.

I blame it all on the Internet

ATTN: any Forvm MBAs:

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Submitted by Jay C on Tue, 11/20/2012 - 1:44pm.

A couple of questions: First, with a quote like this:

"I think that we could offer a slightly better, more labor-friendly deal than what was on the table last week," says Sun co-CEO Marc Leder, in an interview with Fortune. "We also think that one point the unions have made is that there hasn't been a great amount of reinvestment in the business. We've found that investing new capital into companies like this can be very positive for brand, people and profitability... We would look to invest in newer, more modern, manufacturing assets that would enable the company to become more productive and to innovate."

Are we sure this guy really is a 21st-Century venture capitalist? I mean, "labor-friendly"?? SRSLY?

Also:

But Sun also believes that it could "make the company immediately profitable on an EBITDA basis," which could open the door for the current lenders to exit and new ones to step in.

What's EBITDA? Can't find a definition in the article.....

Not an MBA

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Submitted by HankP on Tue, 11/20/2012 - 1:54pm.

EBITDA means earnings before interest, taxes, depreciation, and amortization. It's used as a rough estimate of the underlying health of a company's ongoing operations, because it removes items related to debt, assets and taxes that vary widely between companies.

I blame it all on the Internet

Yeah. It's Profit from Operations

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Submitted by notyou on Tue, 11/20/2012 - 2:13pm.

PE types like it because it's a good indicator of 1) efficiency; 2) the ability of the firm to support more debt. I've usually heard it expressed as a percentage of sales, like profit margin.

Most PEs want to turn the investment in 5-7 years (the goal is an "equity event" such as an IPO or another sale) and improving (1) and therefore EBITDA is how they add value. If they think they can bump EBITDA through cost cutting or capital investment or improved marketing or some combo of that, then they'd prefer to use (2) to pay for it (and to pay themselves while they are waiting around to exit).

(Also not an MBA, but the wife has worked with PE types in the past and probably will in the future.)

Again with the binary

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Submitted by Bird Dog on Tue, 11/20/2012 - 2:55pm.

How quaint.

Had senior management not had their salaries doubled

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Submitted by JKC on Tue, 11/20/2012 - 10:29pm.

instead of cut in half, as they wished to inflict on their workers, your argument might have some merit.

Otherwise, not so much.

"I've been on food stamps and welfare. Anybody help me out? No!" Craig T. Nelson (6/2/2009)

That shouldn't be legal

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Submitted by catchy on Tue, 11/20/2012 - 11:45pm.

Slashing pensions while skyrocketing executive compensation should be illegal.

Yes!

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Submitted by Bird Dog on Wed, 11/21/2012 - 12:43am.

Because there is nothing else other than Labor versus Management. I'm am in this shallow binary world called The Forvm.

Ha. See Israel v Palestinians nt

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Submitted by HankP on Wed, 11/21/2012 - 1:50am.

I blame it all on the Internet

So what is your point about this case?

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Submitted by catchy on Wed, 11/21/2012 - 2:26am.

It looks to be more a story of bad management and the downsides of vulture capitalism than anything else to me.

The fact that labor wouldn't capitulate to entirely jettisoning their pensions doesn't appear particularly germane. Labor just had no reason to believe that management would honor whatever concessions/ agreements they made.

So did you have a point about the Hostess case in particular, are you claiming the case isn't representative of private equity's impact on the economy in general, or what?

The point is that...

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Submitted by Bird Dog on Wed, 11/21/2012 - 10:38am.

...a private equity company kept Hostess alive, and there are other PE firms willing to take the risk and do the same. So, did PE kill the Twinkie or did they try to keep it going? Seems to me like the answer is the latter. The Teamsters saw it one way and the bakers saw it another. Yes, management didn't have a good enough business plan, but they were saddled with problems from Day One, namely still-too-much debt and a still-too-unwieldy cost structure, which was the fault of the bankruptcy court for allowing that situation to persist. That, and the timing of when they emerged from Chapter 11 couldn't have been worse. Hank is trying paint everything with clear black and white but his square paint jars don't fit in the round hole (how's that for a mixed metaphor). And here I was, thinking that liberals embraced complexity and nuance. My mistake. I guess hyperbole is now the order of the day.

I doubt that...

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Submitted by M Aurelius on Wed, 11/21/2012 - 10:44am.

I've seen two private equity deals up close and the only beneficiaries I could see were bond holders and the PE firm itself.

The companies were both left with unsustainable debt loads that wiped out jobs and the possibility of investing in product development. What was left was a shell, a sales force, outsourced everything, and debt service. I saw no value in it.

It's a process more like mining than investment. It identifies value and extracts it, but does not produce value. It depletes it.

I am not a pessimist. I am an incompetent optimist.

do we know

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Submitted by nyoos junkey on Wed, 11/21/2012 - 11:16am.

if the two unions got the same offers? Do they represent the same grades and types of workers.

Dunno

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Submitted by Bird Dog on Thu, 11/22/2012 - 12:20am.

But this sounds like a plausible reason for the bakers balking.

Try looking at it this way...

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Submitted by JKC on Wed, 11/21/2012 - 12:08pm.

You seem to be arguing that Hostess management should be allowed to break contracts, steal pension contributions and do god-know what else in an attempt to save the company. Consider this: maybe the employees who've finally said "no" are trying to save their families.

Mike Hummell, a receiving clerk and a member of the Bakers' union working in Lenexa, Kan., said he was making about $48,000 in 2005 before the company's first trip through bankruptcy. Concessions during that reorganization cut his pay to $34,000 last year, earning $16.12 an hour. He said the latest contract demands would have cut his pay to about $25,000, with significantly higher out-of-pocket expenses for insurance.
"The point is the jobs they're offering us aren't worth saving," he said Friday. "It instantly casts me into poverty. I wouldn't be able to make my house payment. My take-home would be less than unemployment benefits. Being on unemployment while we search for a new job, that's a better choice than working these hours for poverty wages."

Hummel and the Baker's Union made a financial calculation just like PE and corporate management do all the time. An employment contract is not indenture, and no-one should be expected to work for poverty-level wages while their managers get large raises and bonuses.

"I've been on food stamps and welfare. Anybody help me out? No!" Craig T. Nelson (6/2/2009)

executive pay hikes in a situation like this

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Submitted by nyoos junkey on Wed, 11/21/2012 - 12:22pm.

are the tell.

No one who really wanted to save the company would load it with another million for their own salary as has been reported. That's the act of someone who figures the game is up and is grabbing what's left before the collapse.

Another million?

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Submitted by catchy on Wed, 11/21/2012 - 10:24pm.

The CEO's salary was tripled, loading on another 2 million, while unions agreed to pension cuts.

But of course unions are also to blame here b/c they would not completely capitulate.

To suppose otherwise would be black and white thinking.

Uh, no

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Submitted by Bird Dog on Thu, 11/22/2012 - 12:19am.

That's not what I am or seem to be arguing.

Then enlighten us.

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Submitted by JKC on Thu, 11/22/2012 - 9:58am.

<nt>

"I've been on food stamps and welfare. Anybody help me out? No!" Craig T. Nelson (6/2/2009)

"PE company kept Hostess alive"

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Submitted by Jay C on Wed, 11/21/2012 - 12:57pm.

Yes, and with about the same level of consideration for its well-being as the Mad Doctor in a cheap horror-flick keeping his victims/"patients" alive so as to maintain a handy supply of organs to remove and sell for transplants. And, like said MD, when conditions finally become terminal, they can just shove the remains into the furnace, wash their hands, and head on to the next town - after stopping at the nearest bank to cash their fat "severance" checks, of course.

And whatever your critique of Hank's posts, not all of us here have commented on the Hostess mess in a simplistic "binary" fashion.

But you have to remember that most of the initial reports on their looming BK were mainly framed (in the "MSM" at any rate) in the "Union Demands Threaten Hostess Bankruptcy" vein? Most of the more nuanced analyses, especially in the financial press, who, at least, should know better, were follow-ups. No, it's not a simple black-and-white issue: but - at least in your truly's humble opinion - more blame should accrue to the corporate Organ Harvesters who apparently "reorganized" Hostess as a debt-sink and fee-generator rather than as a maker and seller of snack cakes.

Oh, and in my usual coda-of-agreement: yeah, that five-year-long BK reorg of 2009, and its outcome, has a definite malodor to it. The problem is, that (AFAIK) after everyone has signed off on it, there's no warranty or recall provisions....

Double executive pay, ask for pay cuts at the bottom.....

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Submitted by brutusettu on Tue, 11/27/2012 - 1:10pm.

Hostess trebled the compensation of then-Chief Executive Brian Driscoll and raised other executives’ pay up to twofold

h/t LGM

"I’m to believe that North Korea is so dangerously unhinged that they would attack without warning – yet so meek and easily cowed that they will sit quietly and not retaliate when we start bombing them."

Major Kong