Friday, May 13, 2005

Is Kodak Dead? Maybe Not

Here’s the latest on Kodak. Number one in the U.S. in digital camera sales. Biggest market share for home use photo printers. Lead position in franchising digital-photo finishing in retail outlets. Is this the same Kodak from Rochester, New York that had its obituary written several times over in the press over the last few years (see, for example, “Kodak?: Buh-Bye) and just last week in HPC09?

A series of recent reports has chronicled the turnaround. Kodak’s strategy was not a reinvention of the wheel but did recognize that, as new CEO Antonio Perez bluntly put it yesterday, “The world is rapidly moving to digital. Kodak has to do the same and do it in a hurry. This is doable.” Ok, perhaps this isn’t an earth-shattering epiphany and half of the world might already be digital, but it is a reflection that Kodak has finally embraced reality. Furthermore, Perez and his predecessor Carp have also, and this is important, lowered expectations for future earnings, emphasizing the imminent death of the silver halide cash cow. (There is still significant money to be made from traditional film in places like China where Kodak has relocated manufacturing plants from France and elsewhere, though this too is expected to taper). Margins will be slimmer in digital, they argue, but we can compete and we will survive.

So what has Kodak actually done to pull off the apparent turnaround? For starters, they fired a bunch of people and shifted production overseas. Eleven thousand have already been let go and another 15,000 or so will be gone by 2007. Kodak will be left with a 33% leaner operation that numbers 50,000. While not exactly nimble, the smaller workforce cuts costs and enables Kodak to change directions more quickly. Kodak has also made some key acquisitions to head off competition and bolster its presence in the printing business. Just last week the European Union approved Kodak’s $980 million bid for Creo Inc., a Canadian maker of digital printing equipment. Creo might not be a household name here in the U.S., but it’s a heavyweight player in the industry and positions Kodak for significant expansion.

Kodak has also increased its presence in the commercial printing and medical imaging field through the purchase of Sun Chemical Corp.’s 50% interest in Kodak Polychrome Graphics and Israel based Orex Computed Radiography. The combined value of these acquisitions is just over $850 million.

Through work-force reductions, strategic acquisitions and a focus on growth in the digital world, Kodak’s income statement this past year, for the first time, saw digital sales exceed film sales. What’s more, and perhaps more importantly, digital profit growth will exceed the decline in profit from film. The stock market has taken notice. From May of 2004 to the middle of April of 2005, Kodak’s stock price surged more than 23%.

Analysts, however, are not convinced that the new Kodak is out of the woods. Deutsche Bank is concerned about exiting CEO Danel Carp’s makeover strategy and as analyst Chris Whitmore somberly notes, “We believe underlying fundamentals remain difficult for Kodak.” Standard and Poor’s further downgraded Kodak’s credit rating from BBB- to BB+, reflecting recent lower-than-expected earnings reports, a stock price plunge back to the level of May, ’04, and doubts about the company’s ability to make timely payments on their increasing debt. Cross Research sees a lot of uncertainty in the near term, and predicts high volatility due to demand shifts, new acquisitions that might or might not work out and lags between restructuring and the realization of cost savings.

While the analysts’ reports might seem sobering, they are not unexpected and there is a big, fat diamond gleaming in the rough. Volatility. This suggests the possibility of huge upsides if Kodak’s strategy succeeds. If it doesn’t, well, many had written them off anyway.

The big upside for Kodak isn’t the massive profits that they enjoyed for so many decades. It is, rather, survival and profitability at a non-monopoly level.

Kodak didn’t roll over simply because they missed the boat when digital first took off. The company regrouped and moved forward with a coherent strategy to drive growth internally by capitalizing on an exceptionally strong brand, technical expertise, and international presence and externally through targeted investments. Furthermore, Kodak opted to focus on the core areas of digital capture, imaging kiosks, home printing and online mobile imaging. While Kodak recognized that the traditional film business was in a decline, it was still a cash flow rich business that could fund their transition to digital. Clearly, the strategy is working to a certain extent. There’s no arguing with the fact that they’ve made substantial headway into the digital market. The problem is that Kodak faces intense competition across the board. Future success is within reach but far from certain.

Here’s to you, Kodak, for hanging in the game and not calling it quits. You did rest on your laurels and became somewhat complacent over the years, but as former CEO Carp put it, “Although we’re 124 years old, there’s a spring in our step.” Let’s hope there’s a lot of bounce in that spring.

Victor Casier, Sebastien Leroy and O’Neal Spicer

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