Kodak (NYSE:KODK) released a report from its lawyers on Sept. 15 that provides for very interesting reading. Anybody considering investing in Kodak stock should carefully cull through it. It will help you assess Kodak’s move to diversify into the pharmaceutical manufacturing business.
The report, which is easy to read and very detailed, shows the background to the company’s move to try and get a $765 million starter loan from the U.S. government. In the end, the loan was put on hold, but the whole story about how the loan came about is very interesting.
The loan, from the International Development Finance Corporation (DFC), was a way for Kodak to make novel coronavirus vaccine-related key starter materials (KSM). It would allow Kodak to launch a dedicated pharmaceutical manufacturing division. As it stands, Kodak is still waiting to hear whether it can get the loan.
The Kodak Moment of Investor Insanity
The report from the law firm Akin Gump describes the situation in the middle of the summer when the Kodak stock price went berserk. It shot up to more than $60 per share at one point.
A director of the company said it was a “Kodak moment of investor insanity” (page 35). He said that the DFC loan “isn’t anything close to a justification for its massive share-price gains.”
Kodak’s independent committee wanted to find out whether board members and insiders were given “spring-loaded” options. Also, did management trade on inside information? The lawyers’ report said no, everything was copacetic. No one used “material non-public information” (known as MNPI in lawyerspeak).
But all the fuss about this MNPI related to Kodak’s move into pharmaceuticals seems overdone. That is because the DFC only signed a letter of intent, or LOI. Here is a mouthful of terms: the DFC signed an LOI for a loan to KODK to start a KSM manufacturing business. Everyone knows that an LOI is not an actual loan.
Immediately there were allegations, according to Reuters, that the apparently spring-loaded options granted to the CEO and other’s trading just prior to the announcement were fraudulent. The White House and the DFC said the loan was on hold.
From what I can tell now, the lawyer’s whitewash report may be enough for the DFC to issue the loan to Kodak. But in the world of politics, this is not likely to happen anytime soon.
Therefore, if Kodak is really serious about making KSMs for pharmaceuticals, and starting a new division, it is going to have to finance it differently.
Kodak’s Next Move
Here is the quandary that the CEO, Jim Continenza, is in. Kodak stock is up from $2.60 or so prior to the loan LOI announcement to $9.60 on Oct. 14. That is an increase in its market capitalization from about $200 million to $733 million, or $533 million. But the loan seems dead for now.
So Continenza needs to tell shareholders whether he is serious about starting this division in his next shareholder report. After all, the $765 million loan proposal from the DFC was just an LOI, not even a full loan with agreed terms.
I suspect that, if he is smart, Continenza will issue new shares in a secondary offering or a PIPE (private investment in public equities) deal at close to current prices. Then he could use that money to either start the pharma manufacturing business or to get a more conventional loan.
After all, how can you start a brand new business based solely on a loan? The Akin Gump report made it clear that there were some potential holes in the business plan. The biggest one was whether there would be enough customers for the company to generate enough cash flow to pay back the loan. This is on page 24 of the special report.
What to Do With Kodak Stock
The Akin Gump report is a must-read for KODK investors. But more importantly, what should a potential investor do right now?
I think there is no choice but to wait to see what the CEO Continenza will say in the next earnings report. Interestingly, the Akin Gump report seems to indicate that he firmly believes in starting this division. He told people that “Kodak will execute everything we commit to” (page 23). The DFC said Continenza was an “operator” and “executor” who gets things done in business.
Let’s see if this CEO is really an executor. The DFC loan is probably dead. But Kodak’s price is still high assuming it will go through. He needs to do something to make sure the pharma business can be funded in a different way.
Unless you hear something definitive in the next earnings report about this, I would get out of Kodak stock. The company is losing money and has no serious prospects to make large profits and free cash flow otherwise.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
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