The Worst Stocks for 2010: Eastman Kodak

This isn't exactly what you'd call a "Kodak moment." Despite a storied history in photography, it looks like Eastman Kodak (NYSE: EK  ) sees its future as being little more than a patent troll.

Fresh off a settlement with Samsung, the iconic photography company is zooming in on both Apple (Nasdaq: AAPL  ) and Research In Motion (Nasdaq: RIMM  ) with a few rolls of patent infringement lawsuits. The groundbreaking technological innovation it's protecting? Previewing a digital photo.

Not so black-and-white
In reality, this probably amounts more to an argument in favor of patent reform than a screed against Kodak for asserting its rights. Much like Amazon.com (Nasdaq: AMZN  ) getting a business process patent for one-click checkout (which it used to bludgeon Barnes & Noble (NYSE: BKS  ) ) or MercExchange wrangling $35 million out of eBay (Nasdaq: EBAY  ) for its "Buy It Now" feature, such obvious developments were never meant to be protected.

Apple and Research In Motion did have notice, though; Kodak had been trying to obtain licensing fees from the companies for years

Shake it like a Polaroid picture
As its film business collapsed, Kodak was left with few options other than to turn to its patent portfolio to eke out a living. It's not a pretty picture for Kodak:

  • Its traditional consumer film business is all but dead.
  • As newspapers and magazines disappear, its commercial segment is crumbling.
  • It hasn't made a convincing leap from old technology to new.

Even investing legend Bill Miller, who owned more than 18 million shares of the filmmaker in his Legg Mason Value Trust fund (as of Oct. 31, 2009), once noted that few companies have successfully switched gears from old school technology:

There aren't many companies that have been terribly successful making big technological transitions. How many typewriter businesses moved into computers?

It underscores why Kodak is pressing so hard on its digital imaging patent portfolio.

No news left to print
According to Publishers Information Bureau, industry-wide magazine advertising revenues plunged 18% in 2009, twice the rate of decline from the year before, with a 22% decline in ad pages in the fourth quarter. That's bad news for Kodak, whose prepress equipment segment accounts for about 39% of revenue. Sales in the segment were down 18% in the third quarter.

Worse for the company that invented the digital camera in 1975 (clunky though it was) is that net sales of cameras and accessories were nearly cut in half over the first nine months of the year, and not even a 58% jump in consumer printer sales could offset the decline. So revenues at its consumer digital imaging segment are about half of what they were just four years ago, and with Hewlett-Packard (NYSE: HPQ  ) presenting a formidable obstacle to future growth, expect this niche to stall.

Through the viewfinder
While last year's $700 million debt restructuring led by private equity shop Kohlberg Kravis Roberts (KKR) probably gave Kodak a little breathing room, the price may be too high for outside shareholders.

KKR bought $400 million in senior secured notes with steep 10.5% interest rates, but also got warrants to purchase up to 53 million shares, equal currently to about a 20% stake in Kodak. It also got two seats on Kodak's board.

While KKR's infusion may amount to a vote of confidence that better times are ahead for Kodak, the private equity lender will come out ahead on its interest payments on the secured notes, which are due in 2017, regardless of the stock's performance. Commercial banks aren't exactly tripping over themselves to lend money, so KKR's favorable terms may have been Kodak's only recourse -- but that doesn't mean you should want to invest in the photography legend alongside them.

Take a picture; it'll last longer
In short, Eastman Kodak has been a company in freefall, one that seems to be perpetually in turnaround mode, with restructuring charges becoming a permanent fixture on its financial statements.

The fourth quarter may give Kodak a bounce because stronger consumer electronic sales were one bright spot this past holiday season. Web analyst comScore says such sales were up 15% this season, second only to watches and jewelry. But considering the tripod of forces arrayed against it, Kodak is no longer the epitome of innovation and mass marketing prowess that created the Brownie, Instamatic, and Super 8 film.

I've framed my bear case for Eastman Kodak, but do you agree it's picture imperfect? Share your thoughts in the poll below.

What do you think is the worst stock for 2010? See the rest of our contenders and cast your vote!

Apple, Amazon.com, and eBay are Motley Fool Stock Advisor picks. Motley Fool Options recommends a bull call spread on eBay.

Fool contributor Rich Duprey has no financial position in any of the stocks mentioned in this article. You can see his holdings. The Motley Fool has a disclosure policy.


Read/Post Comments (12) | Recommend This Article (18)

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  • Report this Comment On January 21, 2010, at 1:07 PM, solodio wrote:

    This is interesting. It seems the writer really has no idea of how the major revenue sources of Kodak breaks down. The writer still sees Kodak has primarily a consumer camera company which is the view almost a decade ago, totally disregarding Kodak's commercial film business and it's LED supplier channels.

    Kodak will be fine.

  • Report this Comment On January 21, 2010, at 1:43 PM, puravidatoall wrote:

    How many shares is the writer short? Sounds like the writer knows what the final settlements and sale of oled unit to lg , samsung etc. are. Dont under estimate IP licensing.

  • Report this Comment On January 21, 2010, at 2:03 PM, br2424 wrote:

    Actually, Duprey sees the big picture. Kodak has little to give, even going to the extent of dumping the OLED biz. There's some IP left. But, not much more. They sell nothing excitingly different from other companies. BTW, film is dead or haven't you heard? The beloved Kodachrome is no more. The rest will eventually follow. Watch what happens when the movie industry goes totally digital. The cinema division will tank.

  • Report this Comment On January 21, 2010, at 2:05 PM, puravidatoall wrote:

    Is the writer short ? How many shares? Does the writer know what the settlement from lg and samsung will be? IP licensing agreements , royalties ? The sale of oled division to lg , how much?

  • Report this Comment On January 21, 2010, at 3:19 PM, Relaxmec wrote:

    Leica picked Kodak for the CCD image sensor of the M9 and the S2. The two best cameras in the world.

    Hardly a case for Kodak lack of innovation. Maybe it's a small market but if Kodak can deliver for the best, it can deliver for the rest.

  • Report this Comment On January 21, 2010, at 4:36 PM, Gale9880 wrote:

    In framing your margin expectations for 4Q, you may also want to consider the pitfalls of the y-o-y comparison. Since the company had an overfunded pension in 2008, they were recognizing pension income every quarter. The way pension accounting works is that only your expected return on plan assets (framed at the beginning of the year) flows through the income statement. This pension income was sprinkled throughout COGS, SG&A and R&D (I assume based on the function of the employees included in the plan). Any actual gains/losses go into AOCI and are amortized over a number of years. So they were essentially padding income with phantom pension gains that didn't really exist because the market tanked. Even better, they reweighted their portfolio out of equities and into treasuries and missed out on a significant amount of upside in 2009. If you ever wondered what the "Other" item on the operating cash flow statement was, it's mostly pension income that doesn't translate into cash. Expect lower margins to be the culprit for a stinker 4Q and for the company to have burned through a lot of that KKR cash. Looking forward, as the author has pointed out, most of the cash flow they get from FPEG will go right back to the costs of shutting the business down. The end market dynamics for its commercial business, not to Kodak's own fault, are terrible. Kodak is poorly positioned to compete in the low-end digital camera business as companies with integrated component manufacturing (Samsung, Panasonic) are rapidly gaining share and starting a price war. Kodak will also fail to gain critical mass in other businesses (Consumer IJ, Kodak Gallery) to be cash flow positive and compete with HP. Find another investment. The Polaroid story is just being rewritten. Let this dinosaur die!

  • Report this Comment On January 23, 2010, at 11:29 AM, snappingsam wrote:

    In the famous book "who moved my cheese" a CEO of Kodak praises the book

    Shame he didn't buy copies for his managers!

    Many of Kodaks faillings have been caused by short sighted management and bean counters (accountants)

    Discontinuing 35mm cameras was seen as a death knell for film.

    Discontinuing Kodachrome: argh. The only colour process which has a 100 year life. How will digital images compare with data rot - they should of offered an archive service back to film - this is what the BBC are doing with their valuable back catalogue!

    They bought companies who had the products they needed then sold them years later at huge losses never having used the products - then rebought them years later again!!

    Their chip section do great work - with hasselblad and leica using the chips - their years of skill in colour mean they give great results - just get more companies to use them!

    However - as a company they are like a speedboat without a rudder - going nowhere fast!

  • Report this Comment On January 25, 2010, at 2:42 PM, jerryh321 wrote:

    I HAVE WORKED FOR KODAK.25 YEARS TO BE EXACT.WHILE I WAS THERE I WORKED IN THE FILM AREAS BUT ENDED UP IN ENGINEERING.I WAS THEN SENT TO DIFFERENT AREAS OF THE US TO WORK ON THEIR PRODUCTS.BACK IN THE DAY THE COMPANY WAS SOLID AND A LEADER IN SOME TECHNOLOGIES.BUT ALAS,WOULD YOU BELIEVE THEY HAD SOME LOSER MANAGERS WHO WOULD NOT LISTEN OR EVEN ENTERTAIN IDEAS FROM THEIR EMPLOYEES..INSTEAD IF YOU WANTED TO TAKE IT FURTHER IF YOU WOULD BE WRITTEN UP AND THAT WAS HELD AGAINST YOU..OH BY THE WAY DON'T EVEN TRY HR.KODAK YOU LAGGED BEHIND FOR MANY YEARS AND OTHER COMPANIES PASSED YOU WITH NEW TECHNOLOGIES..YOU GOT WHAT YOU DESERVED..GOOD RIDANCE AND I HATE YOUR LUCK..NOT REALLY

  • Report this Comment On January 25, 2010, at 2:49 PM, jerryh321 wrote:

    OH YES,I WAS THERE FOR THE POLAROID DISASTER..WHAT A JOKE THAT WAS..KODAK NEW THEY WERE DOING TO POLAROID..BUT IN DEFENSE OF KODAK A LITTLE,THEY MADE SOME LARGE MONEY AND DENIED US RAISES FOR 2 YEARS EVEN THOUGH WE WERE FAITHFUL EMPLOYEES..THE UPPER MANAGEMENT DUDES GOT THEIRS THOUGH..THAT COMPANY IS EMBARASSING IT SELF TO BE IN BUSINESS..WHAT WOULD GEORGE EASTMAN DO IF HE WAS STILL THERE?

  • Report this Comment On January 28, 2010, at 4:50 PM, hgtv2 wrote:

    Is the recently released earnings report a fluke or were you just completely wrong about EK?

  • Report this Comment On January 28, 2010, at 4:52 PM, hgtv2 wrote:

    Is the earnings report a fluke or was the author just incorrect?

  • Report this Comment On January 29, 2010, at 6:13 AM, TMFCop wrote:

    hgtv2,

    If you read the last section of the article, I do predict Kodak will get a nice bounce out of fourth quarter results because of anticipated strong holiday sales, but I think the long-term outlook for the company is bleak.

    Rich

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