More to Diamond Foods gaffe than meets the eye

Some days CEOs would be better off staying in bed.

By Motley Fool Pick of the Day Feb 10, 2012 5:03PM
By Sean Williams


Last month, I introduced a new weekly series, the "CEO Gaffe of the Week." Having come across more than a handful of questionable executive decisions last year when compiling my list of the Worst CEOs of 2011, I thought it could be a learning experience for all of us if I pointed out apparent gaffes as they occur. Trusting your investments begins with trusting the leadership at the top -- and with leaders like these on your side, sometimes you don't need enemies!


This week I want to highlight the now former CEO of Diamond Foods (DMND): Michael Mendes.


The dunce cap
Seriously, where to begin?


Diamond Foods, one of the largest manufacturers of snack foods and the name behind Emerald Nuts and Pop Secret, announced yesterday that it was placing CEO Michael Mendes and CFO Steven Neil on administrative leave. The reason for their departure was an internal accounting probe which discovered that Diamond had made improper payments to walnut growers over the past few quarters, and that these payments would necessitate a restatement of its 2010 and 2011 results. In short, Diamond was knowingly making late payments to its walnut growers to artificially inflate its profits.


Those three sentences more or less sum up the chaos at the top of Diamond -- but there's more to this story than meets the eye.


Diamond Foods also agreed last April to purchase the Pringles brand from Procter & Gamble (PG) for $1.5 billion in an all-stock deal. If successful, this deal would make Diamond the No. 2 snack food company in the United States, behind only Frito-Lay, the snack food division of PepsiCo (PEP) that owns the Fritos, Cheetos, Doritos, and Ruffles brands, to name a few.


That deal is looking significantly less likely as of now because of the "material adverse change" clause that's built into its buyout agreement. Procter can choose to walk because the earnings restatements may result in up to a 50% reduction in Diamond's 2010 and 2011 total EPS -- a fact that I feel would entice any court to side with P&G.


In addition, P&G isn't likely to accept the deal on the grounds that Diamond is backing the purchase with its stock, and the last time I checked, its share price was approaching losses of more than 75% since September.


To the corner, Mr. Mendes
But wait -- there's more!


The Justice Department in January launched a criminal probe into alleged impropriety related to those payments made to walnut growers. Although the Securities and Exchange Commission hasn't launched a formal investigation into Diamond's practices, I'd consider it just a matter of time before that happens. Let's not forget that you can almost assuredly expect a littering of shareholder lawsuits to hit over the next few weeks following the admission that a restatement of earnings is needed by the company.


Right now, Diamond looks like a shell of its former self (oh, I made a funny), but its near-term outlook is no laughing matter for shareholders. P&G will more than likely look elsewhere for a buyer of its Pringles brand, and I happen to think (on a purely speculative basis, mind you) that Kraft (KFT) would make a perfect pairing with its Ritz and Oreo brand names.


If we were in a nine-inning baseball game, this debacle hasn't even hit the halfway point yet. Mendes has assaulted Diamond Foods shareholders' wallets and completely destroyed his company's image -- all in a years' work.


Fool contributor Sean Williams has no material interest in any companies mentioned in this article. The Motley Fool owns shares of PepsiCo. Motley Fool newsletter services have recommended buying shares of PepsiCo and Procter & Gamble, as well as creating a diagonal call position in PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that never wears a dunce cap.


Feb 10, 2012 5:49PM
I believe that Kraft is splitting off its snack foods division. Would they want to buy another snack company during this process? Maybe P&G would be better off just splitting off its snack foods.
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