As Eastman Kodak Co. (EK) investors bet the 131-year-old photographic pioneer was headed for bankruptcy, the company decided Chapter 11 was the simplest way to become the leaner digital printing specialist it aspires to be.
Bankruptcy allows sales of the photography divisions and patents Chief Executive Officer Antonio Perez wants to jettison to pay off legacy employee benefits and creditors, as he focuses Kodak on faster, flexible commercial and consumer digital printers and the company’s superior ink. Its trove of 11,000 patents could fund expansion by allowing the company to sue for more licensing fees -- a move it has pursued more aggressively in recent weeks.
Efforts to turn Kodak into a company that makes sophisticated printers for the publishing, packaging, and advertising businesses have burned cash. Raising funds from intellectual property stalled amid delays in a royalty battle with Apple Inc. (AAPL) and Research In Motion Ltd. (RIM) Would-be asset buyers shunned deals because of concern that sales made before a Chapter 11 filing would be scrutinized in court for signs that Kodak was fraudulently transferring assets cheaply. Now that the filing has been made, that worry is gone.
“This is a melting ice cube of a business,” Amer Tiwana, an analyst at CRT Capital Group LLC in Stamford, Connecticut, said before the filing. “When you’re staring at a situation like that, it’s typically better to go ahead and deal with it rather than close your eyes and hope that the situation will somehow miraculously improve.”
Bankruptcy makes it easier for Kodak to sell assets to pay for layoffs, U.K. and U.S. employee pensions and health-care benefits, and providing capital needed to install a big enough base of digital printers to eventually be profitable.
The plan is to place printers with high volume users today -- sometimes at a loss -- and profit from ink and service sales tomorrow. The strategy to date has cost more money than it has made.
Perez, Hewlett-Packard Co.’s former inkjet chief, believes Kodak’s new commercial printers will displace older systems by producing pages faster and cheaper on different materials with digital flexibility. Kodak’s inks are made of longer lasting pigments, unlike the watery dye used in most devices, allowing quicker drying and smaller machines.
“We will now be well-positioned to complete our transformation,” Perez said in a video. “Competing in large markets, where we have fundamental technology advantages, such as in digital printing, in packaging, in functional printing, in materials.”
Inkjet Market
Perez plans to increase Kodak’s share of the consumer inkjet printer market, which he has valued at $45 billion, by designing cheaper replacement cartridges. He wants to dominate commercial printing of magazines, books, newspapers and advertising with high volume inkjet machines that are faster and digitally flexible, to deliver smaller and more customized batches cheaper than old-tech presses and plates as the world moves toward on-demand publishing.
To be sure, Perez’s critics said the printing market itself may shrink as the world embraces mobile devices such as tablets and smart phones, eschewing traditional hard-copy publications and paperwork.
“You’re betting on the wrong horse,” Tiwana said, noting that most major paper producers have already gone through bankruptcy, and that consumer printers, like digital cameras, are becoming a commodity. “The amount of pain that printers and printing companies are going to take over the next five years is immense.”
Founder Largesse
Predictions computers would end the use of printed pages have proved premature in the past, said Mark Zupan, Dean of the Simon School at the University of Rochester. The university is the biggest beneficiary of company founder George Eastman’s largesse -- he bequeathed most of his fortune to the institution. Still, Zupan acknowledged printing profitability has eroded.
“The downside of the strategy is that printing is a very competitive field,” Zupan said. “It’s going to be hard to replicate what traditionally the film sector was able to provide Kodak. Ultimately they’ll emerge a leaner company, either independent or part of another company.”
Kodak’s answer is to revolutionize product packaging, an area “immune to digital substitution,” Perez said in his chairman’s letter in the 2010 annual report. The company is promoting its Flexcel technology, which can print quickly on diverse materials.
“Right now the printing business is too small to have an impact,” Dave Novosel, an analyst at bond researcher Gimme Credit LLC in Chicago, said before the filing. “The chances of success with the current portfolio’s pretty slim, unless there’s enough cash to get them through the next year, year and a half and maybe these products catch on.”
Asset Sales
To raise cash, the company could sell other units including Kodak Gallery, its online photo sharing unit that allows users to store, share and print digital pictures on scrapbooks and mugs; Kodak Picture Kiosk, where customers print their own photographs in drugstores and other retailers; and its real estate, including parts of its Rochester, New York, headquarters. Kodak could license its brand to another camera- maker, said Mark Kaufman, an analyst at Rafferty Capital Markets, earlier this month. Kaufman dropped coverage of Kodak Jan. 11.
The company last year said it was preserving tax credits from accumulated losses in anticipation of windfalls from asset sales. So far only small deals have been announced, including a gelatin factory in Pennsylvania and laboratory land in Colorado.
Factories Closed
As digital dissolved its film business, Kodak shed 47,000 employees since 2003 and closed 13 factories that produced film, paper and chemicals, along with 130 photo laboratories. The restructuring has already cost $3.4 billion, because it was done “in a socially responsible” way, said spokesman Christopher Veronda.
Kodak had counted on a victory in a patent-infringement case against Apple and Research In Motion at the U.S. International Trade Commission to help bring in as much as $1 billion in new revenue. Instead, the case had unexpected delays and a final decision isn’t expected until September.
The company, which contends it invented many of the basic aspects of digital imaging and deserves to be compensated, began shopping more than 1,100 digital imaging patents for sale in July. It’s also begun an aggressive patent-litigation strategy, suing Apple, HTC Corp., Fujifilm Holdings Corp. and Samsung Electronics Co. in the past week.
Apple Request
Apple asked the bankruptcy court to attach “clarifying language” to any order approving financing for Kodak. Apple said in a filing yesterday the order should indicate that no security interests or liens will attach to patents that Apple owns and has asserted claims on until the court resolves the ownership dispute between it and Kodak.
Kodak has collected more than $3 billion in digital imaging patent royalties since 2004, including a $550 million deal with Samsung over technology used in mobile phones. The suit against Samsung, filed the day before the bankruptcy filing, is over tablet computers.
The securities market had decided weeks before last night’s filing that Kodak would probably seek bankruptcy protection. Bondholders are likely to recover about 28 cents on the dollar on their investments, debt-market trading shows.
Moody’s Investors Service on Jan. 5 cut ratings on about $1 billion of Kodak debt with a negative outlook, and cited “a heightened probability of a bankruptcy over the near-term” as liquidity deteriorates.
Swaps
Credit-default swaps on Kodak that pay out after a default or bankruptcy signal a recovery expectation of 25.5 cents on the dollar for its senior unsecured bonds, according to data provider CMA.
Five-year contracts tied to Kodak debt were quoted at 69.6 percent upfront, from 69 percent on Jan. 9 and 33 on Sept. 1, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.
That means investors now pay $6.96 million initially and $500,000 annually to protect $10 million of Kodak’s obligations. The swaps, which pay the buyer of the contracts face value, minus the recovery value of the bonds that are set by dealers and investors in an auction of the securities, are up from 12 percent upfront on Jan. 10, 2011, with a recovery of 34 cents on the dollar. Recovery fell as low as 18 cents in October.
The company’s $250 million in 7.25 percent senior unsecured notes due November 2013 fell to 27 cents on the dollar as of 7:54 a.m., according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. They traded at 29.5 cents as of 3:13 p.m. As recently as Jan. 9, they fetched 30 cents, and 63 cents on Sept. 27, compared with par on March 10.
Patents
Kodak’s patents -- including the digital imaging technology it pioneered that ultimately destroyed its iconic photography business -- may prove its most lucrative asset, said analysts including Gimme Credit’s Novosel.
“Filing could actually free them up to sell the patents to hopefully repay debtholders,” Bonnie Baha, the head of the global developed credit group at DoubleLine Capital LP in Los Angeles, which oversees $23 billion, said before the bankruptcy.
For Kodak’s hometown of Rochester, about 340 miles drive from New York City, the legacy includes the university that has educated thousands including business innovators, and grown to become the state’s seventh largest employer. The name is everywhere: Kodak Hall at Eastman Theatre, the Eastman School of Music, and the Eastman Institute for Oral Health.
“Too much success can be your worst enemy” is today’s lesson for all companies and entrepreneurs, said university dean Zupan. “If you’re not willing to cannibalize yourself, others will do it for you.”
To contact the reporter on this story: Beth Jinks in New York at bjinks1@bloomberg.net
To contact the editors responsible for this story: Ville Heiskanen at vheiskanen@bloomberg.net John Pickering at jpickering@bloomberg.net
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