Flowers Foods Is A Good Short On The Hostess Takeover Hype

| About: Flowers Foods, (FLO)
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On November 16, Hostess announced that it is planning on going bankrupt, and had suspended operations in all 33 of its bakery plants. It seems a big reason for the bankruptcy is because the workers are in a union that is continually on strike. "The union has been the death of this company," said a human resources manager who recently left Hostess.

On the surface, the situation looks sweet (no pun intended) for Flowers Foods (NYSE:FLO). The market certainly thinks so as the stock has risen 11.7% since the news on Hostess' bankruptcy came the morning of November 16th. Hostess products like Wonder Bread, Twinkies, and Ding Dongs will have a shortage in stores due to the suspension of its bakery plants. While Hostess is trying to figure things out, this puts more room for Flowers' snack cakes and pastries brands such as Tasty Kakes, Mrs. Freshley's, and Blue Bird Bakeries. Flowers might also be able to acquire Hostess and add it to its pastries brands.

However, now that the excitement is priced in and FLO has popped, it is time to sell short. I believe this is an easy short-term shorting opportunity because Hostess' bankruptcy might not be so rosy for Flowers Foods afterall (again, no pun intended).

Yesterday, on Monday November 19 at about 2:30pm, I stocktalked:

"I'd short FLO now. With all these suitors, it probably won't get a good price for Hostess. And if another company buys hostess: bad for FLO."

At that moment, FLO was trading for $23.70. I realized that the Hostess bankruptcy is probably not a good thing for Flowers.

There are several reasons why I believe FLO's pop is at the very least premature.

First of all, it looks like the Hostess bakeries won't be idle for very long. A bankruptcy judge has urged a private mediation between the lenders and the leaders of the striking union. This is to save jobs, and save the company the expense of shutting down its bakeries and offices and having to dispose of perishable items. However, even if something gets worked out between the union and the lenders, the company will probably still get bought out by Flowers Foods or another suitor. Neither scenario will be good for Flowers. Looking at the two scenarios:

1. Flowers Foods Buys Hostess

This would not be a good idea for Flowers for several reasons. First, an iconic, popular brand like Hostess won't be sold for cheap. Besides Flowers, there are plenty of other suitors that will bid up the price such as:

- Sun Capital, they privately expressed interest in acquiring Hostess earlier this year and are still interested.

- C. Dean Metropoulos & Co., owner of Pabst Brewing Co., said it may seek to buy Hostess's iconic brands.

- Grupo Bimbo (OTCPK:GRBMF), the publicly traded Mexican bakery company, is putting some $1 billion toward capital expenditures here in the United States. It was once interested in Hostess during its last trip through bankruptcy.

Secondly, Flowers is trying to grow its own brands. In its latest earnings call, Flowers said that it is successfully growing its Tastykake brand. It's creating new Tastykake products and focusing on growth. Tastykake pastries are very similar to Hostess treats like Ding Dongs and Twinkies. Buying Hostess and trying to grow it will cannibalize Tastykake sales for Flowers. Management said in its latest earnings call that Tastykake was taking the place of its Blue Bird brand routes. I doubt that they want to already go through the same thing with Hostess. Flowers was in a bidding war with Grupo Bimbo for Tastycake early last year, that had Flowers ending up paying around $165 million dollars (which includes assumed debt) for the unprofitable, mismanaged company at the time.

Thirdly, after its many recent acquisitions, Flowers has amassed a decent amount of debt. Its latest quarterly balance sheet shows total debt of about $600 million and only $14 million worth of cash. It's not a crazy amount of debt for a company that earns $130 million per year, but it is enough to make lenders a little concerned. An acquisition of Hostess is likely a bigger project than Flowers wants to take on right now. George Deese, the Chairman and CEO of Flowers, said in the latest conference call:

"Our expanding market access puts us in good position to build value for our shareholders overtime as we steadily grow our sales and earnings."

I believe an acquisition of Hostess would disrupt the company's steady growth of sales and earnings, as it would boost sales at the expense of earnings.

2. Another Firm Buys Hostess

I believe this is the most likely scenario. A new buyer will most likely pick up Hostess and put more money and energy into it to turn it into a more profitable company with increasing revenues and market share. The current lenders were not willing to put the extra investment needed, which was one of the complaints of the union.

"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.""

A newly restructured, focused, and profitable Hostess can only be bad news for Flowers Foods.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.