Why Diamond Foods’ Stock Has Gone Nuts

Follow the bouncing walnut, investors. Diamond Foods (NASDAQ: DMND ) stock has
taken us for a crazy ride for months, ever since the scandal surrounding its
accounting practices broke in The Wall Street Journal on Sept. 27. A few days
after the report, Diamonds stock dropped 10%. A month passed without ado, then
on Nov. 1, Diamond announced a massive deal to buy Pringles from Procter &
Gamble (NYSE: PG ) was delayed until the first half of 2012 because of an
investigation by its audit committee about crop payments to walnut growers.
Diamond sunk 20% the next day. Ever since then, Diamond has become a trader
magnet, with DMND stock seeing 10 different days of 2 million-plus volume, and
the past three days have seen a 50% gain and a 25% plunge. Where this ends is
anyones guess, but to look forward, we first have to take a glimpse back. From
Nuts to Snacks Before its announcement in April that Diamond Foods was acquiring
Pringles for $2.4 billion, few people had heard of the walnut grower. Until its
IPO in 2005, Diamond Foods was a cooperative owned by northern California walnut
growers with a history dating back to 1912. But the catalyst for change was
current CEO Michael Mendes, who took the reins in 1997. In 2004, Mendes put the
company into the snack market by introducing Emerald nuts. In September 2008,
DMND acquired General Mills (NYSE: GIS ) popcorn business for $190 million.
Eighteen months later, it acquired premium potato chip manufacturer Kettle Foods
for $615 million, putting Diamond squarely in the snack aisle of most grocery
stores and in direct competition with PepsiCo s (NYSE: PEP ) Frito Lay
subsidiary. In just a few years, Diamond had gone from sleepy walnut cooperative
to a player in the snack food business with estimated revenues of more than $2.4
billion. This breakneck business pace pushed its stock from a longtime range of
$15-$20 all the way to $96 in September of this year. Thus its difficult to
believe the timing of $50 million in payments to walnut growers could so
drastically alter the valuation of its stock. The New Deal Walnut growers voted
on July 1, 2005, to approve the conversion from co-op to public company. As part
of the conversion, growers received a combination of $17.3 million in cash and
8.1 million shares in the new company. The IPO states: After the conversion,
former Diamond Growers members will be able to choose to be both an owner of our
business and a supplier of walnuts, solely an owner of our business, solely a
supplier of walnuts, or neither an owner nor a supplier. Growers that chose to
continue supplying the company with walnuts signed Walnut Purchase Agreements of
three-, five- or 10-year periods. Under the terms of the agreement they would
deliver their harvest between September and November each year. Diamond then
pays growers over the subsequent 15 months based on the price set by the company
on March 31 of the following year, taking into account a number of factors
including market conditions, quality of product, etc. Vitally important is that
the first two payments that growers receive are an estimate of the March 31
final price and therefore open to adjustment, which appears to be part of the
focus in this accounting investigation. Its a little like your hydro bill in
that some months are simply estimates while others are actual readings of your
meter. Suffice it to say it would be easy for both the company and growers to
get a little confused. What Does All This Mean? It is going to take a long time
to unravel this mess. Diamond said Monday its fiscal first-quarter results would
be delayed slightly because the audit committee wouldnt wrap up its
investigation until mid-February, with the news sending DMND shares down 25%.
This came just one trading day after Fridays 50% jump that came after a KeyBanc
analyst said the investigation would wrap up quickly and the Pringles deal would
continue.