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Is Eastman Kodak Company (KODK) a Smart Long-term Buy?

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Alex Smith
·7 min read
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Longleaf Partners Small-Cap Fund, a Memphis-based fund under Southeastern Asset Management, recently released its Q3 2020 Investor Letter, a copy of which you can download here. The fund posted a return of 22.2% for the quarter, outperforming its benchmark, the Russell 2000 Index which returned 4.93% in the same quarter. You should check out Longleaf Partners' top 5 stock picks for investors to buy right now, which could be the biggest winners of 2021.

In the Q3 2020 Investor Letter, Longleaf Partners highlighted a few stocks and Eastman Kodak Co (NYSE:KODK) is one of them. Eastman Kodak Co (NYSE:KODK) is a technology company providing industry-leading hardware, software, consumables and services for commercial print, packaging and publishing. Year-to-date, Eastman Kodak Co (NYSE:KODK) stock gained 104.7% and on December 22nd it had a closing price of $9.52. Here is what Longleaf Partners said:

"We have fielded multiple calls and emails on Kodak since the news first broke on July 28, 2020 about the company receiving a potential $765 million loan under the Defense Production Act to produce ingredients used in a variety of key generic medicines.

When we first invested in Kodak in 2016, one of the most compelling but hardest to value parts of our case was the strategic upside in the Eastman Business Park (EBP) in Rochester, NY. This facility encompasses over 1200 acres and millions of square feet of buildings. But the vast majority of it was lying dormant at the time of our investment. One of the many good things about the news of the loan was that it could rejuvenate this asset in a win/win for both Kodak and the United States. The loan would not be a gift, but rather an investment that achieves a good return for both parties by bridging the EBP from an underutilized asset to a productive facility that can handle much more than just the drug ingredients contract initially announced.

It was discouraging that after the news of the potential loan broke, Kodak and CEO Jim Continenza had to endure multiple headlines alleging various improprieties, while the company was unable to publicly defend itself in the midst of a review of the events of the last few months by well-respected law firm Akin Gump. When Akin Gump’s 88-page report finding no illegal behavior by Kodak management came out, there was less coverage, but the good news is that the facts appear to speak for themselves. Importantly, through release of this report, our view is that Jim Continenza and the Kodak board of directors were able to clear the air as it relates to his options granted this year and to potential insider trading. We will continue to monitor any developments regarding these issues.

It is not clear whether the government loan will still go through at this point, but Kodak has confirmed that commercial parties were interested in doing business with the company in this drug ingredients field before the government loan came into view, thus showing that there are multiple paths with and without a government loan to value realization here. Jim Continenza has been working hard to grow value per share since he became CEO of the company last year. Jim has dramatically cut costs, simplified the business and sharpened its focus. We are confident that he will continue to explore a broader array of strategic options for Kodak’s other assets, like its digital printing business, its brand licensing stream and its under-monetized materials science patents from a position of strength.

We were not able to share details with you on our active trading in the midst of the extreme share price volatility, given regulatory restrictions and the sensitivity of the situation. We can now share more of those details and how we managed the position through the news cycle.

We exited our small common stock position the day the deal was announced and then worked with the company to convert our convertible bonds to common shares over the course of the next several days. As noted in Kodak’s 8K filed on August 3rd, we received just under 30 million shares of common stock and $5.6 million in accumulated interest in cash upon conversion. We subsequently sold all of the converted shares to take advantage of the price appreciation and reduce an outsized position, as reported in our Schedule 13G filed on September 10th. Today, we still retain ownership in the preferreds, which represent 10% of the portfolio as of quarter end.

Our investment in Kodak has been mostly done as a lender first with equity upside second because of what we viewed to be a much wider than usual range of outcomes at this company. We chose to live with less near-term liquidity in exchange for this downside protection, coupled with large potential upside. We understood that this could lead to more short-term volatility in the stock price given the small market cap at the time we invested, but we can’t say that we expected a range of $2 to $60 in two days and now $9 two months later. We will always view volatility like this as a gift from Mr. Market, as Ben Graham and Warren Buffett would say. We have also long focused on being approximately right instead of precisely wrong in our appraisals. We have been monitoring the situation and updating our view in real time, and the range of the Kodak value per share today is both higher and wider than it was three months ago. It is likely that the replacement cost of EBP today is an extremely large number. This value needs to be added to Kodak’s other assets that we thought were worth at least $500-750 million, including cash. We can see a path to meaningfully positive free cash flow (FCF) at Kodak over the next few years that can be worth at least a mid-high teens market multiple. With the conversion of our bonds into equity, our preferred investment is now an even higher quality credit, and when the time is right, we will explore various ways to monetize or modify this investment before it matures next year. In the meantime, this investment provides dividends and solid value as a safe credit.

It is important to note that the gains locked in on Kodak are offset by realized losses in the Fund, so the sale has not created a capital gains distribution. We did have 2019 capital gains during the spillback period (i.e., capital gains from fiscal year 2019 that were not distributed in last year’s November distribution). As of September 30th, the estimated capital gain distribution for the Fund is 0.70 per share, based entirely on the 2019 spillback period, not related to Kodak."

Cineberg/Shutterstock.com

In August, we had published an article revealing that Eastman Kodak Co (NYSE:KODK) was in talks to buy TikTok's U.S. business.

In Q3 2020, the number of bullish hedge fund positions on Eastman Kodak Co (NYSE:KODK) stock increased by about 400% from the previous quarter (see the chart here), so a number of other hedge fund managers believe in Kodak's growth potential. Our calculations showed that Eastman Kodak Co (NYSE:KODK) isn't ranked among the 30 most popular stocks among hedge funds.

The top 10 stocks among hedge funds returned 216% since the end of 2014 and outperformed the S&P 500 Index ETFs by more than 121 percentage points. We know it sounds unbelievable. You have been dismissing our articles about top hedge fund stocks mostly because you were fed biased information by other media outlets about hedge funds' poor performance. You could have doubled the size of your nest egg by investing in the top hedge fund stocks instead of dumb S&P 500 ETFs. Below you can watch our video about the top 5 hedge fund stocks right now. All of these stocks had positive returns in 2020.

Video: Top 5 Stocks Among Hedge Funds

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Disclosure: None. This article is originally published at Insider Monkey.