Hostess: Challenges Facing Unions when PE Doesn’t Deliver

November 20, 2012

If there is one thing about the Hostess failure that everyone can agree on, it’s that – in the words of Term Sheet’s Dan Primack – the bakery company’s management was ‘dunderheaded.’ When Ripplewood Holdings bought Hostess out of bankruptcy in February 2009, the company was in danger of failing. Unable to adapt to consumer demand for healthier products and slow to adopt new technologies, Hostess had been in trouble since the early 2000s and in bankruptcy protection since September 2004. As it prepared its takeover offer, Ripplewood presented itself as a hot shot private equity firm that could turn around the ailing company and save its iconic brands. Both Hostess’ largest creditors and its major unions were persuaded.

Ripplewood negotiated major concessions with the bakery company’s two major unions – the Teamsters and the Bakery Workers. Silver Point Finance and Monarch Alternative Capital, Hostess’ largest creditors, set the terms under which they would lend Ripplewood money. And Ripplewood knew the dimensions of the huge debt burden Hostess would carry as it emerged out of bankruptcy. But Ripplewood had a credible plan for saving Hostess that it believed would work – and that it sold its creditors and unions on.

For all the fanfare, Ripplewood failed miserably in implementing the turnaround and misfired badly on execution. The company was poorly managed, failed to introduce successful new products, did not invest in new equipment and technology, and faced falling demand for its products and rising debt and interest payments. Managers took steps to line their own pockets as the company grew increasingly troubled. The company cited sales revenue of $2.5 billion in 2011 as proof that demand remained strong and it had done a good job, but failed to mention that sales revenue was down 11 percent from 2008 and 28 percent from 2004.

Board oversight was especially bad – only Ripplewood and Hostess’ management had votes on the Board. Silver Point and Monarch put up the money and set the terms of the loans that enabled Ripplewood to acquire Hostess, but they didn’t hold voting positions on the Board. The unions made major concessions intended to let Ripplewood make necessary investments in new equipment and technology and get Hostess back on its feet. But they didn’t have a seat on the Board and could not meaningfully protest the poor decisions of Hostess’ management and its failure to use the funds freed up by the concessions to improve the company’s performance.

Not until August 2011, when Hostess failed to make its July payment to its workers’ pension plan and failed to make payments to its creditors on its outstanding debt, were the hedge funds and the unions able to step in. The hedge funds provided Hostess with emergency financing to stop the free fall into bankruptcy and allow time for Hostess to reorganize in Chapter 11. Hostess was back in bankruptcy protection in January 2012, just three years after its earlier exit.

Poorly managed companies – especially those with the debt burden that accompanies a leveraged buyout by a private equity owner – are likely to become an increasingly important challenge for unions. Hedge funds are increasingly buying the debt of distressed companies in a bid to exchange the debt for equity and emerge as the company’s owners in the bankruptcy proceedings. Negotiations with hedge funds and other creditors are likely to become a more common occurrence. How should unions respond?

Looking at the Hostess situation a union could conclude that negotiations over further concessions by workers to keep the company functioning were fruitless. The union could continue to bargain to try to limit concessions and stand up against the greed and mismanagement of the company’s owners and managers. It could refuse to make further concessions to a company It thinks is asking too much. If its demands on behalf of its members were rejected, it might consider striking. And it might feel it had no choice but to strike if concessions were imposed. Under these circumstances, the union might be willing to take the risk that the company would move from bankruptcy to liquidation and workers’ jobs would be lost.

Equally, a union could conclude that it makes sense to participate in negotiations over the future of the company, to investigate what it will take to continue to run the business, and to determine what further concessions it will take to get there. The union might be willing to make these concessions if it gets an equity stake in the company for its members to offset concessions and provide an upside in case the company succeeds, and if it believes that it can change the company in the future – that it can have a meaningful role in the selection of a new CEO and voting seats on the Board; and that painful as the present concessions are, the union can not only save workers’ jobs but can make a better future for them and the company.

The bankruptcy court judge has ordered Hostess and the Bakery Workers union to engage in mediation to avoid liquidation of the company before he will consider the company’s request to terminate all operations. Other private equity companies – notably Sun Capital – have come forward with an interest in buying Hostess. However this saga ends – with Hostess in liquidation, conciliation, or sale to another company – unions will continue to face a challenge when it comes to dealing with poorly run companies owned by private equity or hedge funds. A dialogue within the union community about how to deal with such challenges is urgently needed; a consensus about how to proceed, should one emerge, could provide the basis for concerted action by unions and the union movement when such challenges arise.

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