Diamond Foods is about to have a large data dump. By June 11th in order to avoid being delisted by NASDAQ, Diamond will have to release its financials restatements for the last two fiscal years, plus the financial results for the first nine months of FY2012. That’s a great deal of info to digest. 

One piece of data, however, that will likely be missing is the size of the final payment Diamond will need to make to its walnut growers in July. It is important to remember that this was the payment last year that Diamond tried to shift.

According to some walnut growers, Diamond will have to pay close to 90 cents/lb to give its growers a fair market price for their crop this year. If you assume that Diamond bought at least 100 million lbs of walnut this year, the final payment to its growers could potentially be $90 million dollars.

This is the catch-22 of Diamond’s business. Diamond was able to show dramatic growth by grossly underpaying its captive growers (it has been estimated that since the IPO they have underpaid their growers by over $270 million). Now in order to survive they need to win them back. In order to win them back, however they need to start paying close to the actual market price for the crop. This might be good for supply but will destroy Diamond’s margins. 

And now given all the cash outflows this year that are unrelated to Diamond’s core business (see the definition of “Consolidated EBITDA” in the Securities Purchase Agreement from my previous post), Diamond does not have $90 million dollars in the bank. But because of the Oaktree recap, Diamond does now have $100 million available to borrow on its credit facility.

So in order to pay its growers, I believe Diamond will have to tap its new credit facility for close to $100 million at the end of July. The borrow rate on the facility is a minumum 6.75% (5.5% + minimum libor of 1.25%). This could add over $6 million dollars in cash interest payments annually.

Diamond’s cap structure, therefore, would include, if I am right, close to $475 million of bank debt and $225 million of Oaktree debt. Luckily for Diamond, the Oaktree debt is PIK for two years. Diamond will still be looking at approx. $30 million of cash interest payments in FY2013, plus non cash interest expense that is being compounded at 12% on $225 million (or if they meet their metrics to cancel the warrants $150 will be compounded at 12% and $75 million at 10%). 

The logic of most Diamond bulls at this point appears to be either short squeeze or that no amount of leverage is too much for a branded snack business that also has a volatile commodity business. And therefore paying over 10X EV/EBITDA for a food business is not expensive. 

If you actually do the math, however, it is pretty clear absent real growth from its branded business (prior to accounting issues Diamond’s entire growth was based on high priced acquisitions, underpaying growers and fraud), Diamond Foods’ creditors own almost 100% of their operating profit. 

And to make things worse the two main markets for Diamond are the US and the UK. The US economy is slowing and UK is in a recession. Growing the operating profits (not market share - Diamond is obsessed with market share like all lousy companies) of Kettle Chips, Popsecret and Emerald Nuts organically, and not through fraud or acquisitions, in such a bleak macro environment in a mature category will be difficult. 

A Minsky Moment has become a popular term since the financial crisis. It refers to the fact that long periods of speculation lead to a crisis. The longer the speculation the worse the crisis. Investors eventually run into cash flow problems due to the amount of debt they took on to finance their speculative investments. During a Minsky Moment the market clearing price collapses. 

Diamond, since FY2008, has increased its debt from $20 million dollars to now upwards of $700 million to finance high priced acquisitions and to meet their general cash obligations. They are levered at least 6X over “Consolidated EBITDA.” The de-leveraging that was suppose to occur after these acquisitions still has not happened. The de-leveraging that could have occurred with the recap still has not happened. At some point the de-leveraging will happen. It will happen either by the miracle of growth or by force. 

Diamond bulls: I would recommend you start eating a lot of Kettle Chips, because otherwise Diamond will have its Minsky Moment much sooner then you realize.