Kodak stock has popped a whopping 575% between July 17 and pre-market trade on July 29.

That’s because of news released on July 28 that the photography pioneer is borrowing money from the government to manufacture ingredients for generic drugs such as the malaria treatment hydroxychloroquine.

Should you buy the stock today? I see three reasons not to:

  • Kodak’s financial performance and prospects are poor
  • Demand for generic malaria drug ingredients may be weak
  • Kodak has a long track record of poor management

Kodak is thrilled about the opportunity. As Kodak Executive Chairman Jim Continenza said in a statement, “Kodak is proud to be a part of strengthening America’s self-sufficiency in producing the key pharmaceutical ingredients we need to keep our citizens safe. By leveraging our vast infrastructure, deep expertise in chemicals manufacturing, and heritage of innovation and quality, Kodak will play a critical role in the return of a reliable American pharmaceutical supply chain.”

(I have no financial interest in the securities mentioned in this post).

Kodak Takes a Government Loan

On July 28, Kodak was awarded a $765 million Defense Production Act loan to produce drug ingredients for generic drugs to fight Covid-19, according to CNBC. Those include hydroxychloroquine, “the controversial antimalarial drug touted by President Donald Trump,” according to Bloomberg.

The day before this announcement, Kodak’s stock market capitalization was about $115 million and by the end of trading on July 28, that value had soared 202% to $347 million. In pre-market trade on July 29, the shares were up another 58% — giving Kodak a $548 million stock market capitalization.

Kodak’s Poor Performance and Prospects

Rochester, New York-based Eastman Kodak — which was founded in 1888 — filed for bankruptcy in 2012 and went public again in September 2013 at $25.50 a share. The shares peaked at around $37 that December and have since tumbled — spending much of 2020 falling below $4 a share where they began the year.

In the last three years, Kodak’s financial performance has been depressing. Between 2017 and 2019, Kodak’s revenues fell at a roughly 10% annual rate to $1.24 billion. Its free cash flow — while improving from negative $110 million in 2017 — was $0 in 2019.

In the first quarter of 2020, Kodak — 14.1% of its shares are sold short — gave a weak report and had poor prospects.

For the first quarter of 2020, Kodak reported a $111 million loss with revenues dropping by about 10% to $267 million.

Continenza said Kodak was making alcohol and face masks to help fight the pandemic and would keep cutting costs “to preserve cash and position Kodak for a strong rebound in the aftermath of Covid-19,” according to WHAM.

One Rochester-based analyst saw a potential financial restructuring in Kodak’s future. George Conboy of Brighton Securities pointed out that Kodak had burned through $24 million in cash in the first quarter with about two years’ worth of cash remaining.

Kodak — which employed 4,500 people in May — had large debts coming due in late 2021. Conboy told WHAM, “the company will have to determine how it will pay those – and whether that means more cuts in the future.”

Demand for generic malaria drug ingredients may be weak

The market for generic drug ingredients is full of financially strong competitors. To be sure, the market is huge — the overall market for active pharmaceutical ingredients is expected to grow at a 7.2% annual rate to $293.5 billion worldwide by 2026, according to ResearchandMarkets.

A Wall Street analyst questioned the decision to award this contract to Kodak rather than experienced generic drug makers such as Amneal Pharmaceuticals (market capitalization $1.3 billion), Mylan ($8,4 billion) and Teva Pharmaceutical Industries ($12.5 billion) — which are in much stronger financial shape than Kodak.

As SVB Leerink’s Ami Fadia told investors, “We find it puzzling why generic pharmaceutical companies who have the capabilities and know-how for this have not yet been awarded such contracts. Bringing pharma manufacturing back to the U.S. is no easy feat and (we) continue to believe that leading generic manufacturers will eventually be part of the solution,” according to MarketWatch.

What’s more, it’s possible that soon after Kodak begins manufacturing generic drug ingredients, there could be a change in the White House.

That matters to Kodak because such a change could cost the company a powerful advocate for the use of some of those ingredients. After all, CNBC reports that national virus expert, Anthony Fauci, has said hydroxychloroquine is not effective against Covid-19.

If doctors follow Fauci’s medical opinion and opt not to prescribe hydroxychloroquine to treat Covid-19, Kodak could struggle to keep its generic drug ingredient factories busy enough to pay back its debts.

Kodak’s Long History Of Poor Management

Before it filed for bankruptcy in 2012, Eastman Kodak’s stock market capitalization peaked at $30 billion, according to Bloomberg. But as I wrote in Oct 2011, Kodak’s fall from grace got started in the 1940s when instant camera maker Polaroid took a piece out of Kodak’s film-based money machine.

The basic problem for Kodak was that its creation and decades of dominance of the photography business made the company unable to adapt well to technological change.

In the 1980s, I did consulting work for the maker of the Brownie and saw it heading unstoppably for its end decades before its bankruptcy filing — but it took longer than I had anticipated. While I was there, I was shocked to get a first hand look at one of its diversification efforts — buying a drug company.

When Kodak was founded in 1888, quality was its “fighting argument.” It gladly gave away cameras in exchange for getting people hooked on paying to have their photos developed — yielding Kodak a nice annuity in the form of 80% of the market for the chemicals and paper used to develop and print those photos.

Inside Kodak, this was known as the “silver halide” strategy — named after the chemical compounds in its film. Kodak had a fantastic success formula that keyed off of international distribution, mass production to lower unit costs, R&D investment to introduce better products, and extensive advertising to make sure consumers knew about Kodak’s superior quality.

Unfortunately, competition came along and introduced ugly splotches all over this beautiful picture. Here are three examples:

  • Instant photography. A few days prior to Thanksgiving in 1948, a Massachusetts-based inventor, Edwin Land, offered consumers an instant camera that developed photos in 60 seconds. Instant photography threatened Kodak’s profits from chemicals and film. Kodak responded by introducing its own instant photography products. Polaroid sued — alleging that between 1976 and 1986 Kodak stole its technology — asking for $12 billion in damages. In 1990, Polaroid won a mere $909 million and ultimately filed for bankruptcy in October 2001.
  • Cut rate film from Japan. In the 1980s, Japan’s Fuji started to sell rolls of film at a price way below the one that Kodak had been accustomed to charging. By 1999, Fuji’s market share gains were so great that Kodak took a $1.2 billion charge along with 19,900 layoffs. Such layoffs persisted, for example in January 2009, Kodak took a $350 million charge to nuke 3,500 people on a 24% revenue plunge.
  • Digital photography. Digital photography offered consumers a better value but one that wiped out a decent way for Kodak to make money. After all, digital film — flash memory — was a low margin proposition. And even though Kodak was number two in digital cameras by 1999, it lost $60 on each one it sold. In one of many bids to replicate its silver halide business model in digital photography, Kodak offered a Photo CD film-based digital imaging product — but since it was priced at $500 per player and $20 per disc it did not attract many customers. Kodak also tried to follow Hewlett Packard into the printing business — even hiring an HP executive Tony Perez — who presided over Kodak’s bankruptcy.

I had a personal encounter with another one of Kodak’s strategic blunders. In January 1988, I was standing next to a fax machine on the executive floor of Kodak’s Rochester, New York headquarters.

I watched in astonishment at a scrolling fax of a contract for Kodak to acquire Sterling Drug for $5.1 billion. Kodak thought this was a wise investment for two reasons: drugs had high margins and Kodak made chemicals. Unfortunately, those two facts were not sufficient to make this deal pay off for Kodak shareholders.

To do that, Kodak would have needed capabilities that it lacked — such as the ability to come up with new, valuable, patented drugs or to make generic drugs at a rock-bottom cost. It only took six years for Kodak to realize that Sterling Drug was not a good fit for Kodak and sell it off in pieces.

All this history remains relevant today. As Conboy said, after Kodak’s 2012 bankruptcy, a key issue for the company has been its efforts to compete in printing-related services as the film industry declined.

Sadly for Kodak, it went from the frying pan into the fire. “The market they owned for many years, film, they were the 800-pound gorilla. And when they lost that market, they became the pipsqueak in an industry that had its own 800-pound gorillas – and that industry was shrinking itself, and that’s where Kodak finds itself today,” Conboy told WHAM.

The same thing is probably true of Kodak’s effort to save itself by entering the generic drug ingredient market.

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