Friday, 28 January 2005

Rolling Towards a Takeover?

Tootsie Roll Industries

Ticker: TR (A shares), TROLB (B shares)

Price: $31.95(A)


Market Cap: $1789.3

Avg Daily Volume: 60,000 (A)

9 (B)

Dividend Yield: .88%

First off, the subject of this weeks report has nothing to do with real estate, nor does it trade below its net current asset value. But it may be ripe for a take-over and in that context, may offer compelling value, and is worth a column.

Tootsie Roll Industries is not an exciting company. Your editor has followed it for several years, but has never owned the shares. I’ve downed my share of Charleston Chews, Tootsie Rolls, (the fruity variety, as well as the original) Blow Pops, and other sweets made by the company, though. And that is often the start of my research into a company…”like the product, do the research.”

The company has been around nearly a century, went public in 1922, as the Sweets Company of America. It was renamed Tootsie Roll Industries in the mid 1960’s. Several acquisitions later, the latest being Dubble Bubble brands from Concord Confections in 2004, the company “Rolls” on.

In recent years, though, growth has been weak. Sales have been flat for years. Fiscal year 2003 sales of $392.6 million were down slightly from 2002 sales of $393.19 million. And that’s up just 4.5 percent from 1997 sales of $375.59 million. The earnings story is similar. Not a very convincing argument so far? Read on.

Although growth has been anemic, this is an extremely profitable business. Profit margins (net income/sales) have averaged over 17 percent for the past five years. By comparison, candy giant Hershey Foods has averaged just over half that, at 9 percent, while gum maker Wrigley has averaged just under 15 percent. (Actually, 15 percent is quite amazing in and of itself)

While Tootsie Roll currently trades at a seemingly expensive 25 times earnings, that is well within it’s historic P/E range. The company commands a higher multiple than one might expect for two reasons. First of all, its high profit margins. Companies with consistent, higher than average profit margins can command higher P/E multiples. Secondly, this company has historically maintained relatively high balances of cash and marketable securities, along with little or no debt. This “margin of safety”, helps investors justify paying more per dollar of earnings than they otherwise might, all else being equal. Overall, the combination of high profit margins and a strong, cash-rich balance sheet is a powerful one.

While the recent Dubble Bubble acquisition lowered cash and short term investment balances, the company still has $60 million (down from $139 million). (The company also assumed $105 million in long-term notes payable to pay for Dubble Bubble.) On the non-current asset side of the balance sheet, the company has $107 million in long term investments (mainly municipal bonds), and another $76 million listed as split dollar life insurance and other assets (we are assuming the bulk of that is split dollar life insurance). With 52.275 million shares out, that equates to $3.19 per share in cash and marketable securities. Add in the split dollar life insurance, and that’s $4.65 per share.

You probably aren’t yet convinced that Tootsie Roll is a takeover candidate. I don’t blame you. High profit margins, a strong brand name, and solid balance sheet don’t necessarily translate into a takeover. But aging owners complete this picture.

The Gordons

That’s Melvin and Ellen Gordon. Melvin, at age 85, is Chairman of the Board and CEO. His wife Ellen, age 73, is President and Chief Operating Officer. Melvin has been a director of the company since 1952 and Chairman of the Board since 1962. Ellen has been a director since 1969, and President since 1978. That’s a lot of history, and a lot of time to acquire a major piece of the company. And acquire the Gordon’s have. They currently own, or control more than 79% of Tootsie Roll’s Class B shares (there are 17.6 million outstanding)-that’s the class with most of the voting rights-and 40 % of the class A shares (34.7 million outstanding). The total market value of the Gordon shares is $980 million, or 55 percent of the company’s total equity market value. Ultimately, one would imagine, the Gordon’s will either want out, or want to convert at least some of their shares into cash. Estate planning sometimes necessitates changes in ownership. When you add this piece to the puzzle, the takeover scenario becomes much more viable.

A 12/20/04 article in Crain’s Business Daily suggested that Wrigley might be interested in acquiring Tootsie Roll. That’s an acquisition that could make a lot of sense for Wrigley (I do own shares in this company), on the heals of its 11/15/04 acquisition of Life Savers, Altoids, and other brands from Kraft Foods. Cleary, Wrigley is attempting to move beyond gum, and acquiring a highly profitable well-know brand such as Tootsie Roll would be a next logical step. However, you can’t rule out Hershey as an acquirer, either.

Tootsie Roll shares reacted favorably to the Crain’s story, jumping $2.00 in the week following the story. The stock has since settled back down to the pre-Crain story price range. The real question is, do the Gordon’s want to sell, and at what price? They hold the keys. Stay tuned.

*The author does not have a position in this stock. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.

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