Diamond Foods crashes after running before walking

Diamond Foods has been reduced to an injured crawl after it tried to run before walking. The salty snacks purveyor came clean after the market closed on Wednesday about $80 million of bad accounting and replaced its chief executive and chief financial officer. The shares tanked another 40 percent, to under $22, in after-hours trading, and its hope of buying Pringles looks all but dead. It’s a cautionary tale of how hard it is to go from private and small to public and big. But that’s not the only lesson.

Four months ago, Breakingviews pointed to some oddities in Diamond’s financials, including dubious-sounding “momentum payments” to walnut growers. The company brushed off the inquiries. So did most investors: Diamond shares were trading at over $90 apiece at the time.

As it turns out, Diamond had overstretched. The misstatements now identified by the company’s audit committee suggest the onetime walnut cooperative wasn’t ready for the governance big time. After going public in 2005, Diamond bought popcorn maker Pop Secret in 2008 and then Kettle Chips in 2010. Before long, it set its sights more globally, pursuing a plan to buy Pringles from Procter & Gamble for $2.4 billion. That deal has been on hold and now looks virtually unsalveagable.

Inexperience also showed in the way Diamond initially treated doubters. Short sellers piled into the stock when walnut growers raised concerns about the payments they were receiving. These financial skeptics were dismissed, though word eventually filtered up to the audit committee, which launched its accounting probe last November. A sounder strategy might have been to engage with the shorts – or at least with perplexed growers – sooner. (Though to be fair, there aren’t many public companies that have shown a willingness to do that).

The persistence of skeptics serves as a stark reminder in the post-Enron era that accounting can still catch a company out. It’s all well and good that Diamond Chief Executive Michael Mendes gained the trust of sell-side analysts, many of whom stood behind him even after the irregular payments were brought to their attention. Even on Wednesday, none of the 13 analysts Thomson One records as following the company rated the company’s stock any worse than a “hold”.

The end of that cozy relationship with Wall Street may even bring a silver lining. It’s a numbers game, and the analysts who went nuts for Diamond’s story hopefully won’t be so easily persuaded again by other too-good-to-be-true tales.