Dealtalk: Suitors for Diamond brands have long wait to snack

NEW YORK/PHILADELPHIA Mon Feb 20, 2012 4:36pm EST

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NEW YORK/PHILADELPHIA (Reuters) - Food companies salivating over Diamond Foods Inc's (DMND.O) Pop Secret popcorn and Kettle potato chips will want to wait for a full examination of the company's books to be completed, and by then Diamond may have cleaned up enough of its problems to not even put them on the table.

Those problems certainly mount up. The San Francisco-based company is mired in a federal probe into accounting for payments to walnut growers, many of whom are now so unhappy with the seller of Emerald nuts that they are considering severing ties with the company. [ID:nL2E8DAEJX] The nut business makes up more than half of Diamond's sales.

In addition to working to repair those relations, Diamond faces a handful of shareholder lawsuits since its stock has lost three-quarters of its value since September. After removing its CEO and CFO, it must hunt for permanent replacements and comb through its accounting and restate earnings for the past two years, a move that is likely to breach its debt covenants. Diamond would then have to renegotiate those debt agreements and is likely to face higher interest payments, analysts said.

"We think it will take a while to restate the numbers and it is unlikely a buyer will step forward until the numbers are complete," said Kirk Ludtke, managing director of CRT Capital Group LLC. "It's hard to see the restated numbers coming out sooner than within six months. You have to do some investigative work to make sure you don't uncover anything else."

Nonetheless, talks with potential buyers could take place on a parallel path, he said, and a deal could be arranged subject to the numbers being confirmed in a certain range.

Diamond, born a century ago as a walnut growers cooperative, was on track to become the world's No. 2 snack food maker behind PepsiCo Inc (PEP.N), with the planned purchase of Pringles. But in light of Diamond's troubles, Pringles' owner Procter & Gamble (PG.N) made a new deal with Kellogg Co (K.N), giving the cereal company that distinction and shattering Diamond's dream for now.

"It's fair speculation to question the fate of Diamond," said a consumer investment banker who declined to be identified because he was not authorized to speak to the media. "The non-walnut businesses are strong -- Pop Secret and Kettle -- and would be attractive takeout targets."

Those businesses could attract a host of suitors, including Kellogg itself, Kraft Foods Inc KFT.N, snacks maker Snyder's-Lance Inc (LNCE.O) and Terra chips maker Hain Celestial Group Inc (HAIN.O), analysts said. Bankers said Pop Secret and Kettle could fetch $850 million to $1 billion together, well above Diamond's $540.4 million market cap as of Friday's close.

And there may be some urgency to buy those brands, now that Kellogg is buying Pringles, said Bevmark Consulting CEO Tom Pirko.

He said Kellogg could move to further solidify its place in snack foods by buying Kettle and/or Pop Secret, or that Kraft Foods Inc KFT.N might want the brands, to add to what will soon become a global snack food company once it separates its North American grocery brands.

"If you want to prevail, especially if you have any hopes of going up against (PepsiCo's) Frito-Lay, you must go really fast," Pirko said. "This is a relatively simple game, checkers not chess. The issue is who will muster the boldness to advance across the board."

In an interview with Reuters last week, Kellogg Chief Executive John Bryant declined to comment on his company's interest in Diamond or any of its brands. However he did say that Diamond's salty snack brands would fit better at Kellogg once it has Pringles.

"You could say our ability to do bolt-on acquisitions has probably expanded with the addition of this business," Bryant said on Wednesday.

A Kraft spokesman said the company never comments on speculation. A spokesman for Diamond declined comment.

TOO MUCH TURBULENCE

Diamond's former chief executive, Michael Mendes, took the walnut cooperative public in 2005 and since then, tried to steer it away from commodity nuts into more branded, higher-margin products. He heavily marketed the Emerald snack nut brand, bought Pop Secret popcorn in 2008 for $190 million and Kettle potato chips in February 2010 for $615 million.

Bankers say those brands, were they to go on the block, could now be worth $850 million to $1 billion together.

Ken Harris, of Kantar Retail Americas Consulting, said he was not sure what company would want to buy Diamond Foods as a whole, since its roots as a cooperative of walnut farmers can make deals difficult. As for the individual brands, Harris said they could attract interest from any maker of snack foods, which range from the well-known giants to smaller companies like Hain Celestial and Snyder's-Lance.

Yet Harris said there is "too much turbulence" at the moment to know exactly what will happen.

"If there's a loss of confidence in management, they'll get new management. If there's a feeling that they need to sell some assets in order to increase the available cash to buy the base business produce, then they'll do that," Harris said.

"But I truly believe that they're at this point working through a lot of these issues. And probably the most important thing is to try to get to the bottom of what has happened and what it means," he said.

The global snack food market -- including fruit snacks, potato chips, tortilla chips, popcorn, pretzels, nuts and other sweet and savory snacks -- was worth $111.4 billion last year, according to Euromonitor International. The United States accounted for $31.8 billion, or nearly 29 percent, of the total.

PepsiCo's Frito-Lay business dominates the sector by far, owning four out of the top five brands globally with Lay's, Doritos, Cheetos and Ruffles. Pringles is the No. 4 brand, according to Euromonitor.

MENDING TIES

D.A. Davidson analyst Tim Ramey thinks the most likely scenario for Diamond is that it ultimately recovers from its troubles and gets back on its growth track.

"We're relatively bullish on the stock. It's a terrific company," Ramey said, referring to the company's track record aside from the one accounting issue and his expectation that relations between the growers and the company will be restored.

In a letter to growers last week, Diamond's new managers said the relationship between growers and Diamond "has been strained and now needs to be addressed".

Several growers, including Pat Mecklenburg in Rio Oso, California, have already stopped doing business with the company. When asked in an interview if she would rekindle her relationship with Diamond, now that its new managers are trying to mend ties, Mecklenburg said she would consider it.

"But you've got to give them a year," Mecklenburg said. "Are they going to be a viable company?"

Analyst and bankers said concerns by growers about Diamond's financial future are overblown and unfounded.

"It's not a bankruptcy candidate at the moment. It's a $25 stock. It's not trading for pennies on the dollar. There would have to be a few more surprises to fully derail the company," a second consumer investment banker said. The banker was not authorized to speak to the media.

"When you look at other companies with scandals -- the WorldComs and Enrons of the world -- they got bought out in full or in pieces. But that was after all the dirty laundry was aired. There's still time for Diamond to do forensic accounting and make sure they are fully clean," the second banker said.

(Additional reporting by Sue Zeidler in Los Angeles, P.J. Huffstutter in Napa, California and Mihir Dalal in Bangalore.)

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