Online Extra: What It "Boils Down To" For Kodak
On Nov. 11, BusinessWeek editors met with Eastman Kodak CEO Daniel Carp and President Antonio Perez to discuss its prospects in a world in which digital imaging is rapidly replacing the film-based photography that made Kodak (EK ) an American icon. They also discussed shareholder reaction to their controversial Sept. 25 strategic plan, which cut Kodak's high dividend by 72% to help fund acquistions and invesments in digital-imaging technologies.
During the meeting with BusinessWeek, Kodak declined to comment on corporate raider Carl Icahn, who in early November received clearance to buy up to a 7% stake in the film giant. However, in response to a question on Nov. 13, Kodak spokesman Gerard Meuchner said, "We met with Mr. Icahn, as we do with other investors. He demonstrated an understanding of our strategy, and we intend to have other meetings. He said he planned to monitor our progress in executing our strategy." Following are edited excerpts from the Nov. 11 conversation:
Q: Your stock is now trading at levels not seen since the early '80s. In light of that, some shareholders are arguing that more aggressive action needs to be taken to restore value in Kodak's stock. Carp:
Q: Your stock is now trading at levels not seen since the early '80s. In light of that, some shareholders are arguing that more aggressive action needs to be taken to restore value in Kodak's stock.
Carp:We have a very active board, and we looked at a whole continuum of options on how to create shareholder value. We settled [on a strategy] that the board and management believe will drive the most value. If you think about some of the [alternatives] that have been thrown out, they really aren't viable, practical options.
One of the first things that came out was, Why don't you just manage the company for cash and buyback stock and [essentially] shut it down? I understand how the numbers would work. But think about [how this would impact our customers.] If I'm a radiologist and Kodak comes in and says, "You know what, we've decided to just manage the old X-ray film business down." Then the radiologist would say, "I have a big problem, because I have to transfer myself from an analog [operation] to a digital [operation] and there are four other suppliers out there who are doing both."
So whose products is the radiologist going to buy? [As a result,] instead of coming down gradually, the historical film business would come down in a thump -- and that would consume enormous shareholder value.
Q: Do you think your Sept. 25 presentation was misunderstood? Perez:
Q: Do you think your Sept. 25 presentation was misunderstood?
Perez:Yes. We could have done a better job explaining the details behind the strategy. We didn't emphasize enough the amount of R&D we have been spending for many years in digital technology. The other thing we could have better explained is our acquisition strategy. On Sept. 25, it came out like we were saying we are rich and can spend money on everything that comes around.
What we meant to say is that we are going to stay very faithful to our core competencies. But within that, we may need to fill in some gaps, and that is how we are going to spend $3 billion on digital technologies. And of that, about $600 million is being spent this year. So in reality, it's more like $2.4 billion [that Kodak will spend on acquisitions and investments between now and 2006]. From our point of view, this is more a growth-from-within strategy, with a few acquisitions to fill in the gaps.
Q: So how do you explain your strategy now? Carp:
Q: So how do you explain your strategy now?
Carp:On Sept. 25, we said we were accelerating our investments in digital. But you need to understand that this company has been investing in digital for years and has been growing a fairly large set of digital businesses. The consumer digital business, for instance, is now about a $1.2 billion business [including digital cameras, inkjet paper, and Ofoto], and we have kiosks [for printing digital images] all over the place. But now film is in secular decline in the U.S. and Western Europe.
So we want to accelerate our investment in digital, and in order to fund that, we can no longer pay out 100% of our earnings in dividends. So we're going to bring the dividend down to about the average paid by [companies in the Standard & Poor's 500-stock index].
Q: The decision to cut your dividend from $1.80 to 50 cents a share must have been difficult, and it certainly upset many shareholders. Why did you do it? Carp:
Q: The decision to cut your dividend from $1.80 to 50 cents a share must have been difficult, and it certainly upset many shareholders. Why did you do it?
Carp:It wasn't until the fourth quarter of 2002 that we saw a big uptick [in the use of digital cameras]. That means the earnings power [of the film business] wasn't going to come back, and that if we were going to fund our evolution, we could no longer pay out 100% of our earnings [from film] in dividends. So we had to bring the dividend down to a more normal level and use the cash [saved] to accelerate our investments in digital.
Q: Investor Carl Icahn, who has won approval to buy up to 7% of your stock, isn't seen as a very patient man. So how do you convince him and others to wait until your strategy pays off? Carp:
Q: Investor Carl Icahn, who has won approval to buy up to 7% of your stock, isn't seen as a very patient man. So how do you convince him and others to wait until your strategy pays off?
Carp:You can't pick a strategy to target a selected set of investors. [If you do], you turn yourself into a pretzel, and you kill your company. When I became CEO, I decided to do what I thought was right. So it boils down to picking your strategy, communicating what you can do, and then let the market decide.
Q: How do you think you're doing in trying to persuade investors that your plan is the right one? Carp:
Q: How do you think you're doing in trying to persuade investors that your plan is the right one?
Carp:Since Sept. 25, we've been talking to a lot of investors, maybe 30 to 35. There are still some alternative strategies that are being bandied about. But I think [many investors] understand this was the right thing to do.
Perez: At the beginning, many investors were saying, "I don't understand the strategy." Now, after talking to 30 or 35 investors, I think they're saying, "Maybe this is the right strategy, but can the old Kodak execute this strategy?" Because we have to prove it can be done.
Q: So what's the answer: Can Kodak pull it off? Carp:
Q: So what's the answer: Can Kodak pull it off?
Carp:We now have a new management team, all of whom have experience in the digital world. Antonio is an Hewlett-Packard (HPQ ) veteran [who built its inkjet business]. Bernard Masson [who runs the digital and film imaging systems group] built the inkjet business at Lexmark (LXK ). Jim Langley [who's running commercial printing] has deep experience in digital commercial printing at HP. Willy Shih [a veteran of Silicon Graphics (SGI ) and IBM (IBM )] built our digital camera business from zero to $1 billion in five years.
And there are others: Dan Kerpelman [a veteran of GE Medical Systems (GE ) now running health imaging] and Carl Marchetto [a Lockheed-Martin (LMT ) veteran now running commercial imaging].
Q: What about your plans to enter the highly competitive and well-developed inkjet printer market? Perez:
Q: What about your plans to enter the highly competitive and well-developed inkjet printer market?
Perez:It was a shock for me to discover, when I came to this company, that we have almost 600 patents on inkjet technologies. So we have inkjet technology as good as anyone, but now we have to commercialize it. And when people say, "How can you get into inkjet?" I think it is very attractive. It is a rich environment, almost a $40 billion market, and there are just four competitors. Inkjet is an industry living off 20-year old technology with a business model that is ready to be challenged.
Q: What's your timetable for entering the inkjet market? Carp:
Q: What's your timetable for entering the inkjet market?
Carp:Not next year. We said that inkjet would start contributing to our results by 2006, but that doesn't mean it won't be before 2006.
Q: What other opportunities do you see? Perez:
Q: What other opportunities do you see?
Perez:Just as people have had shoeboxes to store their photos, you need a shoebox for digital images. There is not a good digital shoebox today. But in another 10 years, some people might have 1 million digital images. The problem then will be, how do you find one photo among the million?
We think the world will opt for a Net server where you can easily access your digital images. And that is what our Ofoto online service already does. It doesn't cost anything to join, and you can store as many pictures as you want. You only have to pay if you want to print an image.
Q: What kind of growth opportunities does this create for Kodak? Carp:
Q: What kind of growth opportunities does this create for Kodak?
Carp:We've said we can grow our sales 5% to 6% a year. But sales from traditional products [film, paper and photofinishing, etc.] will shrink 7% to 8% a year, while digital is growing 22% to 26% a year. By 2006, revenues from the digital business will account for 60% of Kodak's revenues, with traditional about 40%. At the same time, the gross profit of the digital businesses will cross over those of the film business.
Q: What's the biggest challenge you face in becoming successful in digital? Carp:
Q: What's the biggest challenge you face in becoming successful in digital?
Carp:The biggest challenge in any evolving market is to help your customers succeed. We have to take this digital technology and make it friendly and easy to use in the consumer, health, and commercial spaces.
Q: Is the film business going to disappear and go the way of vinyl records? Carp:
Q: Is the film business going to disappear and go the way of vinyl records?
Carp:No. It's not going to be an on/off switch. What I think will happen in consumer film is that it will come down fairly sharply and then level out for a long time. So the historical businesses will have a long tail, and that will generate a lot of cash to fund the transition.
Q: Should you have moved sooner? Carp:
Q: Should you have moved sooner?
Carp:I saw my first digital camera inside Kodak in 1982. Today, we're arguably one of the top three providers of digital cameras in the U.S. So we did the right thing. At the same time, we shouldn't have walked away from the historical film businesses before they turned down, because it would have destroyed value.