In 1988, camera giant Eastman Kodak (KODK 4.24%) made its debut in the pharmaceutical sector by acquiring Sterling Drug for $5.1 billion. The company argued that the chemicals used in its photography busines could have potential uses as active pharmaceutical ingredients (API). The venture was moderately successful, and by 1994, Kodak had sold the entirety of its Sterling Drug segment piece by piece for a combined total of $6.5 billion, netting a $1.4 billion profit.

Twenty-six years later, Kodak is back at it again with the announcement of a $765 million government loan for the company to make generic APIs to treat COVID-19 patients. However, this time, the deal has been plagued by allegations of misconduct, leading the Trump administration to halt the loan payment until further notice. If investors are buying shares of Kodak thinking the deal will continue, they may be out of luck. Here's why.

Portrait of a sad dog by a digital camera.

Image source: Getty Images.

Striking allegations

Days after news of the loan became public in late July, Kodak's stock soared more than 1,000%, from about $2 per share to nearly $30. However, it turned out that before the information was released, company insiders had awarded themselves millions of shares in stock options, the value of which swelled to over $50 million within just two days. This sketchy behavior has led to multiple allegations of insider trading.

On Sept. 16, management stated that an investigation conducted by Kodak's internal review committee found no wrongdoing, and the stock soared 36.6% by market close. But investors tempted to buy shares on this news should be very aware of a potential conflict of interest -- after all, the company hired the team of detectives that reached this conclusion. Indeed, the Securities and Exchange Commission's external investigation into the circumstances surrounding Kodak executives' trades is still ongoing.

There are ample reasons for so much scrutiny. For example, when the stock reached its peak of $60 on July 29, a Kodak board member named George Karfunkel donated $116 million worth of stock to a charity foundation he presided over. Now that the stock is only worth $8.51 per share, the IRS's tax code would allow Karfunkel to deduct the full market value of the stock holdings at the time, or $116 million, as a tax write-off.

History repeats itself

Every day, coverage of the COVID-19 pandemic is probably the first thing people see when they read or watch the news, and Kodak is no stranger to trying to capitalize on publicity. During the peak of the cryptocurrency bubble in 2018, the company's management announced it would be conducting an initial coin offering (ICO) of its KODAKOne coin, which was supposed to help photographers store their images and manage intellectual property rights.

The project never took off. By November 2018, Kodak owed over $100,000 in unpaid expenses for the developers it hired. As of September 2020, there is still no news of the coin's ICO. Within a year, Kodak stock rose from $3 per share to $12 on the news of KODAKOne in development, only to fall back down to sub-$3 levels.

Takeaways for investors

The widespread use of smartphone cameras, coupled with travel restrictions caused by COVID-19, have dealt a severe blow to Kodak's growth potential. During the second quarter of 2020, the company's revenue declined by 31% year over year to $213 million. Kodak is also not profitable, posting a quarterly net loss of $5 million.

Even though the company only has a market cap of $632 million, it is not clear how Kodak can turn its business around. Until it does, the company may be bleeding from its net cash balance of $65 million. Furthermore, even if Kodak is somehow cleared of all insider-trading allegations and receives the $765 million loan, it is still a loan -- one that will need to be repaid. In such a scenario, if Kodak finds it cannot turn a profit after hefty investments in manufacturing equipment, it will be in serious trouble. Therefore, investors looking at pharmaceutical stocks should consider other options with far fewer risks than Kodak.