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Diamond Foods Choked on Pringles

Updated to include added information on Procter & Gamble's Pringles sale starting on page two.

NEW YORK (TheStreet) -- Diamond Foods (DMND) "transformational" plan to buy Procter & Gamble's (PG) Pringles business may turn out to be the deal that transformed the company into a financial mess.

Diamond Foods may have pushed too hard on its finances to cut the $2.35 billion acquisition - paid in stock and the assumption of debt in April of last year -- in a deal that may not even close as a result of accounting issues. While Pringles would more than double Diamond Foods sales, it also doubled the company's liabilities and may have put the company in a tight position with its lenders.

Diamond Foods may have choked on Pringles

After Wednesday audit committee findings revealed two years of accounting misstatements that prompted the replacement of top executives, Diamond Foods is poised to breach covenants on loans needed to finance the deal, putting the company's fate in the hands of its bank creditors, instead of shareholders.

"The company as you knew it is not in control of its own destiny anymore," says Louis Meyer a special situations analyst with brokerage Oscar Gruss & Sons.

Instead, Diamond Foods' lenders led by Bank of America (BAC) and a syndicate of six other banks including JPMorgan (JPM), Barclays (BCS), KeyBank (KEY) and Suntrust Bank (STI) now are a key determinant of the company's fate, as a Securities and Exchange Commission investigation and a reported Department of Justice inquiry into the company's supplier payments continue. Meanwhile, shareholders reeling from a near 37% Thursday stock drop, may hold little sway.

Audit committee findings that the company didn't properly account for Emerald Nuts walnuts supplier payments may force the company to recognize an additional $40 million in 2011 expense, pushing down earnings to a point where leverage covenants on loans are breached. According to those loans, a covenant breach can trigger a default, making Diamond Foods' fate contingent on negotiations with its bankers, as is often the case with stressed debtors.

Meanwhile, shareholders may have little say in what the company does as it tries to survive accountancy issues and sudden management change. Currently, Wellington Management, Fidelity Management and TIAA Cref are the company's biggest shareholders with 10%-plus stakes, as of the most recent Securities and Exchange Commission filings compiled by Bloomberg. Del Mar Asset Management and BAMCO, both were the large sellers of the company stock recently, according to the SEC filings.

While Meyer says that it's unlikely the lenders would want to put Diamond Foods into bankruptcy, they will "extract higher compensation for the increased risk that is now associated with lending to this company." Those lenders are also going to look at how to maximize the value of Diamond Foods, whether that means selling assets or continuing the business with a revamped management and operating model. In a November note, Meyer valued Diamond Foods at $21 a share if accounting issues that surfaced last fall were confirmed and shareholder suits moved forward. In December, Bank of America chose not to trigger a covenant breach after Diamond Foods delayed its earnings statements, subject to a filing by March 2012.

Negotiations between Diamond Foods and its lenders have begun in relation to Wednesdays findings, according to a source familiar with the situation.

On top of accounting issues, Diamond Foods announced on Wednesday that Chief Executive Michael Mendes and Chief Financial Officer Steven Neil were placed on administrative leave. Former Del Monte Foods CEO Rick Wolford was named acting president and CEO of Diamond Foods and Alix Partners Managing Director Michael Murphy was named acting financial chief. Turnaround specialist Alix Partners has experience leading companies through management change, improvement of financial controls and bankruptcy. Diamond Foods shares slid nearly 37% to $23.13 after the announcement.

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Consensus estimates of analysts polled by Bloomberg give Diamond Foods a price target of $38.50 a share. In a Thursday note, D.A. Davidson analyst Timothy Ramey said the sum of the company's parts is worth $44 a share.

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