KODK (NYSE:KODK) stock briefly rocketed 80% recently when an internal investigation found not enough evidence of insider trading. The news added to a months-long saga of Kodak’s “will-they-won’t-they” receive a $765 million government loan to produce onshore generic drug components.
There’s a problem though: None of it matters.
Kodak’s shares are still on their way to zero. The company’s top brass has failed in its “turnaround” efforts for almost a decade now. And its obsession with entering the low-profit generic drug market promises more of the same.
Suppose Kodak wants to remake itself as “one of the greatest second acts in American industrial history,” as White House advisor Peter Navarro put it. In that case, the company needs to stop playing in its “sunset-industry” sandbox and start innovating again. But with management that seems more interested in enriching itself, it’s unlikely that will ever happen. It might be a bumpy ride, but here’s why Kodak stock will eventually disappoint investors.
KODK Stock: A Rollercoaster to Losses
When I consider high-tech companies, I look for cutting-edge technology. Something that makes customers go, “wow.”
But Kodak’s business somehow got stuck in the 1990s. Now that it’s photography business is gone, the company now generates two-thirds of its revenues from printing. And that’s not a good thing: the printing industry has shrunk so much that former blue-chip printing companies like RR Donnelley (NYSE:RRD) are now virtually penny stocks. Current Kodak CEO James Continenza hasn’t helped much. Under his watch as chairman (and later CEO), the film company has generated a negative aggregate profit since 2013. Its return on invested capital (ROIC) in 2019 stood at negative 8.9%.
Kodak’s fortunes seemed poised to change overnight when the Trump administration announced a potential $765 million loan. Shares immediately skyrocketed, but then wobbled after accusations of insider trading. The DFC loan now hangs in the balance of a major SEC investigation.
But let’s set aside the loan legalities for a moment. Assuming Kodak does get the loan, what will they do with it?
Generic Drugs: Yet Another Terrible Industry
Like a moth drawn to a flame, Kodak can’t seem to stay away from dying businesses. With a DFC loan, Kodak will stumble into yet another dud: generic drug components.
U.S. manufacturers have shifted away from producing generic drugs for decades. Teva (NYSE:TEVA), the world’s largest generics manufacturer has struggled to turn a profit since 2016. Companies from GlaxoSmithKline (NYSE:GSK) to Novartis (NYSE:NVS) have either sold off plants or spun off generic drug rights to producers in lower-cost countries.
Why? That’s because generic drugs are a commodity business. There’s little that differentiates one producer from the next besides price.
Kodak Getting the Even Shorter End
The Trump administration, however, is tasking Kodak with something even worse: pharmaceutical components. Not the drugs themselves, but the lower-value chemicals that go into making the finished product.
And there’s the problem.
These components, known as active pharmaceutical ingredients (APIs), are already manufactured in the U.S. in large quantities. (Technically, much of it gets made in Puerto Rico). In a 2019 FDA report, researchers found that the U.S. is home to 28% of the world’s API manufacturing facilities, more than the EU combined (26%) and over twice as many as China.
Of course, there’s still a fear of growing Chinese dominance. Having the facilities, after all, doesn’t mean the U.S. can produce everything it needs.
“The increased Chinese dominance of the global API market cannot be understated,” Sen. Chuck Schumer (D-NY) wrote in a letter to the Government Accountability Office. “A decision by China to limit or restrict the delivery of APIs would have a debilitating effect on the U.S. pharmaceutical market.”
But would providing a loan to Kodak solve the problem? Probably not. Unless the government also adds subsidies for American APIs or tariffs on Chinese ones, the market will remain just as competitive. And what if the U.S. government does pass legislation to favor domestically produced drugs? Kodak will suddenly find itself competing against experience drug-makers like Teva. It’s a no-win for Kodak.
Low-Interest Loans Aren’t Unicorn Dust
Investors should remember that the DFC loan is just that: a loan. The U.S. government hasn’t made any promise to buy Kodak products once the factory gets set up. There’s no new law that carves out a market for the company. No sweetheart deal. Instead, the DFC will likely expect Kodak Pharmaceuticals to compete with other API makers and repay the loan within three to 15 years at 2.5% interest (the typical terms for other DFC loans).
Meanwhile, Kodak’s management will continue to pat themselves on the back. In 2019, the company already awarded executives $14 million in compensation (including $10.7 million to the CEO) for losing $66 million in operating income. Their decision to award another $50 million of options the day before the DFC announcement seems on par for the self-serving management team.
What Should KODK Stock Investors Do?
If you believe there’s a massive government contract waiting for Kodak, then certainly invest in KODK stock. A sweetheart government deal will send Kodak’s $840 million market capitalization soaring and make the company a tempting takeover target. (Just don’t buy KODK with insider knowledge).
On the other hand, if there’s no government contract waiting for Kodak, market realists will rightly ask: how exactly does the film company plan to compete? A $765 million loan might buy the company an average-sized API operation, but it certainly doesn’t guarantee profitability against the other 99% of existing API makers.
As a tech analyst, I see so many high-tech companies out there creating amazing things. Unless you know what the Trump administration will do next, don’t settle for a tech company that’s stuck in the 1990s.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.