Katy Askew

Deal or no deal: "Stalking horse" Flowers eyes Hostess bread brands

By Katy Askew | 15 January 2013

Flowers eyes Hostess bread brands

Flowers eyes Hostess bread brands

Flowers Foods showed its hand when it emerged as the "stalking horse" bidder for parts of Hostess Brands' bread business, notably the Wonder and Nature's Pride brands. While the deal is not yet in the bag, Flowers has clearly emerged as the front-runner to snap up a significant chunk of Hostess' bread interests. Katy Askew takes a look at the impact the potential acquisition could have on Flowers.

When Hostess Brands announced it would be auctioning off its business piecemeal after the US baker wound down in November, it was clear that Flowers Foods was one firm that stood to gain from the news.

In a sector marked by over-capacity and pressure on pricing, the implications of a major competitor suddenly stopping production are clear.

As a consequence of declining supply, the past few months have seen price pressure ease somewhat in the US bread sector. And, while Flowers' branded products are coming up against low priced retailer brand alternatives, the company has done a commendable job convincing brand-conscious US consumers to pay a premium, in spite of the wider economic conditions. Some of this has been achieved through a sharp price point, much has been done through brand building and innovation.

Flowers will also benefit considerably from the demise of Hostess through market share gains, as the group picks up new distribution and fills the void left by the Twinkies maker.

"We believe the earnings implication of the share gains in both bread and cake since Hostess halted operations in mid November is dramatic," BB&T Capital Markets analyst Heather Jones suggests.

Aside from any potential acquisition, Jones claims Flowers is likely to have achieved annualised sales gains of "several hundred million" in the wake of Hostess' collapse. "Our current 2013 estimate assumes just US$125m of incremental share gains with a contribution margin of 15%-20%," she adds.

However, with a swathe of strong brands, distribution routes and customer relationships on the block, it never seemed likely that acquisitive Flowers would be satisfied by nibbling away at Hostess's share while the company was out of action.

Flowers has long-touted its ambition to grow its presence outside its strong-hold in the southern US, with the goal of obtaining a nationwide spread. The company has repeatedly indicated it will look to M&A to achieve this.

Indeed, commenting on the group's ambitions following last year's acquisition of north-eastern bakery Lepage, Flowers CEO George Deese indicated the group will look to participate in a process of consolidation that the firm sees in the sector. "We will be prudent with that but we will continue to anticipate as the market consolidates," he said.

The announcement that Flowers is the stalking horse bidder for a number of the Hostess brands therefore came as a surprise to few.

Hostess and Flowers have entered into an agreement that could potentially see the latter take control of Wonder, Nature's Pride, Merita, Home Pride and Butternut bread brands for around $360m. A separate deal would see Flowers acquire the Beefsteak brand for $30m. The agreements would also see Flowers take on 20 bakeries and around 38 depots.

According to Euromonitor analyst Matthew Hudak, each of these brands "fill a need" in the "highly segmented" US bakery category, be it health or price.

"Growth [in the US bread sector] is coming from high-end premium health and wellness products or the other end of the spectrum, where consumers are buying on price," Hudak tells just-food. "It is anyone in the middle who is being squeezed."

The likes of Nature's Pride and the Beefsteak rye bread brand fit neatly with Flowers line-up of premium products, such as Nature's Own.

While there may be some degree of overlap between existing Flowers brands, the regional nature of the business means the largest benefit will be the increased distribution and new retail and foodservice customer relationships that Flowers stands to gain. Hostess brands have a strong presence in the midwest and west: it is likely this was a key drawing point for the Georgia-based baker.

"This agreement is consistent with Flowers Foods' long-term growth objectives to reach significantly more of the US population with its fresh breads, buns, and rolls," Deese reiterated when the agreement was announced after the markets closed on Friday (11 January).

It is typical of Flowers' approach to M&A to take on assets that afford the opportunity to extend distribution of its existing brands into new territories and, rather than risking sales cannibalisation, the Hostess deal should be viewed in this context.

The premium-leaning Hostess brands are positioned in the higher-growth end of the market. They are fairly well invested with strong brand recognition and reasonable levels of NPD. However, it seems likely the greatest challenge for Flowers will be turning around the fortunes of the iconic Wonder Bread brand.

Wonder Bread, which represents around 50% of the revenues included in the acquisition, accounts for 0.9% of bakery sales in the US, Euromonitor figures suggest.

However, the brand has suffered from chronic underinvestment in recent years and its positioning is proving problematic. While Wonder competes at the value end of the market - and lacks the health and wellness selling points that have driven growth in the sector - its price positioning is still above own label, which is losing some of its stigma in the downturn.

"Wonder Bread will need the most investment," Hudak predicts. Nevertheless, he is upbeat on the prospects of a recovery: "Wonder is an iconic brand. You could [turn it around] through cleaver marketing, or you could reposition it. There could be areas that could have international appeal. If you are smart about it, things like this can always be turned around by creating a cultural identity for the brand."

At the current bid price, Flowers said the acquisition would be accretive to fiscal 2013 earnings. Janney analyst Jonathan Feeney suggests that Flowers management likely expects to win through at roughly the current offer price.

"Flowers figures to ultimately prevail at either the current bid or something slightly north of it as the only significant threat, Grupo Bimbo, are likely more focused on Hostess's snack cake business," he says.

Nevertheless, the deal is far from done and there remain a number of moving parts that could potentially throw a spanner in the works.

The agreement is subject to approval from the bankruptcy court and competition authorities. It will also be opened up to a competitive bid process that could potentially mean Flowers will be forced to either up its offer price or walk away. Weighing the benefits the acquisition would bring Flowers against the group's "disciplined" approach to M&A, management would likely think long and hard before moving in either direction.

Sectors: Bakery, Mergers & acquisitions

Companies: Hostess Brands, Flowers Foods, Grupo Bimbo

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