Diamond Foods (NASDAQ:DMND) nosedived nearly 40 percent after an internal probe found the snack company had obfuscated payments booked to walnut growers, prompting the company to fire two top executives and promise to restate the last two years of earnings.

The revelations could result in the San Francisco-based company defaulting on its debt covenants and killing plans to pay $2.5 billion deal to Procter & Gamble Co. (NYSE:PG) for the Pringles brand of potato chips. The canned crisps were to be spun off to Diamond, P&G said in April. The deal was pushed back to the first half of this year after the audit committee's investigation opened last fall. 

We're obviously disappointed by the information released by Diamond Foods, said Paul Fox, a P&G spokesman, told the Wall Street Journal. We need to evaluate our next steps ... either retain the business or we sell it. It's already attracted considerable interest from outside parties.

P&G is expected to walk away from the deal entirely seeking to find a buyer for its last food product, according to Akshay Jagdale, a KeyBanc Capital Markets analyst. The scuttled deal would leave the Diamond, the maker of Emerald Nuts and Pop Secret popcorn, footing a $60 million breakup fee, according to Jefferies analysts.

Effect on shareholders

Despite the difficulties, Jagdale maintained his Hold rating on Diamond stock.

As for fair value, we believe (Diamond) is worth $44 excluding Pringles in a break-up scenario based on our sum-of-the-parts valuation and worth $33 excluding Pringles, Walnut and Other Nuts, Jagdale wrote in a report.

That suggestion to hold could cost investors dearly. The company's stock price, which has endured a six week fall, dropped $13.31 to $23.36 in early afternoon trading. The plummet represents a nearly five-fold fall from a $96 high in the last 52 weeks.

Over half of Diamond's are held in short positions, fueling the precipitous drop, according to the Financial Times.

The investigation

The internal probe by the company's board audit committee found payments made in August 2010 and September 2011 to walnut growers presented an either-or game of guessing what exactly they were for. Growers who received some of the checks in September, which the company labeled as momentum pay, were unsure if the money was compensation for deliveries made for the current or prior year, according to the Journal.

Both months' payments weren't accounted for in the correct periods, according to the audit committee, adding there was no evidence of an attempt to deceive shareholders.

The company plans to restate its figures for both years.

The probe's findings led Diamond's board to axe CEO Michael Mendes and Chief Financial Officer Steven Neil, who are currently on administrative leave until their severance packages and a possible claw-back of past pay are determined.

The internal audit's findings will be handed over to the Securities and Exchange Commission, as well the U.S. attorney's office in San Francisco, for further investigation, according to the Wall Street Journal.

Diamond board member Rick Wolford was installed as acting CEO, while Alix Partners' Michael Murphy will replace Neil as acting CFO while the board seeks permanent replacements.

Wall Street analysts predict the company will likely default on its debt covenants, according to Reuters.

Diamond's restatements will cause debt covenant default and ultimately raise interest expense, Mitchell Pinheiro, an analyst for Janney Capital Markets said in a note according to Reuters.

Shareholders suing the company claim the dodgy payments were used to shift expenses between fiscal years, boosting earnings and stock price.