So Eastman Kodak (EKDKQ.PK) was rearranging chairs on the deck of the Titanic after all. Late Wednesday night (January 18), Kodak announced that it will file a voluntary bankruptcy using an 18-month, $950M debtor-in-possession credit facility from Citigroup (C) to help remain operational through through the restructuring process:
The business reorganization is intended to bolster liquidity in the U.S. and abroad, monetize non- strategic intellectual property, fairly resolve legacy liabilities, and enable the Company to focus on its most valuable business lines. The Company has made pioneering investments in digital and materials deposition technologies in recent years, generating approximately 75% of its revenue from digital businesses in 2011…Kodak expects to complete its U.S.-based restructuring during 2013…
Chapter 11 gives us the best opportunities to maximize the value in two critical parts of our technology portfolio: our digital capture patents, which are essential for a wide range of mobile and other consumer electronic devices that capture digital images and have generated over $3 billion of licensing revenues since 2003; and our breakthrough printing and deposition technologies, which give Kodak a competitive advantage in our growing digital businesses.
This announcement arrived just a week after I jumped in and out of Kodak as part of a "bankruptcy trade." This close call made me think further about the merits of trading or investing in companies that are flirting with disaster. As we have seen in other bankruptcy cases like AMR Corporation, management insisted almost to the very end that it was not seeking an escape through bankruptcy. The battle between rumor/news and management denials creates moments of abrupt, and often tradable, volatility in the stock.
In Kodak's case, the company created a reorganization plan which was the last catalyst for hope that the company could avoid the bankruptcy process. At the time, I believed there was at least enough of a chance the company could figure its way out its predicament that it was worth speculating in survival. The subsequent and sharp ascendance of the stock completely surprised me - I was prepared for a long and drawn out affair. The lift lasted for only a few more days and then news leaked that Kodak was seeking cash from Citigroup for a bankruptcy filing (see "Kodak eyes bankruptcy cash from Citigroup: report").
Lesson #1: never trust claims from management about the prospects of bankruptcy…unless it is admitting to the possibilities of such an outcome. Of course, the difficulty in such situations is that these admissions may cause financial markets, customers, and suppliers to start treating the company as if it is already bankrupt, further restraining the company's options for survival.
The stock market had it right the entire time. The steep downtrend in the stock said everything although shorts were closing out positions along the way in the final months. This context was important in timing a trade; there was little point jumping into the middle of a downtrend without a specific catalyst. The first catalyst came after the company denied bankruptcy rumors that had caused the stock to take a large one-day plunge. The second jump came after the company finally delivered positive news. The last catalyst was on negative news that was not accompanied by obligatory company denials. The stock failed to recover.
Lesson #2: Do not take the plunge until some catalyst has either cleared out enough sellers to provide some upside or positive news provides some ray of hope. Any other jump into a downtrend is akin to yelling into the wind of the market's typhoon.
Kodak's stock is now delisted from the NYSE and trades on the pink sheets. I am not interested in the common stock of a company going through bankruptcy, especially a very extended one like Kodak's. However, the stock could be interesting on the other side of the process. I never even thought about investing in companies on either side of bankruptcy until I read "You Can Be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits by Joel Greenblatt. It is a book with a cheesy title, but it is filled with intriguing non-conventional investment approaches to search for mispriced stocks. A chapter appropriately titled "Blood in the streets (Hopefully, Not Yours): Bankruptcy and Restructuring" includes the following solid premise:
The corner of the investment world occupied by companies at some stage of the bankruptcy process is filled with opportunities - and land mines. Probably the best way to approach this area…is with an open mind but not a hole in your head. While the securities of companies involved in one stage or another of bankruptcy are often mispriced, that doesn't necessarily mean all bankruptcy-related securities are cheap.
Greenblatt explains that after a bankruptcy process concludes, former creditors of the company typically get issued stock in the new company in lieu of much of the former debt. These banks, bondholders, and trade creditors are not interested in stock and will sell at the first opportunity, creating some initially low stock prices. One important exception is where vulture investors buy up the bank debt, bonds, and trade claims during bankruptcy in the hopes of securing a profitable payday when stock gets reissued. The keys to success involve studying the capital structure when the results of the bankruptcy proceedings are made public and finding some evidence that an otherwise good company was forced into bankruptcy by bad decisions, excessive leverage, product liabilities, etc… No matter what happens, the new company needs to generate cash flows sufficient to support its revised capital structure. (For additional warnings against buying the common stock of a company in the woes of bankruptcy proceedings see "Could Kodak Still Make You Rich?")
Kodak teeters on the edge of of being an "otherwise good company." The company has a plan to position itself better in the age of digital photography, but it is focusing on digital printing. This business already has several tough competitors. If Kodak's claims to unique and innovative technology pan out, the company could be a survivor…unless of course in another year, even digital printing begins a descent into obsolescence. For a more detailed evaluation of Kodak's chances to survive after bankruptcy see "Kodak Bankruptcy May Bet on Printing, Shed Photography" in Bloomberg.
Be careful out there!