The Hostess Liquidation: A Curious Cast Of Characters As The Twinkie Tumbles

By Taylor Durden

Perhaps one of the most interesting aspects of the just announced Hostess liquidation, one that will be largely debated and discussed in the media, or maybe not at all, is the curious cast of characters and the peculiar history of this particular bankruptcy. Some may not be aware that the company's Chapter 11 (or colloquially known as 22) bankruptcy filing this January, which today became a Chapter 7 liquidation, was the second one in the company's recent history, with Hostess, previously Interstate Bakeries, emerging from its previous protracted multi-year bankruptcy in 2009. What is curious is that its emergence had all the drama of an anti-Mitt Romney PAC funded thriller, with a PE firm, in this case Ripplewood holdings, injecting $130 million in order to obtain equity control of Hostess as it was emerging last time. There were also more hedge funds, investment banks, strategic buyers, politicians involved in this particular story than one can shake a deep fried numismatic value Twinkie at. More importantly, however, as America has been habituated following the last season of the reality TV show known as the presidential election, if Private Equity then "bad." Only this time there is a twist: because it wasn't really PE that was the pure evil in the Obama long-term campaign, it was associating PE with Republicans, and thus: with jobs outsourcing. And here comes the Hostess twist: because Tim Collins of Ripplewood, was a prominent Democrat, a position which allowed him to get involved in the first bankruptcy process in the first place, due to his proximity with the Teamsters' long-term heartthrob Dick Gephardt (whose consulting group just happens to also be an equity owner of Hostess). In other words, the traditional republican-cum-PE scapegoating strategy here will be a tough one to pull off since the narrative collapses when considering that it was a Democrat who rescued the firm, only to see it implode in a trainwreck that has resulted in the liquidation of a legendary brand, and 18,500 layoffs.

But it only gets better. Because the full cast of characters involved here is quite stunning, as David Kaplan summarized so well recently:

Ripplewood is run by Tim Collins, 55, who's been at the center of other famed PE transactions. Known as a brilliant capitalist-philanthropist-networker, he's an eclectic character: a Democrat in an industry of Republicans; an Adirondack enthusiast dreaded by pheasant and fish; a board member at the Yale divinity and business schools; and someone who took a year at 31 to work at a refugee camp in the Sudan. Ripplewood orchestrated the $1.1 billion turnaround in 2000 of the Long-Term Credit Bank of Japan, which marked the first time that foreign interests controlled a Japanese bank. (Collins made the cover of Fortune Asia for it.) The bank was renamed Shinsei, and in 2004 it had a lucrative initial public stock offering. Far less fortunately, in 2007 Ripplewood acquired Reader's Digest -- and saw its $275 million investment vanish in Reader's Digest's bankruptcy filing in 2009. (Collins reportedly had visions of merging Reader's Digest with the magazine division of Time Warner (TWX), which owns Fortune.)

Ripplewood's foray into Hostess was partly enabled by Collins's connections in the Democratic Party. He wanted to explore deals with union-involved companies and sought the help of former Democratic Congressman Dick Gephardt, who in 2005 founded the Gephardt Group, an Atlanta consulting firm that provides "labor advisory services." In his 2004 presidential bid, Gephardt -- whose father was a Teamsters milk truck driver -- was endorsed by 21 of the largest U.S. labor unions; in 2003, Collins was one of 19 "founding members" of Gephardt's New York State leadership committee. (Today, Ripplewood and Hostess are listed online as major clients of Gephardt's consulting group, which is also an equity owner of Hostess.) Back when Hostess was coming out of the first bankruptcy, Gephardt's credibility with both Ripplewood and the Teamsters gave them each a little more room to break bread.

During this first bankruptcy, Hostess was almost sold. In 2007 it warded off a $580 million bid from its biggest competitor, Bimbo Bakeries USA. Bimbo Bakeries USA is part of Grupo Bimbo, the Mexican baking giant that owns such brands as Sara Lee, Entenmann's, Freihofer's, Arnold, Boboli, Ball Park Buns, and Thomas' English Muffins. Joining Bimbo in the bid were the union-friendly investment arm of supermarket titan, (huge Democratic fundraiser and bundler) Ron Burkle and the Teamsters themselves.

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.

Based in Greenwich, Conn., Silver Point was founded in 2002 and has approximately $6.5 billion under management; its two co-founders are 49-year-old Edward Mulé and 47-year-old Robert O'Shea, both former Goldman Sachs (GS) partners. Silver Point helped bail out Krispy Kreme Doughnuts, Delphi, CIT Group, and various TV stations. Monarch, based in Manhattan, was created in 2008 as a spinoff from the Quadrangle Group. It reportedly has more than $3 billion under management; among its three co-founders are 52-year-old Michael Weinstock and 48-yearold Andrew Herenstein, both formerly of Lazard. Monarch has invested in Eddie Bauer and the Texas Rangers. (In 2010, after Herenstein sent a letter to baseball teams warning them not to approve a sale of the Rangers "at a price below fair market value," the letter became public, and the Dallas Morning News ran this ominous blog headline: MONARCH ALTERNATIVE CAPITAL THREATENS BASEBALL.)

Silver Point and Monarch, along with about 20 other lenders, owned about $450 million of Hostess secured debt at the time of the bankruptcy filing in 2004, according to court records. Remarkably, though -- given that Hostess's financials are now supposed to be an open book in federal bankruptcy court -- it's unclear how much the lenders actually paid for those notes. But it's presumably less than face value. Opportunistic investors like Silver Point and Monarch commonly buy distressed debt at a considerable discount. Their strategy: Invest in fundamentally "good" companies that have "bad" capital structures brought about by overborrowing, bankruptcy, or other corporate stresses.

Neither the specific amount put up by each investor nor the percentage of the total debt is public record (In re Hostess Brands, Case No. 12-22052). So it's impossible to know for sure how much "skin in the game" the creditors have. But according to sources with knowledge of Hostess's debt structure, Silver Point owns about 30% of the debt; Monarch, also about 30%; and the other lenders combined own the remaining 40%. Clearly, it was Silver Point and Monarch, along with Ripplewood, that had the biggest bets going forward.

Confused yet? Here it is summarized in a schematic:

The rest of the story is your typical post-emergency NewCo gone horribly wrong with a prominent role for the Snafu here reserved to Hostess restructuring banker Miller Buckfire for not cutting enough of the firm's pre-petition debt, with the straw that broke the camel's back being, what else, unfunded pension liabilities. As was explained back in July:

The critical issue in the bankruptcy is legacy pensions. Hostess has roughly $2 billion in unfunded pension liabilities to its various unions' workers -- the Teamsters but also the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union (which has largely chosen not to contest what Hostess wants to do -- that is, to get out of much of that obligation). If the bankruptcy court lets Hostess off the pension hook -- which often happens in these cases -- it only moves the struggle outside the courthouse, and the ante goes up. For the Teamsters can then call a strike -- which its Hostess employees have already ratified by a 9-to-1 margin. If the court doesn't grant relief, Hostess can seek liquidation, which would mean that some creditors get some money, but equity would be gone for good, as would a lot of jobs. Either way, each side holds a nuclear warhead with which to annihilate the company.

Liquidation is what ended up happening, as no compromise was possible, and the magic money tree, primarily as a result of equityholders (and creditors) refusing to inject any more cash.

Yet while the balance sheet burden was certainly the pension liabilities, what precipitated the liquidation was the income statement, and more accurately, the cash flow statement, or specifically the lack of cash flow.

As the company tried to reinvent itself in 2009 and 2010, external currents were running against it. The Great Recession hurt many consumer brands generally, and the prices of the commodities that Hostess relied on -- corn, sugar, flour -- went up, which is the opposite of what's supposed to happen in a downturn. In addition, the bakery industry underwent more consolidation when Sara Lee sold out to Bimbo.

Those fortuities aggravated Hostess's two root problems -- a highly leveraged capital structure that had little margin of safety, and high labor costs. Neither problem was adequately addressed in the first bankruptcy, and neither existed to the same degree in major competitors like Bimbo and Flowers Food (owner of such brands as Nature's Own and Tastykake). On exiting the first bankruptcy, Hostess's total debt load was nearly $670 million. That was well above what it went into bankruptcy with in the first place -- an unusual circumstance that the company justified on expectations of "growing" into its capital structure.

But the company was dead wrong. Its debt sowed the very seeds of the next bankruptcy. Looking back on the decision to reinvest in Hostess in the first bankruptcy, one of the lenders now says, "If you look in the dictionary at the definition of throwing good money after bad, there should be a picture of Hostess beside it."

By late 2011, Hostess was getting, well, creamed. Its sales last year -- $2.5 billion -- were down about 11% from 2008 and down 28% from 2004. (Twinkies remain the best individual seller -- 323 million of them in the 52-week period ending June 29, give or take a splurt.) Overall, Hostess lost $341 million in fiscal 2011, 2½ times the loss of the prior year -- and by early 2012, primarily because of burgeoning interest obligations, its debt had grown to about $860 million.

As revenue declined, the company continued to burn cash -- in the second half of 2011, the rate was $2 million a week. The liquidity crunch forced Ripplewood in the early spring of 2011 to pump in $40 million more in return for more equity as well as debt that was subordinate to that held by Silver Point and Monarch. In August -- to save a company teetering on the edge of fiscal calamity and forced liquidation -- Silver Point, Monarch, and the group of other lenders put up an additional $30 million to see if a negotiated turnaround was possible.

They turned to the unions and demanded new concessions. But the unions, having three years earlier given up thousands of jobs and millions in benefits, flatly refused.

The company was going to pieces -- again -- and Hostess filed for Chapter 11 protection -- again -- in January of this year. This time, though, the moneymen were no longer on the same page. As the majority equity holder, Ripplewood badly wanted to keep Hostess out of bankruptcy. It pleaded with the lenders to show flexibility, but they were not so inclined. They lenders held superior fiscal hands and had less downside if Hostess failed. In the event of a bankruptcy, given all the assets Hostess owned, the lenders would still walk away with millions.

There is much more to this story, but the ending is well-known to all, and it is not a happy one.

End result: a near total loss for everyone involved, except the secured creditors of course, who will now get pennies on the dollar, or perhaps even par, for their claims when all is said and done.

Sadly, in many ways Hostess is now indicative of that just as insolvent larger corporation, the USA, whose insurmountable balance sheet liabilities will be the eventual catalyst for its collapse, but only once the Income Statement and the Cash Flow sheet join in. For now, the Fed provides the flow needed to avoid the day of reckoning, but everything ends eventually.

In the meantime, what the Hostess story will hopefully teach the always gullible public, is that nothing is ever black or white, and there are numerous shades of gray in every story: even one in which an "evil" PE firm is unable to come to resolution with labor unions, despite the man in charge of it all being a prominent democrat. Because when it comes to money other things such alliances, ideology and certainly politics are always, always, secondary. Sadly, ever more Americans will be forced to learn this lesson the hard way.