Smucker: Price Paid for Hostess Looks Fair, but Past Execution Mistakes Worry Investors

We don’t anticipate a material change to no-moat Smucker’s SJM fair value estimate of $140 per share for the announced acquisition of Hostess Brands. We think Hostess’ investors are the big winners. Hostess’ faster top-line growth, higher gross margin, strength in the convenience channel, and market-leading brands are attractive. However, we think Smucker paid a full price. The acquisition also adds execution and integration risk, which likely worries investors given Smucker’s past disappointments, driving shares down 7%. Even with the Sept. 11 decline, we don’t see much risk-adjusted upside at current prices.

Strategically, Hostess is a nice addition. Its brands hold a leading 10% share in the U.S. packaged cakes market, according to Euromonitor. Additionally, its convenience store presence complements Smucker’s existing distribution. Hostess’ sales have grown about 14% per year over the last three years at midteens operating margins, better than Smucker’s 3% growth at slightly lower operating margins over the same period.

However, we think Smucker paid a full price at $34.25 per share ($30 in cash, the rest in stock), a whopping 45% premium over the 30-day average prior to reports that Hostess was for sale in late August. The deal value/adjusted EBITDA multiple of 17.2 times looks high. The 13.2 times multiple when including $100 million of run-rate synergies, which at first glance looks achievable at 9% of Hostess costs and overhead, looks more reasonable. Leverage will also increase, as management expects net debt/EBITDA to spike to 4.4 times, up from 2.2 times.

Investors appear to be experiencing déjà vu, with the acquisition looking hauntingly familiar to the past disappointments of Big Heart and Ainsworth—deals for high-growth assets that drove leverage higher but failed to deliver. The full price makes it unlikely for the Hostess acquisition to create value for Smucker unless Hostess can deliver faster than mid-single-digit growth or higher synergies.