Eastman Kodak

Decades ago, when cameras used physical film, Eastman Kodak (EK) was among the bluest of blue chips.  The company has been unable to adjust to the end of that era, however.  Although still listed on the New York Stock Exchange, EK was trading at a stock price below $3 a share in mid-September, giving the company a market capitalization of below $750 million.

the 8-K

On Friday September 23rd, EK filed an 8-K with the Securities and Exchange Commission, in which it revealed it had borrowed $160 million from its banks under a credit agreement negotiated earlier in the year (summary on p. 12 of the 2Q11 10-Q).

Since the 8-K, EK shares have dropped from $2.38 each to $.78–a loss of 67% of the company’s value.

Why this reaction?

details of the situation

The corporate balance sheet from the June 10-Q shows EK to have $957 million in cash.  Working capital is $842 million.  On the surface, then, there seems to be no pressing need to use the credit line.

The credit line has a maximum borrowing amount, subject to the availability of adequate collateral (like receivables, inventory, etc.–as defined in the credit agreement), of $400 million.  According to the June 10-Q, $235 million of that was available to EK then.

Therefore, EK borrowed most, if not all (maybe the amount of EK’s specified collateral has shrunk since the end of June) of the credit line, suddenly and without further clarification–and at a time when it didn’t appear to need the money.

what Wall Street fears

Bank credit lines aren’t set in stone, even after an agreement is signed.  In this case, I see two possibilities that would diminish or eliminate EK’s ability to borrow from the credit line it just used.

1.  The line is asset-based, meaning the amount lent depends on EK’s ability to furnish acceptable collateral, like receivables.  If that shrinks, so too does the available credit.

2.  Also, the banks’ credit committee can meet at any time and decide to withdraw part or all of the line right away, if it determines that EK’s financial condition has deteriorated.

Wall Street is reading the suddenness of EK’s borrowing action and the large amount as signs that EK borrowed the maximum amount it could because it feared one of the two might happen.

last Friday

Last Friday, the New York Times reported that EK has hired a law firm that specializes in corporate restructurings, including bankruptcies.  After the market close that day, EK issued a press release stating it has “no intention” of filing for bankruptcy.  That caused EK shares to rebound to $1 each in aftermarket trading.

what’s next

EK’s fate may not be entirely in its hands, however.  The credit line EK has just borrowed under (and probably all its debt, for that matter) has a set of stipulations, called covenants, that specify financial tests EK must continue to meet, as well as things the company may/may not do, in order to keep the loan in good standing.  Since this credit line is EK’s most recent borrowing, it presumably has the most restrictive covenants.

(To be clear:  I have no position in EK and I have no intention of buying or selling it.  I just think the current situation is worth writing about.  As a result, I’ve only read the summary of the credit line terms that is contained in the company’s latest 10-Q–not the full document, which is also available on the Edgar website.  I haven’t gone through the company’s other borrowings or done a credit analysis, either.)

Anyway, if EK violates these covenants in a serious enough way, the company’s banks can declare it in default of the loan agreement.  They can then demand immediate repayment of the entire outstanding amount. The banks aren’t compelled to declare a default in this situation, but they are able to.

If they do, however, EK’s response may be to seek court protection under Chapter 11 bankruptcy.

Only time will tell.