Diamond Foods (DMND) has had a horrible performance in 2012. The company has been accused of fraud and scandals by regulators, which caused the stock to plummet. There has been talk that Diamond has not been properly compensating walnut growers. There is an estimate that Diamond owes the walnut growers around $50 million and that it might have held off on the payment to inflate earnings.
Once the investigation was announced, Joe Silveira, the Audit Committee's Director committed suicide. It is still unclear the motive behind such an unfortunate incident. However, there was plenty of speculation saying that it was due to the investigation into the company's accounting practices.
When news of the suicide and investigation was announced, the stock got hammered. The company pushed back filing its 10-Q and there was possible rumors of the stock being delisted.
Last year, Diamond planned to acquire Pringles from P&G (PG) for $2.35 billion. However, with the recent probe going on, the deal has been halted until a decision has been made. Procter and Gamble has been trying to sell Pringles so the company can shift its attention to its personal cleaning business. I believe the market has knocked down for two reasons.
The investigation is of course a major reason as if it turns out that the fraud could be large then major lawsuits could follow. However, what the market fails to see is that the company's max liability is $50 million. This is the amount it would owe to walnut growers if there truly is fraudulent activity occurring. It also seems that Diamond was not intentionally trying to skim money from the farmers rather there fiscal year did not properly match the calendar year for farmers which is what seems to be causing the disparity. There is a strong possibility that Diamond could end up paying $50 million plus additional compensation to farmers for "pain and suffering" if it comes to that. However, I believe the max that Diamond could pay if everything goes smoothly is in the range of $50 - $125 million, which is a fairly conservative estimate. This doesn't make a whole lot of sense considering the company shed nearly $1.5 billion of market cap following the news of the investigation.
The other reason is that there is still uncertainty behind the Pringles deal with P&G. While P&G has been patient with Diamond's investigation, which is suppose to end in February. The deal is set to triple Diamond's revenue. The last day to close the deal is on June 30, 2012 otherwise it becomes invalid. When the deal was announced, Diamond was set to pay $850m to assume Pringles’ debt. At the collar’s lower boundary, a share price of $45, causes the level of debt to rise $200M to a ceiling of $1.05B to compensate P&G for the lower value of Diamond shares. The thing is that both parties would like to see this deal go through. The synergies between Pringles and Diamond are strong and P&G does not seem to have many interested candidates.
I believe there is way too much pessimism in Diamond Foods. There is a very good chance that the company will walk away unscathed from this and once it does then shares will easily be above $45. This would mean the deal would go through and Diamond would be able to reap the benefits of the deal. I recommend investors take up a position in Diamond as the risk-reward is great. One important note is that this is still a speculative play and there is a chance that the fraud is real and could be very large. I do not see this scenario happening, but investors should consider all possibilities when investing.