Thursday, September 17, 2009

A Kodak Moment in Junkland

Sometimes you make an investment and you feel uneasy about it almost immediately.
I had such a moment, a “Kodak” moment, back in January when I picked up some Kodak bonds.

These were 7.25% 2013s, yielding around 17% at the time and price of purchase. I had checked out Kodak’s financials and though they weren’t pretty, figured that the cash balance of over $2 billion would buy the company some time to get its act together. And it wasn’t a large investment. I was buying a lot of bonds at the time and trying to “spread it around”.

Yes, I was aware of Kodak’s problems. Bonds don’t get the “junk” label if they aren’t somehow flawed. But c’mon, it’s KODAK, the camera Dad used to take my baby pictures.

Then the First Quarter 2009 results came out (ugh) and later the second quarter performance was just as ugly. The cash balance was now down to $1.1 billion. Not unexpected, I guess, since there IS a recession going on (in case anyone on Wall Street forgot). This wasn’t just the recession, though; Kodak has been spiraling downwards for over a decade and now very sharply over the last five years. Sales for 2009 are likely to be approximately half what they were in 2004. Cash flow was negative. No tangible equity left on the books.

Consumer Digital Imaging Sales (i.e. Digital Cameras for us consumers) were down 33% Q/Q in Q2 09. And that’s the business that’s supposed to be a “keeper”. Kodak’s attempts to regain market share have been futile.
This was bad upon bad.

Despite a booming high-yield bond market; my Kodak bonds were floundering about where I had bought them. I pondered selling them, but the market was so good…maybe they’d catch up anyway.
But they sat there until about a week ago, when they jumped from the 65-70% range, to close to 80%.

Today I found out why. KKR will buy up to $400 million in SECURED senior bonds with warrants attached (maturity 2017) and Kodak plans to issue an additional $300 million in convertibles. This money comes at a hefty price. The KKR bonds haven’t priced yet (as far as I could see), but Kodak will pay KKR a 3% placement fee (for selling the bonds to itself, I guess) and the coupon is set at 10-10.5%. The details of the other issue (the convertible) haven’t been disclosed yet, but expect the financial cost to be high.

First order of business for these $700 million will be to pay off Kodak’s 3.375% 2033 convertibles, which have a put option (holders can and WILL sell them back to Kodak) in October 2010. That totals $575 million. Those bonds are trading close to par now (logically) after this announcement. LINK

So KKR’s deal bought Kodak some time and perhaps brought some frustration to stockholders who resent the possible dilution. Bondholders were mostly happy with the development (I sure was).
Who knows? Maybe Kodak will get its act together or develop some radical technology it can capitalize on. Or just survive to pay those 2013 bonds (all $500 million worth). These “maturing” companies sometimes decline gracefully. More often, they don’t, but still seem to find some nostalgia-filled white knight to give them a second, third or fourth lease on life. Not that KKR fits that bill, but…

I won’t hold my breath. My plan with most bond purchases is to hold until maturity and junk investors are optimists almost by definition. But when you make what you think is a mistake and you get a chance to correct it –at a profit- you have to take it.

So, with the bond trading up into the high 80s today, I’ll be looking for a chance over the next few days to sell these and let someone else enjoy a Kodak moment. Say CHEESE!

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