Eastman Kodak: What's The Real Picture?

| About: Eastman Kodak (KODK)

Summary

The value of Kodak’s segments is greater than the current market value based on sum of the parts analysis using EBITDA and industry multiples.

The imminent sale of one of its business segments will help pay down its debt and increase cash flows.

The company has focused on cost cutting by reducing headcount and cutting both operating expenses and corporate costs.

Investors have overreacted to news of declining revenues in some business segments.

By: Max Janik, Reilly Cotter, Mark Kugler, Brian Schneider

Eastman Kodak (NYSE:KODK) is a global commercial printing company that utilizes its material science technologies to serve its customers in the commercial print, publishing, and packaging markets. By valuing each segment using sum of the parts valuation, we believe the firm is undervalued.

In the past few years Kodak has focused on promoting its main revenue drivers while cutting costs to improve its profitability. The company's free cash flow is improving as the company pays down its once large debt burden. Although Kodak is a completely different company post-bankruptcy, investors still view Kodak fearfully, which presents a great asymmetric investment opportunity.

Investors have overreacted on news that some of Kodak's segments are in declining growth areas. The main parts of Kodak's business are in growing industries and only a few segments that make up a minimal part of Kodak's valuation are in declining revenue industries. In 2015, revenues in some segments declined greater than expected but that was mostly due to currency FX headwinds. By breaking down the company one can find tremendous value in some of its overlooked segments.

Going forward, management has made it a priority to monetize any parts of the business where it can receive good value. By selling off parts of its multi-faceted business, Kodak can focus on its growth driving segments by allocating more resources to them and then cutting unnecessary overhead associated with the other segments.

Industry Overview

The U.S. commercial print industry has experienced rapid change since the new millennium in the form of limited growth and continued industry consolidation. However, this has presented opportunities for companies able to react and respond to new trends. Consumers are demanding more value and companies will have the technology and big data necessary to capitalize on and meet these needs. While facing headwinds, total market shipments continue to increase modestly since 2010, driven by shipments of digital presses. Although growth in this industry may be unspectacular, consumers will continue to demand services beyond hardware from these commercial printing companies.

Segments

Print Systems Division

Kodak's Print Systems Division is the company's largest revenue source. In 2015, Print Systems accounted for 51% of net revenues. The division is mostly made up of Prepress Solutions which is their plate manufacturing division. Kodak manufactures printing plates which it sells to its customers on 2-3 year contracts. 92% of the division's revenue is annuity based and there is a strong leadership base behind it. With a LTM EBITDA of $104 MM and a comparable multiple of around 7x this division represents a large portion of the company's value.

Enterprise Inkjet Systems

Kodak's Enterprise Inkjet Systems product offerings include production press systems, consumables (primarily ink), inkjet components and services. Kodak's main product in this segment is its PROSPER Press System. PROSPER is one of Kodak's most innovative product and is used in publishing, commercial print, direct mail, and packaging. The Enterprise Inkjet Systems segment contains a base of customers which use KODAK VERSAMARK printing systems, comprising inkjet printing heads, inks, head refurbishment services as well as on-site maintenance service from Kodak. This segment also has recurring revenues from ink sales, equipment parts, and maintenance and makes up 10% of Eastman Kodak's total revenues.

Micro 3-D Printing and Packaging

Includes flexographic printing equipment and plates and related consumables and services, as well as printed functional materials and components. This is a new line of business that seeks to provide innovative printing techniques to customers, which means that this segment currently requires a higher degree of investment and has a lower contribution to earnings that other segments. Micro 3-D printing products offer many advantages over traditionally manufactured products, including lower cost points and reduced adverse environmental impact. The Packaging business consists of flexographic printing equipment and related consumables and services, which enable graphic customization of a wide variety of packaging materials.

Software and Technology

The two components of this segment are: Kodak Technology Solutions, which includes enterprise services and solutions; and Unified Workflow Solutions. The main product is the PRINERGY workflow production software which creates value for customers through automation, web integration and integration with other Kodak systems and third-party offerings. This software is used by customers to manage print content from file creation to output; the software manages content and color to reduce manual errors.

Consumer and Film

This segment is comprised of three lines of business and Kodak view it as a declining/maturing group of businesses.

Motion Picture, Industrial Chemicals and Films: This sector manufactures actual motion picture film; however, sales have declined and Kodak has finalized supply agreements with major studios to wind down this area. Consumer Inkjet Solutions: Involves the sale of ink to an existing installed base of consumer inkjet printers. Consumer Products: Includes Kodak's licensing agreements which include batteries, cameras, and camera accessories.

Intellectual Property Solutions

Intellectual Property Solutions contains the research laboratories and licensing as well as new business development activities related to Kodak's patents and proprietary technology. Kodak actively seeks opportunities to leverage its patents and associated technology in licensing and/or cross-licensing deals to support both revenue growth and its ongoing businesses.

Eastman Business Park

This segment includes the operations of the Eastman Business Park which is a 1,200-acre technology center and industrial complex in Rochester, NY and the leasing activities related to that space. The majority of this space is used by Kodak for its own manufacturing and other operations.

Catalysts

PROSPER sale

Kodak's management has been looking to sell PROSPER for over a year now.Sale talks were expected to be completed in 2016, but talks have spilled over into 2017. Kodak is looking for ways to streamline the Prosper press business and refocus the business to emphasize print head components and the development of ULTRASTREAM technology. Management has indicated the cash from the sale of PROSPER will be used to pay back part of the 1st lien term debt due in 2019.

Kodak has $498 million cash on hand as of its last quarterly earnings report (2016 Q3). After the past two years of cost cutting strategies and the reduction of interest payments, Kodak's management expects positive cash flows for the foreseeable future.

Below was Kodak's long term debt obligations as of its most recent earnings report (9/30/16):

1st Lien Term Debt due 2019: 396 MM @ 7.5%

2nd Lien Term Debt due 2020: 258 MM @ 11.08%

Southeastern Asset Management Deal

On November 15, 2016,Kodak announced a $200 MM sale of 5.5% Series A Convertible Preferred Stock to Southeastern Asset Management. Immediately after the sale, Kodak paid in full the 2nd lien term debt due in 2020, which significantly reduces its debt burden. Currently, Eastman Kodak has approximately $464 MM in long term debt. As mentioned earlier, management hopes to sell PROSPER for over $200 MM which will be used to pay part of the 1st lien term debt due in 2019. This transaction will reduce interest expense in half. With the recent cost cutting strategies and the plan to reduce interest expense, Kodak will have recurring profits soon.

Before PROSPER and SAM

(millions of $)

After Deals

(millions of $)

Debt

670

196

2016 EBITDA

146

136

D & A

105

105

Interest Expense

63

15

Net Income

(22)

16

Source: Eastman Kodak Company 2016 Q3 10-Q

Cost-Cutting

While the PROSPER and Southeastern Asset Management deal will be beneficial to Kodak's free cash flow, management's cost cutting strategies will be beneficial to the company's EBITDA. Last year, the company cut headcount by 26%, operating expenses by 32%, and corporate costs by 32%. In the most recent quarter, management continued to cut SG&A by 17% from the same quarter last year. In the company's most recent 10-Q the company stated it will "continue to streamline processes to drive cost reductions and improve operating leverage."

This means further cuts will help improve EBITDA immediately and will be a large part of the company's mission to sustain strong profitability.

Risks

One of Eastman Kodak's largest risks is the competition it faces in its business segments. Although the commercial printing industry forecasts stable future growth, Kodak must compete against all competitors in the industry. A loss of market share would be significant because so much of the company's' revenue is annuity based.

In the Print Systems division, it is important to note that the recent decline in aluminum price should allow the Sonora Plates margins to improve. Looking at this division it is also important to note some of the flaws we have discovered. The main concern we saw is that this is a commodity product and with that comes pricing erosion and competition from China. Because there is a significant amount of competition in the industry it is important to take this concern into account as we evaluate Kodak's stock price.

Another risk is the possibility that PROSPER does not sell for as much as Kodak is projecting. If PROSPER sells around Kodak's estimate of $100-$200 MM then the company can pay down a significant portion of its debt that has held back cash flows. But if not, the argument for stock price appreciation is weakened.

Sum of the Parts Valuation

We valued each segment by identifying competitors and pulling their forward EV/EBITDA multiples. Using this data from Bloomberg, different scenarios were evaluated to provide a broader picture of how the stock will fare in various conditions. Competitors for certain segments have been identified in the chart below. For the Intellectual Property and Consumer and Film segments, we used multiples identified in past research conducted by Peter Rabover, CFA of Artko Capital LP. (All numbers in millions of U.S. Dollars).

Division

2016 EBITDA

Bear Mult.

Bear Value

Base Mult.

Base Value

Bull Mult.

Bull Value

Print

Systems

104 MM

6.5x

676

7x

728

7.5x

780

Enterprise Inkjet

Versamark

16

3x

48

6x

96

9x

144

Micro 3-D

P and P

7

8x

56

9.5x

66.5

11x

77

Software and Solutions

5

10x

50

10.5x

52.5

11x

55

Consumer and Film

32

.5x

16

1x

32

2x

64

Intellectual Property

-15

4x

-60

4x

-60

4x

-60

Eastman Business Park

3

15x

45

20x

60

25x

75

TOTAL

146

831

975

1135

Source: Bloomberg

Current Share Price: $14.00

Case

Value

(+) Cash

(-) Debt

EV

Shares

$ / Share

Bear

831

498

196

1133

42.8

26.47

Base

975

498

196

1277

42.8

29.84

Bull

1135

498

196

1437

42.8

33.57

Segment Comps

Print System Division

HPQ, XRX

Micro 3-D Printing and Packaging Division

BERY, GPK, PKG, SEE, WRK

Eastman Business Park

FR, MNR, PLD, REXR, STAG, TRNO

Software and Solutions

CTRL, EFII, ZBRA

Source: Bloomberg

Conclusion

The imminent sale of PROSPER along with the continuation of cost cutting strategies will improve Kodak's profitability greatly. Fearful investors have overlooked a strong investment opportunity because of the company's struggles in the past. Management's main goal is to monetize its assets in order to extract value. Management has implemented very successful measures so far and should continue to do whatever possible to maximize value for the shareholders because they were put in place by one of Kodak's largest investors, Blackstone.

With EBITDA improving by over 30% from 2015 and the deal with Southeastern Asset Management to pay down debt, Kodak's financial situation has improved exponentially in the past year alone. Kodak can now focus on its growth segments while selling off its low growth segments to reduce costs further. All of these factors make Eastman Kodak well positioned for strong profitability in the coming year.

Using the sum of parts valuation method, we have valued Eastman Kodak between $26 and $33 per share. With a current share price of $14.00, this makes Kodak an asymmetric investment opportunity with a significant margin of safety between 47% - 58%.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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