Double-dipping Twinkies tarnish bankruptcy process

January 11, 2012

By Agnes T. Crane

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Wednesday marked a day of mourning for American junk food aficionados – and not for the first time. Hostess Brands, maker of the cream-filled bright yellow Twinkie snack, filed for Chapter 11 bankruptcy just three years after emerging from the court’s protection. That’s not just a kick in the gullet for Ripplewood Holdings, the private equity owner that sank $40 million into the baker last year. The company’s failure leaves a greasy stain on the American bankruptcy process itself.

Filing for Chapter 11 protection is supposed to give debt-laden companies a fresh start. General Motors, Chrysler, major U.S. airlines like United and others have used the courts precisely for this reason. It is easier to renegotiate labor contracts and ax unsustainable debt loads inside the courtroom. Hostess clearly didn’t go far enough in pruning its obligations the first time around. Its largest unsecured creditor isn’t a bondholder or bank; it is a pension fund. The company, in fact, blamed legacy pension and health benefit costs for its current predicament.

To be fair, Hostess isn’t the only repeat filer. Edward Altman, finance professor at New York University, tallies 215 so-called “Chapter 22” filings between 1984 and 2009. The main problem, it seems, is that companies are not emerging from bankruptcy in solid enough shape. One 2006 study found that firms had higher debt ratios compared with the industry standard even after substantially cutting their debt burdens in bankruptcy.

That’s hardly encouraging for firms like General Motors that have returned to the land of the living in recent years. Operating at a disadvantage when times are tough, especially if, like at Hostess, pension costs remain significant, is hardly ideal. Yet if a producer of baked staples like Wonder Bread and Ding Dongs can’t make it, investors should remain skeptical about just how effectively Chapter 11 can scrub away problems.

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Chapter 11 is for creditors. It’s intended to be used when continuing the company will return more to existing creditors than an immediate liquidation (think 20 cents on the dollar instead of 5 cents on the dollar). It is not supposed to ensure the long-term viability of a company. It merely gives creditors a chance to come together a say, “after discounting the 20 cents/dollar forecasted return by the risk that the reorganized company will fail again, the expected return is still higher than the liquidation value of the company, so keep the company in business.”

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