In late June I wrote that Eastman Kodak (EK) “may be one of the top contrarian value plays of the year.” The company that once dominated film and related businesses, and spent 74 years in the Dow Jones industrial average (top-tier companies only), may never return to profitability or stage a big enough comeback to compete with the much bigger Canon (CAJ), Sony (SNE), Xerox (XRX) and others. However, with the company now valued at only $200 million, Kodak’s increasing appeal as a takeover target makes it a very interesting speculative bet.
Kodak may have a very small chance of ever returning to profitability. But as I mentioned in June, there are plenty of reasons why Kodak could be a rewarding buy:
1) Extremely Low Expectations. “The stock price has dropped so much that expectations of failure may be already priced in…any good news for the company or improved financials could send the stock soaring as investors start paying attention to the company again.”
2) Company Components Worth More Than The Stock. Perhaps Kodak’s biggest catalyst, the patent portfolio the company owns could be worth one or two billion dollars! The company stock may be trading for only $200 million, but if Kodak has billions of dollars worth of very important patents (rights to 11,000 of them), it may well be worth much more than the sum of its parts. And with very large recent interest over patent disputes and patent sales for companies like Google (GOOG), Samsung (GM:SSNLF), and Apple (AAPL), Kodak could be a huge beneficiary of demand for its vital patents.
3) Lots of Cash. The company may have large debt as well, but its cash of nearly $1 billion adds value per share.
4) Brand Name Recognition. “Kodak has been a household name for over 100 years. Even as a failing company, the Kodak name still holds some considerable value. And with the stock at such depressed levels, a bet on the brand name may be best taken now.”
5) Buyout Candidate. “Kodak may be doomed to stage a comeback or even fail, but the combination of a desirable patent portfolio, recognized brand name, respectable cash levels, and dirt-cheap company make Kodak a potential buyout candidate as well. In other words, even if the company is failing, a larger company may come in and buy Kodak out for a premium over current prices.”
6) Huge Short Interest. Also a sign of extremely low expectations for the company, the large 33%+ short interest in Kodak stock adds tremendous value as a short-squeeze play. In other words, so many people are betting against the company right now, that if any decent news even comes out, the stock could soar.
Based on my June article, I bought call options to profit from a rise in Kodak (EK) shares. Though the stock is down big since that article, I was able to time the Kodak trade very well. While Kodak rose approximately 20 percent in June, my option bets were up over 135 percent.
Once the technicals began to weaken in late June, I decided it was time to sell out of my Kodak position and await a better entry point. At the same time, however, I have kept in mind that Kodak is a tremendously appealing takeover target and could see a huge price increase when larger companies begin to bid for it. Bankruptcy is not to be ignored, but with so much value in its patent portfolio, brand name, and individual parts of the company, Kodak could be bought out for $3/share or more (a 200% premium above current prices).
On Friday, September 30, Kodak fell over 50% “on a report the company is hiring restructuring lawyers. Two days ago, Fitch cut its rating on Kodak's debt to a level suggesting a default is probable (SeekingAlpha, Market Currents).” I liked the stock as a takeover target at $3, so seeing it at under 70 cents a share was a HUGE bargain for me. I understood that bankruptcy was a factor, but a well-placed options bet would help me limit risk and have big-time profit potential from a Kodak bounce or takeover.
I bought rights to over 10,000 shares of Kodak (EK) stock for approximately $1,500. Instead of placing a huge bet on the stock itself, and taking a big risk if Kodak collapses, I simply bought call options that would soar in value if any good news came out. If, for example, Kodak is bought out for $3 or $4/share, I own 10,000 shares – and I only paid $1,500 for that opportunity. If I’m wrong, I lose $1,500; but if I’m right, I can gain $10,000 or even $30,000. That’s a nice risk-reward ratio.
Making the trade profitable right away, Kodak announced quickly after the bell on Friday that:
It has no intention of filing for bankruptcy, refuting earlier reports: "It is not unusual for a company in transformation to explore all options and to engage a variety of outside advisers, including financial and legal advisers." EK +41% AH. (Seeking Alpha, Market Currents)
The stock is up nearly 70% today (Monday), but the good news may only be in its beginning stages. I think there is a huge possibility that Google (GOOG), Canon (CAJ), Sony (SNE), Apple (AAPL), Xerox (XRX), or another large player comes in and scoops up Kodak for the extreme value it presents. Paying $500 million or $1 billion for Kodak would be a steal!
Investors should therefore prepare for a takeover by buying Kodak with limited risk. To do so, I have bought call options for what I have determined to be my “maximum loss.” I am risking only $1500, but have the rights to over 10,000 shares. If anything decent happens, I will more than double my money; if the company is bought out, I will see gains of over 1,000%.
Kodak offers tremendous upside potential, allows investors to limit their risk through call options, and provides an outstanding takeover candidate for the larger companies who see the huge value in Kodak’s brand name and patent portfolio. Buying the company is a steal for the larger players in the space; buying the stock may be a steal for investors.
Disclosure: I am long EK through call options.