Diamond Foods: Cue The Comeback?

By Will Ashworth | May 23, 2012 AAA
Anyone who spends a decent amount of time following stocks probably knows the story behind the downfall of Diamond Foods (Nasdaq:DMND), the California snack food company that tried to buy Pringles from Procter & Gamble (NYSE:PG), but got indigestion instead. Long story short, Diamond's CEO and CFO lost their jobs over bad accounting practices and its stock dropped from $90 to below $30 in a matter of weeks. Since then, a lot has happened to try to right the ship. Is it enough to cue the comeback? We'll see.
New CEO
Many will question the May 7 decision by Diamond's board to hire Brian Driscoll as its new CEO, replacing interim boss Rick Wolford, the board member who took the helm in February until a replacement could be found. Driscoll's last gig was running Hostess Brands from June 2010 until March of this year. Walnut growers seem leery of the hire because Driscoll's background is with consumer goods companies like Kraft (NYSE:KFT) and Procter & Gamble, and not within agriculture. Clearly, Driscoll is going to have his hands full on that side of the business, but it's ludicrous to think there isn't someone in the company that can deal with the growers on issues of a technical nature.

Still others believe he is the wrong man for the job because he led Hostess, which went into bankruptcy in January and the board is simply reshuffling the chairs on the Titanic. That view is short sighted. As Kraft's president of sales, Driscoll was instrumental in the acquisition of Cadbury in early 2010 and was looking for an opportunity to be a CEO.

The problem with Hostess is it is still saddled by union contracts and pension benefits that make it uncompetitive in the food industry. Once it became apparent that the unions were not going to play ball, Driscoll had no choice but to step aside. Ripplewood Holdings, Hostess' current owner, sunk $130 million into it, with nothing to show for its investment. I once had a minister who liked to say he was qualified to talk about sin because he himself had sinned many times in the past and could relate. Driscoll joins Diamond well versed in financial difficulties. I view his Hostess experience as preparation for the task. In my opinion, it was an astute hire.

Capital Injection
Diamond announced May 24 that Oaktree Capital Management (NYSE:OAK) was investing $225 million in the company in an effort to solidify its balance sheet. In return for Oak Tree's investment, Oak Tree receives senior secured notes paying 12% interest that mature in 2020 as well as warrants to purchase 4.4 million shares at $10 apiece, representing a 16.4% ownership interest.

If Diamond achieves certain criteria by January 2013, the warrants would be cancelled and Oaktree may then exchange $75 million of the notes in return for convertible preferred stock with a conversion price of $20.75 and paying a dividend of 10%. With the proceeds, Diamond will repay $100 million in term loans and $100 million on its revolving credit, which reduces its total bank debt to approximately $475 million. Now that the ship is righted, it can go to work mending its relationship with walnut growers.

Changes Affecting Walnut Growers
I'm sure the growers are bitter about what's happened. However, the company is committing additional resources to the walnut side of its business, which obviously was neglected in recent years. Most importantly, it's put into place several improvements for growers that are meant to heal some of the wounds. Three of the big ones are paying growers sooner, providing greater clarity on final crop prices, and reducing the number of years for new contracts. There is a saying that you can be either a part of the solution or part of the problem. The growers need to decide which is more constructive, and I think we all know the answer to that.

The Bottom Line
The Street.com believes that Oaktree Capital took Diamond shareholders for a ride by forcing them into a one-sided deal. Any successful deal I've ever witnessed means both parties win something and lose something simultaneously. In Diamond's case, it pays through the nose for the $225 million, which is what it loses in the deal.

However, it gains the right to rebuild its business, which you can't put a price on. As for Oaktree, it gains a good income investment with an even better equity kicker. On the downside, and there is one; it stands to lose some or all of its investment should Diamond fail to get back on track and is forced into bankruptcy protection.

That's because the notes, while senior in nature, are unsecured. No, this deal is a good one because both sides understand what is at stake. In the end, it had to get beyond the debacle of the past year and it couldn't do that without putting itself in good standing financially. Can we cue the comeback? We most certainly can.

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At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.

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