Private Equity: Could It Have Saved Kodak?

Current bankruptcy proceedings of Kodak are the end game of almost thirty years of failing health of a once great corporation, third largest in the world in 1972.  When I went to work there in 1965, there were 88,400 employees, up from 81,500 a year earlier.  At the peak in 1982, there were more than 60,000 in Rochester, NY, alone and, I think, more than 120,000 worldwide.

Current employment is a fraction of the 1980’s level and dropping fast, and the retirement pensions and health care benefits of thousands of retirees are in jeopardy.  The damage has already been done to the pension funds, university endowments, IRA’s and 401k’s that held the stock.  Kodak is struggling to stay alive based on exploitation of its patents, but the outcome is looking doubtful.

Kodak was a pioneer in the digital technology that put it out of business, but was unable to successfully exploit that technology alongside the traditional silver halide technology that had served it so well and was so ingrained in the company culture.  Photographic film and paper were commonly referred to as “the family jewels,” the possible mortality of which was not a subject to be discussed.  Kodak chose to continue to try to maximize revenues from the old technology and simultaneously develop the new, always looking for opportunities such as the short-lived Photo CD to have the two complement each other.  At the same time, the company purchased Sterling Drug and expanded its health care business. 

With knowledge of that history and the current situation, it is interesting to speculate about whether “private equity,” the kind practiced by Mitt Romney’s Bain Capital, would or could have made a difference.  Private equity investors bring to the table a dispassionate assessment of businesses and their prospects and a set of tools designed to separate the unfavorable from the favorable, get rid of or change the former, and invest appropriately in the latter.  Such actions often result in immediate termination of businesses and employees, a sort of corporate euthanasia, with transplant of usable organs to the surviving parts of the business or, as for gall bladders and appendixes, removal to the trash heap.  Human euthanasia, most of us agree, is immoral, but corporate euthanasia is often an economic necessity.  Corporations, in spite of recently expressed legal opinion, are not people and have no inherent right to life.

Such a ruthless approach may seem heretical and cruel in light of all the talk about job creation and whether President Obama or Governor Romney is the better “job creator.”  I’m guessing the President Obama is the better job  creator, but created jobs are patronizing, unchallenging, unsatisfying, demoralizing, unnecessary, and generally unwanted.  With a generous supply of borrowed money, it is easy to create jobs.  Just tell a group of people to move a pile of dirt from point A to point B.  Then tell them to move it back to point A.  It is like producing pennies that we don’t need at a cost we cannot afford or maintaining USPS employment at unaffordable levels to provide services we do not need and are unwilling to pay for or funding a solar panel start-up that has no hope of competing with producers in China.  What we need, rather than created jobs, is meaningful work that is economically justified because it provides products and services that people are willing and able to pay for or infrastructure needed for such work.

And that is what private equity does.  It structures businesses to provide products and services that can be sold at market prices while paying investors in the business a satisfactory return on their investments.  And, in the process, it provides meaningful employment to those qualified to work in the enterprise.  And, if successful, all the entities, investors, employees, and the corporation, earn money and pay taxes on those earnings.

If a group of private equity investors had read the handwriting on the wall in 1980, Kodak stock down 65% from its peak, and had coughed up about $15B to buy the outstanding shares, what might they have done to maximize the value of the company and keep it off of life support?  I think the Chemicals Division would have been spun off or sold almost immediately rather than a dozen years later.  Kodak would never have bought a floppy disc company to make a product doomed to obsolescence in the near future.  I think Sterling Drug would never have been bought…or sold a few years later at a loss.  I think all the digital technology people and the digital patents and research would have been bundled up and spun off as a different company, KodakDT (for Kodak Digital Technologies) maybe, and shipped out of Rochester to Palo Alto with instructions to compete with the digital technology leaders.  I think all fundamental R&D on silver halide would have been shut down, employment would have been reduced, and focus would have been put on TQM to reduce cost and required selling price for film and paper and to maximize the volume as “the air was gradually let out of the balloon,” a phrase from my former boss at Kodak who was smart enough to realize what was happening but powerless to do anything about it.  Many Kodakers would have been unhappy, and Rochester would have suffered sooner rather than later, but chances of corporate success would have been greatly increased. 

Unfortunately, 1980 would have been too late for the private equity owners to prevent Kodak entering the instant photography business which resulted in being sued by Polaroid for patent infringement and having to pay Polaroid $909 million in 1990.

If such a private equity strategy had worked as planned, KodakDT would be a leader today in digital imaging, film would still be a profitable, though much lower volume, product, and a big bunch of KodakDT employees would still have a bright future, a good trade-off for having had fewer employees laboring in a dying business over the past twenty years.  And pensions and health care for retirees would be more secure. 

It is just something to keep in mind as we consider the two approaches being proposed for “job creation.”  We really don’t want or need job creation.  What we want is meaningful work that builds economic value in the USA.  It may be appealing to argue in favor of keeping a company going as long as possible just to provide jobs, even if the company is failing and the jobs are non-productive, but few really want to waste their time and talents in such enterprises.  Most people want to work for a successful company and play a role in that success.   For that reason, I’m voting for the business approach.

Afterthought: And, speaking of non-productive, created work, Kodak was a big target for the federal anti-trust regulators because of its monopoly on silver halide photography.  After surviving consent decrees in response to successful federal anti-trust attacks on “private label” film (1921) and on bundling film and processing (1954), these issues became moot beginning in the 1980’s with the advent of digital photography and digital images and the proliferation of private label film and single use cameras.  Kodak was able, in 1995, to have the consent decrees set aside based on the argument that the company no longer had any power in its markets.  What an admission, and what a waste all that anti-trust activity was, perfect examples of created jobs destroying value simply because the trust busters had failed, along with Kodak, to understand the true scope of the market.

Another Afterthought: It is not only private equity managers that can make tough decisions and maximize value.  Jack Welch ran GE for 20 years, creating so much value and keeping the stock price so high that no private equity investor could have touched the company.  Private equity generally steps in only when a company is already in trouble.

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