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by Eric Englund
The
employment of more and better tools is feasible only to the
extent that the capital required is available. Saving – that
is, a surplus of production over consumption – is the indispensable
condition of every further step toward technological improvement.
Mere technological knowledge is of no use if the capital needed
is lacking. ~
Ludwig von Mises
Eastman
Kodak Company (EKC) has become another poster child pertaining
to the foolishness
of stock buybacks. With EKC’s roots going back to 1880,
this company has been a world leader in photographic film
and camera sales for well over a century. Keys to Kodak’s
past success include research, development, innovation, and
a keen focus on customer satisfaction. Success, however, can
breed failure. EKC’s tremendous profitability, during the
twentieth century, didn’t prepare it for the digital revolution.
Over the years, EKC bought back billions-of-dollars worth
of its common stock. Kodak’s top management, to be sure, would
love to have this money back as EKC’s executive team has not
yet developed a business model allowing it to profitably transition
from an "analog" to a digital company. I fear time
and cash are running out for this iconic company and bankruptcy
is looming on the horizon.
A
Brief History
Of Eastman Kodak Company
George
Eastman was a high school dropout who built an incredibly
successful multi-national corporation. The company he founded,
and which flourished under his leadership, is Eastman Kodak
Company. George Eastman became interested in photography in
1878; and his vision, of bringing photography to the masses,
came into focus over time. A few months before his 26th
birthday, in April of 1880, Eastman founded a business to
mass-produce photographic dry plates. Within five years, Eastman
introduced the first transparent photographic film and this
became a highly profitable product for the company. In 1888,
the Kodak camera was introduced using the slogan "You
press the button – we do the rest." George Eastman stated
his objective was "…to make the camera as convenient
as the pencil." In doing so, amateur photography became
a growth industry with Kodak leading the way. Through continuous
research and development, by 1900, Kodak introduced the Brownie
camera; which sold for $1 and used film that sold for 15 cents
per roll. This camera was highly popular and it launched Kodak,
into the twentieth century, as the industry leader in both
photographic film and cameras.
George
Eastman’s Business Principles and Policies
Not only
was George Eastman a visionary inventor and entrepreneur,
he was a hard-working and astute businessman capable of successfully
building a global business enterprise. Along these lines,
Eastman Kodak Company provides
the following information about its esteemed founder:
Eastman
built his business on four basic principles:
- Mass
production at low cost
- International
distribution
- Extensive
advertising
- A
focus on the customer
He
saw all four as being closely related. Mass production could
not be justified without wide distribution. Distribution,
in turn, needed the support of strong advertising. From
the beginning, he imbued the company with the conviction
that fulfilling customer needs and desires is the only road
to corporate success.
To
his basic principles of business, he added these policies:
- Foster
growth and development through continued research
- Treat
employees in a fair, self-respecting way
- Reinvest
profits to build and extend the business
George
Eastman died in 1932. His principles and policies provided
a foundation upon which to build continued success.
When
examining Eastman’s policy of reinvesting profits to build
and extend the business, it is self-evident he desired to
build Kodak’s financial strength through retaining profits.
A strong balance sheet allows a company to fund research and
development in order to develop new products and services
to fulfill customer needs and desires. Sound financial management
goes hand-in-glove with retaining market leadership.
Eastman’s
policy of financial conservatism was not adhered to by executives
who succeeded him; and it shows.
Kodak
Is On The Brink Of Bankruptcy
Initially,
it may be difficult to grasp that Kodak is on the verge of
bankruptcy. Well, during fiscal-year 2010, Kodak suffered
a net loss of $687 million and saw its net worth drop to negative
$1.075 billion – yes, Kodak has a negative net worth. EKC’s
management understands it is in serious financial trouble
and stated the following in the 2010
Annual Report:
Our
business may not generate cash flow in an amount sufficient
to enable us to pay the principal of, or interest on, our
indebtedness, or to fund our other liquidity needs, including
working capital, capital expenditures, product development
efforts, strategic acquisitions, investments and alliances,
and other general corporate requirements. Our ability to
generate cash is subject to general economic, financial,
competitive, litigation, regulatory and other factors that
are beyond our control. We cannot assure you that:
-
our businesses will generate sufficient cash flow from
operations;
-
our plans to generate cash proceeds through the sale of
non-core assets will be successful;
-
we will be able to repatriate or move cash to locations
where and when it is needed;
-
we will realize cost savings, revenue growth and operating
improvements resulting from the execution of our long-term
strategic plan; or
-
future sources of funding will be available to us in amounts
sufficient to enable us to fund our liquidity needs.
These
are not words spoken by an upbeat executive management team
looking toward a bright future in the digital age. Management
has acknowledged EKC is in deep trouble; yet they won’t tell
you it is financial mismanagement that has taken this company
to a state of insolvency.
How
Kodak Got Into This Financial Mess
A fundamental
reason Kodak has fallen into financial distress is that, over
the past decades, management had not adhered to George Eastman’s
policy of reinvesting profits to build and extend Kodak’s
business. Stock buybacks, in fact, are the polar opposite
of this reinvestment policy. Share repurchases inherently
deplete cash, working capital, and equity. Such capital depletion
has deprived EKC’s management of the funds needed to support
the implementation of a business model allowing Kodak to transition
to a profitable digital imaging company.
Over
the five-year period of 2000 to 2004, Kodak generated net
earnings of $3.062 billion; and EKC turned a profit in each
of these five years. Moreover, at fiscal year-end (FYE) 2004,
Kodak’s retained earnings position stood at $7.922 billion;
which is a pretty stout number. At fiscal year-end 12/31/04,
EKC’s financial condition was sound.
Kodak,
by 2005, had become the leading
seller of digital cameras in the United States. In fact,
for Kodak, digital camera sales amounted to $5.7 billion in
2005; which was fully 50% of the company’s sales volume that
year. In spite of Kodak’s No. 1 ranking, in U.S. digital camera
sales, this company suffered an operating loss of $1.073 billion
in 2005. It is clear this is the year in which Kodak hit the
tipping point where its margin-rich, film-based photography
business had been displaced by digital imaging; a commoditized
business with thin margins. With digital cameras yielding
slim profit margins, it is no wonder Kodak’s CEO – Antonio
M. Perez – called them a "crappy
business".
For Kodak,
indeed, digital imaging has been a crappy business; as EKC
has not turned an operating profit since 2003 (2004 was a
profitable year due to significant earnings from discontinued
operations). Over the past six years, Kodak has lost $2.525
billion. Retained earnings, by fiscal year-end 2010, had declined
to $4.969 billion.
If Kodak
had a positive retained earnings position of $4.969 billion,
at fiscal year-end 2010, then how did it have a net worth
of negative $1.075 billion? Over the decades, after all, Kodak
had been a very profitable company and had built up a substantial
retained earnings position. A quick perusal of Kodak’s FYE
2010 balance sheet provides an answer to this question. With
$5.994 billion of treasury
stock (a contra-equity balance sheet entry) leaping off
of the balance sheet, it is unmistakable that stock buybacks
have played a significant role in depleting Kodak’s cash,
working capital, and equity over the years. When a corporation’s
treasury stock position exceeds its retained earnings by over
$1 billion, it shouldn’t be a surprise to see a company with
a negative net worth.
Kodak’s
dividend payouts, most certainly, haven’t served to preserve
the company’s capital base either. From 2000 through 2008,
Kodak paid out $2.757 billion in dividends; while no dividends
were paid in 2009 and 2010. During the five-year span of 2004
through 2008, in which Kodak suffered an operating loss each
year, this company paid out $714 million in dividends. EKC’s
executives, undoubtedly, would love to have this money back
almost as much as they wish the company had never engaged
in stock buybacks.
Conclusion
The future
is uncertain; hence it is impossible to foresee what twists
and turns a business may encounter while attempting to remain
on a path of customer satisfaction and profitability. Technology
evolves rapidly while consumer tastes are ever changing. As
Kodak has discovered, it must still develop a viable business
model in order for the company to survive in the new era of
digital imaging.
Kodak’s
management has also discovered that reinventing their company
has become a time consuming and expensive undertaking; and
they are rapidly running out of money. For the very reason
that the future is uncertain, Kodak should never have engaged
in the financially-draining practice of stock buybacks. If
Antonio M. Perez could wave a magic wand and receive back
the $6 billion Kodak squandered in share repurchases, you’d
witness a CEO waving his arms wildly. Kodak, accordingly,
would suddenly regain the needed capital to continue the search
for its own unique path to profitability in this uncertain
world. Alas, it isn’t so.
Kodak’s
stock, today, is selling for $1.27
per share. It once sold for $95
per share; so much for the assertion that share repurchases
enhance shareholder value. I’ve never understood how people
can believe weakening a company’s balance sheet, via stock
buybacks, improves the value of a company.
Following
all of George Eastman’s principles and policies would have
prevented Kodak’s unfolding financial disaster.
October
19, 2011
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