Tootsie Roll Industries (NYSE:TR) is an emblematic brand in American culture, having a history dating back to the early 1900s. Investors and analysts have longed for Tootsie Roll to unlock the value embedded in the company since as long ago as 1997, but entrenched and conservative management in the executive suite have kept a lid on revenue growth and the stock price over the past decade.
The executives at the helm of Tootsie Roll are 92 year old CEO Melvin Gordon and his 80 year old COO wife Ellen Gordon, who have led the company since the 1950s. Tootsie Roll has a long tradition of conservative management, and marketing and new product introductions have been limited, causing Tootsie Roll to lag in terms of sales and profit growth in the highly competitive environment that includes competitors Hershey (NYSE:HSY), privately held Mars, and Kraft's (KFT) newly-integrated Cadbury. Kraft's purchase of Cadbury in 2010 brought attention to consolidation in the sector and contributed to a brief spike to the price of shares in 2010. However, there have proven to be no lasting catalysts to share price gains for the company.
Investors considering investments in TR must weigh the probability of acquisition upon a change in leadership. Although the existing management has been clear in their intentions to not sell the company, when the aging executives do exit there will no doubt be motivation for other firms to acquire TR, which is an iconic brand in the United States and has a relatively narrow stable of products that would keep product redundancy in a transaction to a minimum.
The valuation metrics gleaned from two recent deals are as follows: Kraft paid 1.9 times sales and 21 times earnings for Cadbury, while Mars paid 3.7 times sales and 36 times profits for Wrigley in 2008 (funded by Warren Buffett and Berkshire Hathaway). TR presently trades at a price/sales ratio of 2.5 and a trailing price/earnings ratio of 30 with a share price of 22.56. Range midpoints of the Cadbury and Wrigley transactions would indicate a 2.8 times sales or 26 times profits for a transaction involving TR. This view is likely far too pessimistic, however, due to the factors below.
The potential suitor of TR, whether it is Kraft, Hershey, or an international player such as Danone or Nestle, may be enticed to pay a substantial premium due to a number of factors. First, the relatively small size of the deal may lead to a higher price to sales or profit metric. Even the most optimistic metric of 3.7 times sales only indicates a total deal value for TR at $1.9 billion, far below the $23 billion spent by Mars on Wrigley or the $17 billion spent by Kraft on Cadbury.
Second, the relative lack of product extensions that TR has produced from the flagship Tootsie Pop line is likely to make potential purchasers of the company optimistic about the growth prospects of the business.
Third, the executives at TR have been handsomely rewarded in terms of salaries and benefits despite the limited growth, which may offer significant operating synergies for a suitor in terms of overhead.
Fourth, the conservative manner in which TR has been run for decades has left it with a sterling balance sheet, particularly for a consumer products company. Because TR has no long term debt, very few liabilities, and nearly $100 million in cash, it will be especially attractive to add for an acquirer because it will not require the extinguishing of any further debt.
All of these factors could lead to TR being acquired for well beyond the existing comparable deals discussed above, which would be a well deserved reward for TR investors who have been patiently waiting for the value in the company to be unlocked by acquisition. Investors considering making an investment in TR at this juncture should anticipate the company to continue to be operated in a conservative manner by existing management, which makes downside risk on the shares limited. However, when management does shift in the near future, there is the potential for explosive upside in shares due to either acquisition of the company or the prospects for a more aggressive management of the iconic Tootsie Roll brand.