Hostess Brands Gets a Cupcake of a Deal from Smucker
When I was a kid, my mother kept a stash of Hostess cupcakes and twinkies in the basement freezer. I was allowed one per week, which I consumed slowly so I could savor every bite.
That childhood memory came to mind two weeks ago. On September 11, The J.M. Smucker Co. (NYSE: SJM) announced that it will consume Hostess Brands (NSDQ: TWNK) for $5.6 billion. Hostess shareholders will receive $30 in cash and 0.03002 shares of SJM for each share of TWNK. The deal is expected to close during the first half of next year.
That price equates to a 54% premium to TWNK’s closing share price on August 24. That’s the day rumors of a potential buyout became public.
I can’t say this deal surprised me much. Last year, I booked a 505% profit on a put option trade on SJM (a put option increases in value when the price of the underlying security goes down).
In May 2022, Smucker released its Q2 results that came in much worse than expected. The stock tanked and my put option shot up in value.
It was then that I realized Smucker had a serious problem. If a company that sells comfort food can’t make a profit during a pandemic when people are stuck inside, then something’s wrong.
In that case, supply chain disruptions caused the coronavirus pandemic was the culprit. You may recall the empty shelves at your local grocery store that drove food prices higher last year.
Too Much Debt
Fortunately for Smucker, the supply chain problem dissolved in time for the company to report decent results during the second half of 2022. After closing below $120 in May, SJM finished last year above $155.
Unfortunately for Smucker shareholders, that’s about as high as it would get. After that, SJM gradually dwindled lower until breaking below $130 two weeks ago.
Clearly, Wall Street thinks Smucker is paying too much to acquire Hostess. The day this deal was announced, SJM fell 7%. The same day, TWNK jumped 19%.
It’s not that Wall Street feels Hostess is a bad fit for Smucker. Smucker sells a wide variety of comfort foods in addition to the peanut butter and jelly for which it is famous.
The problem is the way in which this transaction will be financed. According to Smucker, “The cash portion of the transaction is expected to be funded through a combination of cash on hand, a bank term loan and long-term public bonds.”
Now is not the best time for a company to issue new debt. Interest rates are higher than they’ve been in decades.
Smucker stated that its “total net debt estimated at the closing date will be approximately $8.6 billion.” That’s nearly double the $4.5 billion in total debt the company had on its books at the end of July.
Nevertheless, Smucker believes this transaction will “be accretive to adjusted earnings per share in the first fiscal year.” The operative word there is ‘adjusted’ since that gives the company a lot of leeway in how it reports the cost of getting this deal done.
I can tell you who is very happy about this deal: options traders. That’s because they thrive on volatility. The day this deal was announced, anyone owning put options on SJM made a lot of money.
That’s the beauty of options trading. You can profit no matter which way a stock goes as long as you are right about the direction.
The big question is what direction SJM will go now that the terms of this deal are known. Is Smucker paying too much for Hostess, in which case its share price may go lower? If so, then buying a put option on SJM could be a profitable trade.
A few days ago while SJM was trading near $126, the put option that expires in January 2025 at the $125 strike price could be bought for $11. For that trade to be profitable, SJM would have to fall below $114. That works out to a decline of 10% over the next 16 months.
I think there is a smarter way to play this. If this deal falls through, TWNK could quickly fall in value. At the start of this week, the put option that expires this April (when the deal is supposed to close) at the $30 strike price could be bought for 25 cents.
Keep in mind, TWNK was trading near $22 before this deal was announced. If it falls all the way back to that price, the return on this trade could 3,200% or more.
I don’t think that is likely, but I don’t think it is impossible, either. Smucker is paying too much to get this deal done, and that may leave a bad taste in the mouths of its shareholders.