By Matt Bacon
July 31st, 2020
Note: Carmichael Hill does not maintain a position in Eastman Kodak (KODK)
On Tuesday this week, the Federal Government announced a $765m loan to Eastman Kodak (KODK) to start producing pharmaceutical drug ingredients under the Defense Production Act. The loan is notable not just for its size, which itself is more than 650% of Kodak’s 2019 net earnings, but also for its repayment period – a full 50 years. The White House has said they are reviewing 30 other companies for additional deals under the Act.
Kodak has soared on the news. Since exiting bankruptcy in 2012, the stock has largely traded within a range of around $2-$4/share. The stock jumped just over 200% on Tuesday following the announcement. It continued its meteoric ascent on Wednesday adding close to another 320% and hitting a fresh all-time high of $60/share. Trading was halted in the stock 20 times on Wednesday due to volatility. Investor appetite, however, was not satiated. Figures provided from Bianco Research show 9,289 Robin Hood accounts holding KODK on Tuesday. By end of day Wednesday this had risen tenfold to 95,608.
Until this week, Kodak was not a stock that saw shares trade hands frequently. Volume was relatively low. A rush into the stock like we saw this week is more than enough to drive the price up to epic levels. It looks to us to be a case of fast money chasing after returns. We saw a similar event last month when a record number of worthless shares of the bankrupt Hertz company traded hands on the Robin Hood platform. Kodak is trading at close to $21/share at the time of this writing, or nearly 1/3 of the high it set just two days earlier.
Moreover, Kodak hasn’t produced any pharmaceuticals since 1994 when it owned drug company Sterling Winthrop. Even then, Winthrop produced over the counter medicines such as aspirin. Kodak has never manufactured the more complicated prescription medications that carry higher margins, nor will they under terms of the deal. Kodak will manufacture only the basal ingredients needed for generic medications, a fact that long-term investors must view with a least some disappointment.
The announcement is just one in what we believe will be many that follow. COVID has laid bare the risks in outsourcing critical components to essential goods overseas, such as medicine. For national security and the uninterrupted continuity of the American way of life, some supply chains will have to come home. The White House and relevant agencies are still determining exactly what components and which supply chains will need to domicile stateside. Trying to determine the winners at this stage would be prophetic.
The knock-on effect of moving production to the US will be higher prices for consumers. This begs the question of how much higher and whether Americans will accept it? Unraveling the answer is complicated. Absent tariffs, domestic subsidies, or some other protective measure, American producers of simple low-margin goods will still be at a disadvantage to foreign suppliers. It just costs more to manufacture here. Moreover, the domestic producers of sophisticated high-margin goods, such as advanced medicines and semiconductors, aren’t required to buy their inputs from expensive local suppliers. Even if Kodak met their production targets they may not have the ready-made market of buyers their hoping for.
More government intervention will likely be required if supply chains are to become more resilient and production is to move back to US shores. To an extent, the success of Kodak and other yet-to-be-named domestic champions will depend on the government “getting it right”. We wish Kodak the best, but we’re not prepared to back that horse.