P&G deal partner probe proves shorts aren’t nuts

November 3, 2011

By Jeffrey Goldfarb
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.Skeptical investors who went nuts over Diamond Foods may not be so crazy after all. More than a third of the snack food company’s shares were out on loan in late September in anticipation of the company’s planned December purchase of the Pringles brand from Procter & Gamble. That’s indicative of interest from short sellers, who questioned Diamond’s accounting. Now, the company is undertaking an internal investigation, putting the $2.6 billion deal on hold.

Diamond’s expansion plans excited shareholders. Its soaring stock price, which hit an all-time high of over $92 six weeks ago, reflected a heady enterprise value of more than 14 times pro forma EBITDA, including Pringles, for the 12 months to July 31. But the odd timing of certain payments made to suppliers – big enough amounts of money to potentially make the company’s results look materially different – piqued the interest of the shorts and other observers, including Breakingviews.

Deeper analysis turned up more curiosities at Diamond. Trade receivables have been growing faster than sales, which in theory can be a worrying trend. Investor presentations use charts that are at best sloppily compiled to exhibit the company’s growth. Diamond failed to provide a clear explanation for its upward revision to merger-related costs. Then, even after acknowledging some possible fuzziness, the company repeated the same description in a later statement.

The company for the most part initially dismissed the concerns. And only a month ago, more than half the 13 analysts Thomson One records following Diamond recommended its shares as a “buy” or a “strong buy.” None rated the company “underperform” or “sell.” Representative of the group was Jefferies, which on Oct. 10 considered concerns over the grower payments “unfounded,” upgraded Diamond to a “buy” and set a $94 price target, against a close of around $74 the previous trading day.

Word nevertheless filtered up to Diamond’s audit committee. The company postponed the Pringles deal this week and news of its accounting probe has pushed the shares down under $52 apiece. Even if nothing untoward turns up, Diamond might still be inspired to improve its delivery of information. Either way, it calls attention to the value provided by the salty side of investing. At least the company is listening to the short-selling messengers, not shooting them.

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