Eastman Kodak Company
What Buffett Might Say about EK

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By buffettstudent
September 26, 2003

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Eastman Kodak would normally be a decent value today in relation to the free cash flow that the company generates. The KEY, though, is what management chooses to do with that free cash flow. Today EK made it clear that they basically plan to take the free cash and set it on fire and burn it.

When Mr. Buffett bought Berkshire Hathaway in 1965 he adamantly refused to let management re-invest the free cash back into the dying textile mills. He knew that the return on capital in that business was terrible. Therefore Buffett re-allocated the capital to other areas where the return on invested capital was far better.

In a shrinking enterprise (such as Eastman Kodak's core print photography business), management is well served to think very carefully about what to do with CURRENT free cash flow. It is very sad when management decides "Hey, let's reinvent ourselves as a completely new kind of business and we'll use our free cash to get us there." ..If there is one major lesson we can learn in business history, it is that this kind of risk-taking RARELY (if ever) works.

Eastman Kodak's decision to plunge into digital photography, digital commercial printing, and even things such as color laser printers is appalling. Mark these words... they will NEVER make any money doing that. This field is already awash in enterprises that have rapidly filled that space, and it is already HIGHLY competitive (read: years and years before anyone will make good money.)

An alternative for Eastman Kodak's management would have been as follows:
They could have said, "Yes, we have a shrinking business. We don't know how far it will ultimately shrink, but in lieu of blowing all of this current free cash on new operations that will return zero, we should simply allocate all the free cash back to the shareholders. We will do what we can to maintain our shrinking core business, but we will also be VERY CAREFUL not to invest money that we doubt will ever provide a decent return. Since we, the management, are unable to provide a good rate of return on this capital in our own core business, we will turn the cash over the owners in the hopes that they will be able to put the money to good use."

Today Eastman Kodak turned 100% away from that concept.

It is a truly sad day for Kodak, a truly sad day for Kodak's shareholders, and a truly sad day for American business.

Afterthought: I have noticed that some people I talk to seem to brain-lock on the concept that Kodak "needs to do something" and that therefore throwing money at digital photography is simply "what they have to do." ...I'm amazed at how even some very bright people think this.

Folks, Kodak can save its money. It doesn't have to gamble it on a digital start-up. It can save its money and stockpile it until someone can think of a more sensible use for it. You point out that their core business is shrinking? Well, that's the way it goes sometimes. Berkshire Hathaway's core business in 1965 was shrinking as well. Did they go the suicidal route of throwing good money after bad? No, they didn't.

Most management today thinks of growth as an absolute good. Buffett would heartily disagree. What counts is NOT how much top line revenue a company generates. What counts is profit as a percentage of capital invested. Unfortunately Kodak's current management is quite oblivious to this. If you listen to their investor's conference from 9/25/03 (replay available at their website), note how much emphasis management places on their projected top-line revenue figures...It's almost a perfect example from the non-Buffett play book.

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