Could This Iconic American Company Go Bankrupt?

David Sterman
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Posted: Nov 03, 2011 12:01 AM

The year 1880 ushered in a new era of for America, setting the stage for technology leadership that would last for more than a century. That was the year that Wabash, Ind., became the first electrically lit city in the world, Thomas Edison conducted his first tests of an electric-power railway and the first cash register was made in Dayton, Ohio.

And in Rochester, N.Y., the Eastman Kodak Co. (NYSE: EK) was formed. Sadly, 2012 may spell the end of the famed company that spread the field of photography from technologists' niche to a mass market

How did this company slip so far to the point where its stock is below $2, at levels last seen in 1935, and perhaps headed to zero? It would be easy to pin it on the demise of traditional photography and the advent of digital photography. After all, this was a razor-and-razor-blades business model, because all of the consumables required to process and develop film were the cornerstone of Eastman Kodak's business.

But that's not the real story. Many other struggling technology companies had to learn to re-invent themselves. IBM (NYSE: IBM) for example, saw its stock slide below $10 (on a split-adjusted basis) in 1993 before an aggressive move into software and services saved the day. Its shares now hover just under $200.

Other technology icons such as Xerox (NYSE: XRX) at least had the wisdom to radically cut costs and debt, and will surely live to fight another day. [I discussed Xerox's turnaround plan in this article.]

So what happened to Eastman Kodak? It simply failed to come up with a compelling turnaround plan. A push into digital cameras has not paid off, because the company's photography brand failed to resonate with digital-focused customers that had come to be increasingly reliant on Asian consumer electronics firms. Canon, Sony, Nikon, Samsung and Panasonic held a collective 68% of the digital-photography market in 2010, while Kodak had just 7.4%. (Ironically, Kodak invented the digital camera in 1975, but saw little use for it at the time.)

You'd have to go back to 2004 to find the last time Eastman Kodak posted sales gains. Annual sales peaked at $13.5 billion back then, but are likely to be less than half that amount this year. More important, shrinking sales have meant stubborn losses. The company has lost $3 billion (on an operating income basis) in the past six years, which has eaten into cash and kept the company from paying down its onerous $1.2 billion debt load. Another $150 million in annual interest expenses make it yet harder to claw back to break-even, while $1.1 billion in underfunded pensions will also need to be addressed at some point.

That's where things stand today. The company is locked in a showdown with its lenders, and they hold the cards. To keep them at bay, Kodak needs to raise cash, primarily through the sales of assets and legacy businesses. This process began in mid-August, when the company announced the hiring of investment bank Lazard Co. to shop roughly 100 digital-imaging patents (out of a portfolio of more than 1,100 patents). Shares spiked 25% in just one day and another 19% the next day, perhaps due to short covering. (More than 70 million shares are currently held short.)

That's a bit like killing the golden goose, because Kodak has generated more than $2 billion in licensing fees from its patent portfolio since 2008. The loss of that income stream makes the rest of the business even more unprofitable. Investors initially thought the group of patents might fetch a few billion dollars, but many quickly realized such a figure was vastly inflated, so shares have been in free-fall ever since.

A late September decision to borrow an additional $160 million against an open credit line made it clear that cash is running too low to run the business. Bond ratings agency Fitch Ratings subsequently slashed its ratings on Kodak's bonds to "CC," which implies a greater than 50% chance of default. This move eventually pushed the stock below $1. Analysts at Citigroup question the timing of tapping that credit line if asset sales were truly imminent: The "recent withdrawal of $160M from its line of credit provides evidence of the company's inability to monetize its IP portfolio."


 
Yet like a chicken with its head cut off, Kodak's shares have sprung back to life temporarily -- they have nearly doubled since that late September bottom. A plea from shareholder Investment Partners Asset Management that Kodak sells off the pieces and liquidates the company (at presumed prices that would add up to more than the company's current market capitalization) has led investors to expect imminent stock-boosting steps, whether it's a change in management, a sale of the digital-imaging patents, or even a sale of the still-healthy inkjet printer business.

But management may realize that any asset sales are easier to pull off under the protection of bankruptcy court. Without that cover, bondholders and stockholders can more easily block major moves by suing Kodak. In bankruptcy court, the shareholders have no ability to tie management's hands, and bondholders would find the task to be more difficult. That's apparently the view of entities looking at buying the digital-imaging patents, according to a report by Reuters. They don't want to make a bid and end up getting tied up in court. A decision to hire Jones Day, a law firm that handles painful business restructurings, is just another sign that a bankruptcy declaration could hit the tape soon.

Risks to Consider: Even in bankruptcy, a stock may not be fully worthless. If the company is able to sell assets, pay off debt and still have a remaining business, then shares could continue to have post-bankruptcy value .

Action to Take --> There's a difference between a company that's "at risk" of failing and a company that's "guaranteed" to fail.  Eastman Kodak is "at risk" of failing -- it's not "guaranteed" to fail. Either way, these types of proceedings can end quite badly for shareholders. Bondholders tend to look for ways to wrestle control of an entity, a task made much easier if current shareholders are wiped out. So the result of this drama will hinge on the value of Kodak's assets and the legal maneuverings of creditors.

If you own this stock, then you may want to sell it now, and if you are looking for stocks to short, then Kodak has the makings of a profitable downside trade.

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Disclosure: Neither D. Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.