December 07, 2009 - 11:09pm EST by
2009 2010
Price: 27.00 EPS $0.932 $0.932
Shares Out. (in M): 56 P/E 29.0x 29.0x
Market Cap (in $M): 1,505 P/FCF 40.0x 40.0x
Net Debt (in $M): -42 EBIT 77 0
TEV (in $M): 1,458 TEV/EBIT 19.0x 19.0x
Borrow Cost: NA

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Short: Tootsie Roll Industries

Market Cap: $1,500m

Price: $27.00

Tootsie Roll Industries ("TR"), is one of those nice, steady, boring little family companies that has some of the qualities of a great hidden-value long.  It's fully controlled by the Ellen and Melvin Gordon, it's COO and CEO, respectively, who own 56% of the total outstanding stock and 74% of the voting stock.  Ellen and Melvin are 78 and 90 years old, respectively.  Melvin has been CEO of the Company for 46 years, Ellen inherited the Company from her father, who has owned it since the great depression.  The company has a stable of iconic, but tired brands - in addition to it's namesake it owns Charms/Blowpops, Junior Mints, Charleston Chew, Sugar Daddy, Dubble Bubble and a mixture of other tiny little names you probably haven't heard of.  It's in the confectionary industry, where competitors have been acquisition-hungry, Ellen & Melvin are both quite old, their 4 daughters are not a part of the family business.  GAMCO owns 5% of the stock, and has been talking about it as an acquisition target since building its stake in 2003.

So why go short?  This boring, no-growth (literally NO non-acquisition growth for the past 10 years), which the 74% voting owner has repeatedly sworn will never be sold, is trading at a RIDICULOUS VALUATION - 30x earnings, 40x cash flow, 15x EBITDA. 

Despite the $1.5B market cap, this co. has no real analyst coverage and trades just a few bucks a day. 

How has Tootsie Roll performed over a decade?

Let's look at Tootsie Roll a decade ago versus now. 


Sales: $400m

EBITDA: $115m

Net Income: $70m

EPS: $1.09

In 2009, the stock traded btwn $29-$47. 



Sales: $500m

EBITDA: $95m

Net Income: $51m

EPS: $0.93

Div yield: <1%

Stock at $27

So, over the course of a decade, sales increased a bit, profitability declined, investors lost money and today own a hugely overvalued equity.  The modest sales growth came WHOLLY a result of the $218m 2004 acquisition mistake of Concord (a rich price paid for the declining Dubble Bubble brand).  On 12/31/1999 they purchased Andes mints for $70m, and amazingly didn't even increase sales by a dollar as a result. 

A decade at Tootsie Roll

                          Blow the
                      LTM   Doors Off
  1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 9/30/2009   Case
Summary Income Statement                          
Revenue       396.8       396.8       391.8       393.2       392.7       420.1       491.1       501.1       497.7       496.0       504.3         510.0
  % Growth  2.1%  0.0%  (1.3%)  0.4%  (0.1%)  7.0%  16.9%  2.0%  (0.7%)  (0.3%)  1.7%    
Gross Profit       204.2       189.7       175.4       171.0       170.1       175.6       190.7       188.6       168.7       161.8       177.7    
  % Margin  51.5%  47.8%  44.8%  43.5%  43.3%  41.8%  38.8%  37.6%  33.9%  32.6%  35.2%    
EBITDA 114.5 124.0 110.9 107.6 103.7 101.6 107.8 103.3 86.7 83.6 95.0   105.0
  % Margin  28.9%  31.3%  28.3%  27.4%  26.4%  24.2%  22.0%  20.6%  17.4%  16.8%  18.8%    20.6%
EBIT       104.5       110.7         94.2         95.2         92.4         89.9         93.1         87.5         70.9         66.5         76.7    
  % Margin  26.3%  27.9%  24.0%  24.2%  23.5%  21.4%  19.0%  17.5%  14.2%  13.4%  15.2%    
Net Income         71.3         75.7         65.7         66.4         65.0         64.2         77.2         65.9         51.6         38.8         51.3           65.0
  % Margin  18.0%  19.1%  16.8%  16.9%  16.6%  15.3%  15.7%  13.2%  10.4%  7.8%  10.2%    12.7%
EPS       1.085       1.175       1.029       1.049       1.053       1.058       1.283       1.115       0.886       0.683       0.932         1.166
  % Growth  6.8%  8.3%  (12.5%)  1.9%  0.4%  0.5%  21.3%  (13.1%)  (20.5%)  (22.9%)  30.8%    
Acquisitions       (74.3)          (218.2)            6.8            
Summary Cash Flow                          
Net Income 71.3 75.7 65.7 66.4 65.0 64.2 77.2 65.9 51.6 38.8 51.3           65.0
D&A 10.0 13.3 16.7 12.4 11.4 11.7 14.7 15.8 15.9 17.0 18.3   18.3
Gain on Sale             (21.8)            
Other (8.4) (6.5) (1.5) (3.3) 7.1 0.4 12.4 (26.1) 22.6 1.2 3.6    
  Cash from Ops 72.9 82.6 80.9 75.5 83.5 76.2 82.5 55.7 90.1 57.0 73.1   83.3
Capital Expenditures (20.3) (16.2) (14.1) (10.3) (12.2) (17.9) (14.7) (39.2) (14.8) (34.4) (36.7)   (15.0)
  Free Cash Flow 52.6 66.4 66.8 65.2 71.3 58.3 67.8 16.5 75.3 22.6 36.4   68.3
   FCFE Yield 3.5% 4.4% 4.4% 4.3% 4.7% 3.9% 4.5% 1.1% 5.0% 1.5% 2.4%   4.5%
Valuation (current value against hist. numbers)                      
P/E 24.9x 23.0x 26.2x 25.7x 25.6x 25.5x 21.0x 24.2x 30.5x 39.6x 29.0x   23.2x
TEV/EBITDA 12.7x 11.8x 13.2x 13.6x 14.1x 14.4x 13.5x 14.1x 16.8x 17.5x 15.4x   13.9x
FCFE Yield 3.5% 4.4% 4.4% 4.3% 4.7% 3.9% 4.5% 1.1% 5.0% 1.5% 2.4%   4.5%

Aside from the '04-'05 growth as a result of the Concord acquisition, this business has been in a steady, slow decline on the sales line, and has been getting hit on profitability by the rise in commodity costs this decade.  Speak to the Company about why TR decided it was willing to shoulder the entire brunt of the commodity runup which has halved their net income, they sheepishly answer "customers don't like price increases, particularly Wal-Mart" (incidentally, 25% of their sales).  

They are raising prices with mixed success (partially through direct price increases, partially through reduced serving sizes), but the real problem here is volumes are falling.  There is no good disclosure around volumes (generally very poor disclosure all around), however, you can look simply at their flat cost of goods sold against rising input costs (energy, foodstuffs) to understand volumes must be significantly down.  Hedging activity is minor and short term.

              LTM / 
      2005 2006 2007 2008 YTD '09
Tootsie Roll COGS   $300.4 $312.6 $329.0 $334.2 $326.6
  % change     4.1% 5.3% 1.6% -2.3%
Wholesale Corn Syrup $21.25 $20.67 $24.52 $28.41 $32.95
  % change     -2.7% 18.6% 15.9% 16.0%

There are a few funky accounting aspects to the co, but nothing that materially alters the view you can get of the business before a deep dive.  There are some generous deals with executives to defer tax on very generous compensation packages that largely wash out, though they boost cash from ops artificially a bit and, depending on the year, profitability.  But nothing materially disturbs the picture of the co. you see with a simple look at it's financials - just a tired old company, losing volume, share and profitability.  That simply is not worth 30x earnings, 40x cash flow.



So what is this co. worth?  I'd view 10-12x earnings (a 7-8.5% free cash flow yield at historical earnings>cash conversion rates), as a generous valuation for a long term investment in Tootsie.  Adjusting for year end cash, some minor hidden assets and assuming the "blow the doors off case" return to historical profitability highs shown above, you get about $14.50 - $16.75 a share, compared to current $27, or a 40-50% decline.  I'd call that valuation feasible, but still quite rich.

You can look at comps below under M&A, but comparing Tootsie to its comps is not a hugely worthwhile exercise, because these companies are growing, market leading, worldscale confectionary companies.  Not very comparable to small, declining, Tootsie.

A note on the "blow the doors off case" shown above - this assumes Tootsie can get back to it's profitability peaks in the early 2000s, before commodity prices ran up and the company lost volumes.  Looking back, 2005's outperformance should be disregarded as 2005 profitability was driven by a $21.8m pre-tax gain on sale of a piece of real estate that was included in operating profit, so I look mainly to the ~$65m profitability years as their post-Concord acquisitions heyday.  With declining volumes, it will take quite a bit of work to get back to that.  YTD they've made quite a bit of progress against 2008's low.  This is driven by a) lower raw material prices in early '09, b) TR being budget "recession-candy", c) funny accounting that causes investment losses in the deferred comp plans to boost operating profit (seriously).  Point c) is cancelled out by the time you get to net earnings, but funny as it sounds, investment portfolio losses reduce compensation, boosting operating profitability (LTM impact I believe is artificially boosting EBITDA by ~$6.5m, so what looks like $95m LTM EBITDA is really ~$89m).


Is TR simply priced up in anticipation of being acquired?

If so, you've got some patient (and hopeful) investors.  GAMCO entered the stock in 2003 on that thesis, and still owns ~5% of shares outstanding.  Ellen Gordon, who inherited the co. from her father and at the ripe age of 78 is still running the co. with her 90 year old husband, has repeatedly ruled out ever selling Tootsie, and says she expects her family to own it for generations.  But once the parents pass, maybe their 4 daughters who aren't involved in the Company will look to sell it despite mom's wishes?

That actually sounds very possible.  But what price would interest strategics?  Well with a bidding war underway for Cadbury, you've got a good yardstick of what a strategic, growing, worldscale, confectionary goes for in a contested, hostile acquisition in 2009.  The Hershey/Nestle battle for control of Cadbury has the stock trading at a premium to Nestle's hostile tender and 40% premium to pre-announcement levels.  At these bid-em-up levels, Cadbury is worth 2x sales, 12.7x '09 EBITDA and 22x '09 earnings (a 25% DISCOUNT to Tootsie's market value).  But Cadbury is a very different company than Tootsie.  Tootsie is a marginal player in decline for over a decade, while Cadbury is a worldwide market leader, growing organically and projected to continue growing EBITDA 10% p.a. for the next 5 years.  Before the acquisition hoopla, Cadbury's spent most of its history priced between 9-14x forward earnings. 

An outlier data point one could fear is Mars' purchase of Wrigley announced in April, 2008.  Mars paid ~16.5x EBITDA, 3.7x sales.  This was a strategic price for a strategic acquisition buying the dominant global gum company (>50% mkt share worldwide).  Wrigley had 22.5% EBITDA margins, 19% EBIT margins, and was growing 15% per year.  I don't think this kind of valuation is relevant at all for declining Tootsie Roll, but you can look at this as a worst case scenario and get comfortable that Tootsie Roll would not change hands at a value much above current market price.


              P/E  TEV / EBITDA
      Mkt Cap EV Sales EBITDA   09   10     09    10
Tootsie Roll     $1,501 $1,459 $504 $95 29.0x     15.4x  
Hershey     $8,198 $9,866 $5,269 $1,053 16.8x 15.8x   9.4x 9.0x
Trading @ Takeout Premiums                
Cadbury     $18,045 $20,957 $9,397 $1,392 22.0x 19.0x   12.7x 11.5x
Wrigley @ takeout (Apr-08) $22,040 $22,990 $6,200 $1,400 30.1x     16.4x  

I do think an acquirer could do more with Tootsie's brands than Tootsie does, but I don't think a buyer would pay up for much of that.  Sources of growth potential -- Tootsie spends almost nothing on advertising, perhaps an aggressive campaign and new products could shake up Tootsie's sales.  Tootsie has only small positions overseas, perhaps an acquirer could get excited about investing in Tootsie's brands for international expansion.  Perhaps.  But these growth opportunities are not gimmes - they require significant investment and work by any buyer, and would be valued accordingly.  Some cost savings are always achievable (starting with the executive suite's excessive pay packages), but generally Tootsie is a low-cost, high margin candy company (19% EBITDA margin vs. Hershey's 20%, Cadbury's 15%).

In short, I think an acquisition does make a lot of sense for Tootsie when the Gordon's children take control (see more under Death & Taxes), but I wouldn't stay up at night worrying that it's done at a significant premium to the current trading levels, acquisition speculation might actually provide some welcome light on this company and what a "reasonable" price is.


Any hidden value to upset a short position?

There is some hidden value within TR, but nothing that begins to make this company worth $27/share. 

Real Estate - The Company owns about 1.6m sqft of manufacturing and warehousing space that has been on its books for quite a while.  However, hidden real estate value in a company trading at 30x earnings is not really hidden (e.g. TR's market valuation applied to this real estate would be a pre-tax sale-leaseback cap rate of ~5%, fairly aggressive in current market).

Assets/Investments - TR has ~$36m of cash, $62m of short & long term investments, and $75m of split dollar life insurance (premiums that have been paid to create a benefit of it's COO/CEO's estate, but Company recoups the actual premiums paid upon death - e.g. it's a 0% investment of the company's cash for benefit of the executive).  For simplicity, much of this is offset by ~$55m of deferred comp and balance-sheet recognized employee benefits.  The company is run a bit like a private bank for the CEO/COO, they keep personal assets in the company as deferred comp to avoid current income taxes.  The disclosure around these accounts is a bit light, but seems there is some excess value here for the Company, and we're talking about a short position so we'll give them the credit.  However, not enough potential value to have a meaningful impact when looking at this valuation.


So how does the short thesis come to fruition?  Death & Taxes?

I hope the short position comes about the old-fashioned way, the market realizing this company is overvalued with time, and TR providing a low-cost short in the interim.  Mrs. Gordon is a very sweet woman, she is kind on the phone, loves her family business, and I hope she has many more fulfilling years.  But, at the risk of being ghoulish, she is 79, and her husband is 90.  Once both pass away, their holdings will likely be inherited by their four daughters.  Based on the information I can access, I believe this will generate quite a tax bill.

Gordon family ownership of Tootsie Roll                
Source: 2009 Proxy                    
      Common   Class B (10x voting)    
      Owned Trusted Total   Owned Trusted Total   Combined
Ellen R. Gordon   8,364,119 104,892 8,469,011   9,133,046 41,316 9,174,362   17,643,373
Melvin J. Gordon   1,360,207   1,360,207   1,360,207   1,360,207   2,720,414
Melvin & Ellen joint fiduciaries   5,730,356 5,730,356     5,263,741 5,263,741   10,994,097
  Total     9,724,326 5,835,248 15,559,574   10,493,253 5,305,057 15,798,310   31,357,884
Total Share Class       35,823,231       19,923,778   55,747,009
  Current Price       $27.00       Illiquid    
% of shares owned by Gordons   56.3%              
% of voting rights owned by Gordons 73.8%              



Total Non-trusted stock owned by Ellen & Melvin & Tax Bills      
* Assume no premium for Class B stock compared to preferred to minimize tax bill (conservative)
    Direct-held Shares        
    (excl. trusts) Estate  Offset Split   Adj. Estate 
    Shares Value Tax Life Insurance   Tax
Ellen   17,497,165 472,423,455        
Melvin   2,720,414 73,451,178 At Current Estate Tax Levels    
  Total   20,217,579 $545,874,633 $300,231,048 -$77,728,775   $222,502,273
Shares sold for tax bill   11,119,668     8,240,825
  As a % of total     19.9%     14.8%
  As a % of common     31.0%     23.0%
        If 35% Estate Tax Reform goes into effect    
        $191,056,122 -$77,728,775   $113,327,347
        7,076,153     4,197,309
        12.7%     7.5%
        19.8%     11.7%

The Gordon's have put a substantial portion of their shares into trusts for their daughters.  The Company has also taken it upon itself to provide "split life insurance" whereby the company makes a 0% investment in life insurance --- Tootsie pays in premiums that will be recovered by the company years later at cost, with excess insurance proceeds going towards the executive's estates.  So, assuming all this cash is used to pay taxes on inheritance, it appears to me that to cover the tax bill, the daughters would have to sell 15% of total shares outstanding, or 23% of common shares outstanding at current tax levels after 2011 (contemplated estate tax reforms shown above as well).

In most cases, employer-funded life insurance is itself subject to tax, unlike most life insurance, in which case the daughters would have to sell even more stock than shown above.  I'm not certain how this particular insurance works so I've given them the tax-free benefit of the doubt.  This analysis also of course depends on what other assets the daughters inherit, etc., which we don't know, but I imagine these stockholdings ($837m in all including trusted assets), is the majority of the estate.

So, at least there's one potential catalyst in an egregiously valued company that should require none.


Market attention

Death & taxes - see above

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