It was Friday the 13th and another black cat crossed Diamond Foods' (DMND) path. For a company who sells nuts and popcorn, the combination of an SEC inquiry and a DoJ investigation takes the fun out of owning small-cap food companies. Both agencies are investigating DMND on accounting treatment of payments to walnut growers.
Last week, KeyBanc threw in the towel and downgraded DMND to hold after beating the table with a "buy" several months ago.
KeyBanc analyst Akshay Jagdale who issued the downgrade report was also one of several other analysts who had been gung-ho on Green Mountain Coffee (GMCR) prior to that stock's implosion following their Q4 earnings.
It should be noted that KeyBanc was affiliated with underwriters of GMCR's latest secondary.
Ironically, KeyBanc had hired accounting consultant Robert Willens to help them assess the bookkeeping at DMND. In early December, Willens gave DMND a clean bill of health suggesting that potential restatements would be likely be limited to violations of its contract with walnut growers.
More interesting, Willens was also a consultant to KeyBanc regarding Green Mountain in support of their bullish view of the coffee company back in Oct.
The Merriam Report has had a thumbs down on GMCR's accounting since 2010. Their financial statements were some of the worst we have seen in a long time...and blatantly so.
The Diamond story however, is perplexing. There are shareholder lawsuits lined-up out the door, the SEC and DOJ are sniffing around and mixed signals from the knuckleheads who get paid big bucks to know these things...analysts!
As mentioned in our November 10th Seeking Alpha story, we view the deal risk associated with DMND's proposed Pringles acquisition (from Proctor & Gamble) as a primary suspect to the hoopla surrounding this situation.
As the stock price surged into outer space, it was obvious that investors were more focused on the strategic merits of the deal rather than concerned with details to the working parts of the transaction.
Obviously, the protracted uncertainty of multiple investigations (internal, regulatory and now criminal) have been costly for investors. It also comes as no surprise to see the surge in class-action complaints either. Many of the recent headlines regarding DMND are from law firms reminding us of upcoming "lead" plaintiff deadlines.
On the matter of litigation we see several anecdotal trends emerging. Most of these complaints allege that DMND mis-lead investors by its failure to properly account for payments to walnut growers and in doing so, painting an overly optimistic view of its efforts to acquire the Pringles brand. To the extent that DMND's allegedly improper treatment of the payment was, in fact, an intent to defraud investors is one thing.
However, it was common knowledge that DMND wanted to purchase Pringles, but not much attention was being given to how P&G was structuring the deal in a tax advantaged "Reverse Morris Trust".
The bottom-line is that while Pringles would make a potentially strategic fit for DMND, they would be selling their soul (via equity) to get it. If anything, Proctor & Gamble shareholders stood to benefit most. They influenced terms of the deal and DMND was going to have to pay to step-up in the world.
It can't be any worse than the pompousness of "team" Green Mountain's three-ring circus act pitching their massive secondary to investors. GMCR needed the liquidity to pay down debt (a portion of it to certain parties affiliated with the lead underwriter) and for insiders to dump hundreds of millions of dollars worth of stock.
Despite several years of rapid growth, GMCR didn't have tangible equity or cash-flow when its insiders cashed in recently. In the case of DMND, they will potentially be giving-up lots of equity, but in return for operating assets which while costly, have the potential to be a driver of future growth to DMND shareholders. At least DMND generates cash-flow from their operations.
In our view, the wealth destruction suffered by GMCR shareholders has a far more sinister characteristic than the fear of uncertainty (and possible negligence) in the timing of a $50 million payment to walnut growers.
In each case, the irony of financial engineering is obvious, but the construction and motive of its elements couldn't be more different. It's the irony of the situation we believe, that many investors and some analysts may be overlooking.
In theory, an accounting "discovery" for a farm-to-fork enterprise shouldn't be too complex to trace precedent and dependent actions within the financials. By contrast, the due diligence of a technology company (such as a smartphone manufacturer) is much different. But, we are talking nuts here!
So, unless we are missing something totally out in left-field, or some bizarre soap-opera abrogation of contractual obligation on the part of DMND, the company's financial statements look straighter than the line of litigants standing at the door.
Keep in mind DMND shares are in the dog-house and will likely continue to be at least until the company's preliminary results of its internal investigation into the accounting of the payment are released. Yet, at some point we see a company whose stock at current prices might be a tempting snack to munch on.
Disclosure: I am long DMND.
