Diamond Foods (DMND) is having a rough week. It announced that it would need to restate two years’ worth of financial earnings in the wake of questionable accounting practices on Wednesday, February 8. Just a few hours later, Procter & Gamble (PG), a top pick for Warren Buffett’s Berkshire Hathaway, announced that it was re-evaluating the sale of the Pringles brand to Diamond Foods. “Pringles remains a valuable asset and it has attracted considerable interest from other outside parties,” said Paul Fox, a spokesman for Procter & Gamble. “We need to evaluate next steps and we are currently keeping all our options open.”The deal, which was announced last April, was worth roughly $2.4 billion, largely financed through stock. The idea was that Procter & Gamble would spin off its Pringles business and Diamond Foods would acquire it, making it the second-largest snack foods company in the world, but there were delays after questions regarding Diamond Food’s accounting practices, particularly with regard to payments it made to walnut growers. Diamond Foods responded by conducting a complete audit, which ended by the company laying off its CEO Michael J. Mendes and CFO Steven M. Neil while replacements are found and its announcement that it would be restating its earnings. The earnings restatement is likely to be significant. According to the New York Times, “A $60 million momentum payment made in September 2011 will now be included in the company’s 2011 fiscal results, which ended July 31. A similar $20 million momentum payment made in August 2010 will now be shifted from Diamond’s 2011 financial results to 2010. Diamond earned only $50 million in 2011 and $26 million in 2010.” The shift could mean that Diamond Foods’ 2011 earnings will fall from the $2.61 a share it reported to a mere $1.14 a share. Its 2010 earnings would take a similar cut.
The situation is certainly unique, especially given that the contracts were signed – but there was a clause that lets Procter & Gamble walk away. It is called a material adverse change or MAC, and it happens anytime the practical matters of a company or situation change after a deal is announced but before it actually goes through. The combination of restating earnings with the changes in its leadership gave Procter & Gamble the right to terminate the acquisition.
Diamond Foods took a major hit on the news. It had been trading at $36.66 a share when the markets closed on Wednesday, February 8. The news of Procter & Gamble’s cold feet on the Pringles deal was announced Wednesday evening. By the time the markets opened trading on Thursday, February 9, Diamond Foods had fallen to $21.79 a share. Some of the serious decrease could be owing to the massive volume of traders selling the stock – on February 9, Diamond Food’s trading volume was roughly 26.34 million, compared to an average volume (3m) of just over 2.6 million.
On top of all this, there will likely be investigations and litigations to deal with, by shareholders and possibly the SEC. Of course, Diamond’s short sellers are rejoicing. But, if Diamond Foods can pull through this, there could be a silver lining for investors who believe in the snack foods company in the long term.
Wellington Management Company, an investment management provider also bought a large stake in Diamond Foods during the fourth quarter, almost 3 million shares or 13.60% to be precise according to the 13G filing with the SEC. Wellington Management Company is a privately owned investment firm that specializes in pension and profit-sharing plans. The company also owns significant stakes in Shutterfly (SFLY), JetBlue Airways (JBLU), LinkedIn (LNKD), Swift Transportation (SWFT), MDC Holdings (MDC), United Rentals (URI) and Newfield Exploration (NFX). There have also been several companies that bought into Diamond Foods in February 2012. The list includes the Vanguard Group which bought 5.39% and TIAA-CREF Investment Management which bought 7.48%.
With so many asset management companies involved and the relative power of the Diamond Foods brand portfolio, which includes Kettle chips, Pop Secret popcorn, Emerald nuts and, of course, Diamond nuts, the company could recover from this and, if not, it could be a good acquisition target – and, as such, carry the potential for a fair profit. Take the acquisition of Anheuser-Busch by InBev (BUD). InBev offered $70 a share for Anheuser-Busch. On October 29, 2008, well after the acquisition was announced, Anheuser-Busch was trading at $59.83 a share. If an investor bought in, he would have made $10.17 a share or a profit of 17%. The same thing could happen with Diamond Foods.