The Twinkie Story Demonstrates the Devolution of U.S. Business

hostess cupcakeI’ve never understood the allure of a Twinkie.

On the other hand, chocolate Hostess Cupcakes (born in 1919) were a fav until I moved to Philadelphia and met Tastykake. I was soon two-timing Hostess and eventually quietly divorced myself from its charms.

But that was decades ago.

Today, I might eat a Hostess cupcake once a year in an orgy of childhood memories and in defiance of the unholy mix of sugars and chemicals that mark the modern creation.

I read Friday’s headlines and listened to the soundbites and tweets with a skeptical attitude.

Hostess employed approximately 18,500 with 36 bakeries, 565 distribution centers and 570 bakery outlet stores throughout the United States. In addition, the company operated about 5,500 delivery routes.

This is a huge capital investment in regional facilities.

And the need to close the doors, sell off assets (like brand names) is labor’s fault? Really?

I didn’t believe it. After my research, which you can read below, I still don’t believe it.

And by the way, the closure impacts far more than Hostess Twinkies, donuts and cupcakes. The list of bakeries and brands under the Hostess corporate umbrella might surprise you:

  • Ding Dongs
  • Dolly Madison
  • Drake’s Ring Dings and Yodels
  • Ho Hos
  • Home Pride
  • Hostess
  • Merita
  • Nature’s Pride
  • Twinkies
  • Wonder Bread

Sources: CNN, Hostess.

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Once upon a time, more than 160 years ago, a man surnamed Ward started a bakery in New York City. In 1925, his grandson gave part of the family business a grand name, a name that illustrated the unbridled optimism of the roaring 20s: Continental Banking Co. The same year, he bought what was then the largest bakery in the country, the maker of Wonder Bread.

Oh, and on April 3, 1926 (pdf) the Department of Justice forced the parent company, Ward Food Products Corporation, to be broken up into three “independent corporations”: Continental Baking, General Baking and Ward Baking Co.

In 1930, the manager of Continental’s Hostess Bakery in Chicago invented the Twinkie. The Great Depression was underway, and “we needed a good two-pack nickel number,” James A. Dewar said in a 1980 interview.

Hostess already had bakery molds for the now-familiar shape–used to bake shortcakes and sold only during the strawberry season. It was Dewar’s inspiration to fill the cakes with a sugar-cream mixture, the formula for which is still a tightly held secret…

Twinkies caught on immediately. By 1980, Twinkies had become celebrated in song and story and were selling at the rate of about 1 billion annually, Continental said. There was something in the name that tickled Americans. Songwriter Larry Groce’s “The Ballad of the Junk Food Junkie” was a hit tune in 1974. Twinkies were a mainstay of Archie Bunker’s diet. He called the goodies “WASP Soul Food” on the TV series “All in the Family.”

But all was not well at Continental Baking.

ITT, which acquired 350 companies from 1959 to 1979, bought Continental in 1968 even though it had been subjected to an anti-trust ruling in 1960. In 1974, the U.S. Supreme Court ruled that ITT/Continental had violated its consent order prohibiting the acquisition of firms.

During the ITT ownership, Hostess introduced one new product, a chocolate covered Twinkie called the Chocodile, in 1975.

Ralston Purina bought the company in 1984 for $475 million in cash; this was ITT’s “largest divestiture and the second-largest financial transaction in ITT’s history.”

In 1986, Continental introduced a reduced-calorie “Wonder Light” bread. And also while under Purina’s umbrella, the company acquired (Drake’s) Ring Dings.

In 1993, when Ralston Purina announced they were going to spin-off Continental, their “poorly performing bakery subsidiary,” its shares jumped $4.375 (almost 10%), to $49.625.

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Interstate Bakeries Corp. (IBC) bought Continental from Ralston Purina in 1995. The sales price: $220 million in cash and 16.9 million common shares of stock worth $241 million. The sale was contingent on an anti-trust decision from the Clinton Administration Department of Justice.

In 1999, the DOJ accused Interstate of failing to honor that agreement. At issue was a license for white bread that had been issued to Webers, a label subsequently purchased by Interstate’s largest competitor, Bimbo Bakeries, the American arm of Mexico’s Grupo Bimbo. Brands include Entenmann’s, Oroweat, Sara Lee, Stroehmann and Thomas… Cinnabon bread, Roman Meal bread and Sun-Maid bread.

The downward sloping financial trajectory accelerated.

By 2004, the company was about $450 million in debt and in trouble with Washington, D.C. And there appeared to be a little … nepotism.

Struggling due to a government investigation of its workers’ compensation reserves and trouble with a newly installed financial data system, the company twice delayed filing its 2004 10-K. Later that year the company hired Alvarez & Marsal, a crisis-management and turnaround firm and subsequently filed for bankruptcy. Also, chairman and CEO James Elsesser resigned at that time. Tony Alverez was named interim CEO and John Suckow was brought on board as chief restructuring officer. (Alvarez and Suckow were also officers of the turnaround management firm, Alvarez & Marsal.) Leo Benatar was named chairman.

… In January 2005 the SEC began a formal investigation with regard to how workers’ compensation and other reserves were set.

In September 2004, it declared bankruptcy for the first time.

After five years — unusually long for a reorganization — the company became a private entity, having won concessions from the unions and new capital from investors. The deepest pocket: Ripplewood Holdings, a [private equity] firm based in midtown Manhattan that reportedly once managed $4 billion in capital.

When Interstate emerged from bankruptcy in 2009, it immediately changed its corporate name to Hostess Brands, Inc. in order to “leverage an iconic brand that Americans have enjoyed for almost 100 years.”

Today marks a new beginning for Interstate Bakeries,” CEO Craig Jung said in the release. “We are now a stronger and more competitive company. With this period behind us, we can now unleash and empower 22,000 IBC employees to better serve our consumers and customers, revitalize our core brands and launch product innovation that will profitably grow our business.”

All of IBC’s 423 union locals ratified revised labor agreements that allowed IBC the flexibility to adjust to the changing market, IBC said in the release. In addition, all of IBC’s secured lenders voted in favor of the reorganization plan, which a Kansas City bankruptcy court approved on Dec. 5, 2008.

“I want to thank IBC’s employees for the sacrifices they have made and our union leaders for their commitment to our company and saving jobs,” Jung said in the release. “Their actions made possible the financing required to execute a business plan that will build competitive advantage and secure our company’s future.”

Two Ripplewood partners — with Pepsi and Kraft roots — got seats on the IBC board.

John Cahill, former CEO of The Pepsi Bottling Group Inc., left Ripplewood in 2011. Greg Murphy, former CEO of Kraft Food Bakery Company, became Major League Baseball Enterprises “CEO of business and marketing” in 1996. One of his first marketing agreements was with Pepsi Cola; however, his management style quickly caused controversy. He resigned from MLBE in late 1997. He is still a Ripplewood partner.

According to Fortune, “Hostess was able to exit bankruptcy in 2009 for three reasons.”

The first was Ripplewood’s equity infusion of $130 million in return for control of the company (it currently owns about two-thirds of the equity). The second reason: substantial concessions by the two big unions. Annual labor cost savings to the company were about $110 million; thousands of union members lost their jobs. The third reason: Lenders agreed to stay in the game rather than drive Hostess into liquidation and take whatever pieces were left. The key lenders were Silver Point and Monarch. Both are hedge funds that specialize in investing in distressed companies — whether you call them saviors or vultures depends on whether you’re getting fed or getting eaten. (emphasis added)

But the just-out-of-bankruptcy company had a “a highly leveraged capital structure that had little margin of safety and high labor costs.”

And then there was the Great Recession.

Consumer spending shrank; Hostess sales in 2011 dropped 11% compared 2008 and had plummeted 28% compared to 2004. The cost of ingredients (corn, sugar, flour) has gone up. Way up.

What sorts of innovation occurred after 2004? Wonder Bread introduced a whole wheat white bread in 2005. In 2009, Wonder launched an online tool that let consumers “create unique sandwich combinations from a list of more than 120 ingredients.” In 2010: an iPhone app. In 2011: Wonder joined Facebook.

Hostess introduced Nature’s Pride in 2009, “first 100% natural line of bread available across the country.” Beefsteak; nothing. Dolly Madison; nothing. Drakes; nothing. Home Pride; nothing. Merita became the official bread of the Southeastern Conference football league in 2010.

In August 2011, Hostess saved almost $100 million when it “temporarily” stopped making its annual pension contribution. That action angered the unions. [Note: that is equivalent to the annual labor savings negotiated as part of the first bankruptcy proceeding.]

And then in January 2012, the company filed Chapter 11 bankruptcy again. But its PR woes were far from over.

In early February, Hostess had asked the bankruptcy judge to approve a sweet new employment deal for Driscoll. Its terms guaranteed him a base annual salary of $1.5 million, plus cash incentives and “long-term incentive” compensation of up to $2 million. If Hostess liquidated or Driscoll were fired without cause, he’d still get severance pay of $1.95 million as long as he honored a noncompete agreement.

When the Teamsters saw the court motion, Ken Hall, the union’s secretary-treasurer and No. 2 man, was irate. So much, he thought, for what he described as Driscoll’s “happy talk” about “shared sacrifice.” Hall says he tracked Driscoll down by phone and told him, “If you don’t withdraw this motion, these negotiations are done.” Hostess withdrew the motion a few weeks later when Driscoll left — the same Driscoll who, Hostess told the court in its motion, was “key” to “reestablishing” Hostess’s “competitive position going forward.” Abbott and Costello couldn’t have made this stuff up if they’d gone to Wharton.

So the company appointed Greg Rayburn, hired as a consultant only nine days earlier to help with restructuring, as its sixth CEO in 10 years.

Rayburn was a serial turnaround specialist who had worked with such high-profile distressed businesses as WorldCom, Muzak Holdings, and New York City Off-Track Betting… Within a month of taking over, Rayburn had to preside over a public-relations fiasco. Some unsecured creditors had informed the court that last summer — as the company was crumbling — four top Hostess executives received raises of up to 80%. (Driscoll had also received a pay raise back then.) The Teamsters saw this as more management shenanigans. “Looting” is how Hall described it in TV interviews.

Also, at one point Hostess management asked the bankruptcy judge let it unilaterally change the conditions of the Teamsters contract.

Earlier this year, Rayburn painted the pension funds — and by implication, the unions — as its reason for needing bankruptcy protection. No surprise, then, that the company pushed for this:

Hostess contributions to multi-employer pension plans would cease until 2015, at which point the current required level of funding would plummet from $100 million to $25 million.

The Teamsters agreed; the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union did not.

To put the pension commitment into context, this year’s bankruptcy costs to professionals — including lawyers and investment bankers — totals about $333 million. They were willing to waive $60 million of that, but you and I know that’s not going to 18,500 people (the number employed by Hostess).

The company’s largest liability is $944 million, owed to the Bakery & Confectionary Union & Industry International Pension Fund. How many years has the company been able to continue operations while turning a blind-eye to its contractual obligation with labor? And was there vested interest in forcing the closure; by largest liability, is the union’s pension fund first on the “get made whole” list when assets are liquidated?

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If there is a demand for these brands and products, some of the plants will resume operation under new ownership and some employees will find a new job (with any seniority gone bye-bye).

The assets aren’t worthless. The Seattle Times reported that the Seattle bakery is valued at $7.8 million by the county assessor. And the brand names will be sold to the highest bidder. (As though we need every questionable calorie that haunts the grocery store aisle.)

If nothing else, this sad tale exposes the myth that mergers inevitably lead to savings and economies of scale.

It should also bring into question the federal government’s failure to enforce the Clayton Anti-Trust Act. You can’t get this big and tangled without an OK from D.C. And who is overseeing the pension funds and where have those watchdogs been hiding?

Finally, there’s the under-reported issue of multi-employer pension plans, like those in the baking industry. Earlier this year, Credit Suisse estimated that US funds are under-funded by 48% (pdf) – that’s $369 billion. These plans are common in construction, entertainment (film, television and theater), retail food, garment manufacturing, mining and transportation (trucking and maritime).

Also missing in the reporting I’ve seen: what happens to private label contracts? Hostess (headquartered in Texas) is preparing 7-11 (also headquartered in Texas) branded cupcakes. At least that’s what’s available in the store that’s walking distance from my house.

The doors may be closing, but the ending hasn’t been written yet.