Kodak: The CEO vs. the Gadfly After the film company announced plans to remake its business, one investor activist declared war. Did he overplay his hand?
By Joseph Nocera Reporter Associate Kate Bonamici

(FORTUNE Magazine) – Early this fall Daniel Carp, chairman and CEO of Eastman Kodak, stood before a large audience in midtown Manhattan to unveil a new strategy. Acknowledging that Kodak's traditional cash cow--its "yellow box" business, as the film business has long been called--was in irreversible decline, he outlined an ambitious plan to move the company toward its inevitable digital future. Kodak, he said, would quit making big investments in film, which accounted for a large portion of the company's 2002 revenues of $13 billion. Instead it would shift resources toward digital cameras and accessories (already a $1 billion business), digital health-imaging technologies, and on and on. Kodak would get into inkjet printing and liquid displays. It would make new digital inroads in the commercial printing business. Altogether it would make $3 billion worth of investments and acquisitions.

To help finance the new strategy, Carp said, he was cutting Kodak's hefty dividend by 72%, from $1.80 a share to 50 cents, which he said would generate $1.3 billion in "investable cash" over three years. Carp called the strategic shift "probably the biggest turning point in our history."

If Carp had expected the investment community to leap for joy at his news, he was quickly disabused. During the Q&A, one investor compared Kodak to Xerox--which had also announced, several years earlier, a move into inkjet printing that had produced nothing--and openly wondered why Kodak thought it would do any better. Others suggested that Kodak's financial projections--$16 billion in revenues by 2006, $20 billion by 2010--were wildly optimistic. Another investor called Kodak's strategy "highly speculative" and said shareholders would be better off if management shrank the company and paid out the cash flow to shareholders. The market's reaction was even more brutal: The stock, which had been hovering at $27 a share, immediately fell nearly $5.

The next day Herbert Denton bought 5,000 shares. "Bert" Denton is neither a value investor nor a growth investor; he is best labeled an opportunistic investor. He seeks out troubled companies, buys some stock, then agitates for change. In the 12-plus years since he began his own investment boutique, Providence Capital, he has been in numerous spats with underperforming companies, including well-known names like Aetna, Hollinger, Disney, HealthSouth, Tyco, and Navistar. "Bert comes into situations where the share price is telling you that there is legitimate shareholder concern," says Bill Miller, the legendary fund manager of Legg Mason Value Trust.

But over the years Denton has become a lightning rod in the small world of shareholder activists: someone whose tactics and public posturing have made him a controversial figure. In targeting Kodak, Denton unwittingly provides a case study of his methods and their shortcomings. And during an era of corporate corruption and outright fraud--an era when investors have plenty to be angry about--he offers up as well a larger lesson in the limits of shareholder activism.

"Ask them where the Kodak hangar is," Denton whispers conspiratorially, not five minutes into our first conversation. "Ask about their new $50 million plane. I hear their campus is 12 square miles. A hundred and fifty buildings." He shakes his head in mock dismay.

We're sitting in his Manhattan office. It has the usual complement of computers, pictures, and mementos, but the rest of Providence Capital's suite is oddly barren. The only people who seem to be there are Denton and a receptionist. Behind me, on a chalkboard, is a list of a dozen companies Denton is targeting.

Some six weeks have passed since the Kodak announcement, time Denton has spent ratcheting up pressure on the company in the fashion of the modern shareholder activist. He has kept up a drumbeat of publicity, explaining why Kodak's strategy is a loser for Wall Street. He put together a highly publicized meeting for Kodak's institutional shareholders. It was standing room only, with one-third of the outstanding shares represented. "The lady from the New York State pension plan couldn't even get in the room!" Denton says happily. He finished a tough letter to Carp and the board.

"When we looked at Kodak," he says, "we saw a stock in mortal peril." (Among other flamboyant touches, Denton favors the royal "we.") The question from Denton's point of view is not whether Kodak should be moving from film to digital--if anything, the move is overdue--but whether long-suffering Kodak shareholders are being asked to bear too heavy a burden during what is sure to be a difficult transition. "By Carp's own admission, this strategy is going to get Kodak only 5% to 6% growth until 2006," says Denton, "and that's if they hit everything on the nose. That's not enough! The reality is that the average professional money manager does not have a three-year time frame. And in eliminating most of the dividend, Kodak has eliminated any reason for anybody to hold on to this stock." He leaps out of his chair and begins pacing the room.

Denton hands me a copy of the letter he's about to send Kodak. It lists four "suggestions." First, Denton wants Kodak to approve a shareholder committee that will review strategic alternatives the company has chosen not to pursue. "They say they picked the best plan," he says, his voice growing louder. "So fine. Let's look for ourselves. What are we, chopped liver? We own the company, remember?" Second, he wants "improved corporate governance," by which he means that Kodak should put someone on its board specifically to represent institutional shareholders. Third, he wants Kodak to sell off research and development projects that the company is unlikely to pursue.

Finally, he wants Kodak to cut costs. "Ever since we've been associated with this stock," he says, "we have been inundated with information suggesting that Kodak spends very generously. I'm trying to tighten everybody's belt a notch. If they reduce operating expenses by 5%, they would add $1.25 a share in earnings. Suddenly it's a $35 or $40 stock."

One of the raps against Denton is that his own stakes are always minimal. Relational Investors, the activist fund in San Diego, has $2.5 billion it can invest in a targeted company. The sheer size of its position causes management to take it seriously. Denton, by contrast, is rumored to have at most $5 million to put into play--and he usually spends much less. How can he expect to strike fear into Kodak management with only 5,000 shares of stock?

Denton gives me a withering look. He says he has bought more stock, though he declines to say how much. ("The Wall Street Journal would kill for that information!") Besides, he adds, it doesn't matter how much he owns: "In the mid-1990s it dawned on us. We can own 100 shares and still get results." That's because proxy rules were altered in 1992 to allow shareholders to exchange information. However, the rules still prohibit them from pooling stock to take collective action against a company. Denton claims he is not hamstrung by that restriction. He instigates. He makes phone calls and holds meetings to gauge shareholder interest in his ideas. Then he leads the charge against the company knowing that he has the cavalry backing him up.

And what a cavalry it is! To hear Denton talk, he knows everybody who matters. He has ties to Calpers, to TIAA-CREF, to Bill Miller, and to Carl Icahn. He picks up his Rolodex and waves it at me. "If I need to call Carl Icahn--look!" He plucks out a tattered card with Icahn's phone number and flings it triumphantly in front of me.

With Kodak, the first place Denton called was Legg Mason, Bill Miller's base of operations. Miller is widely viewed as the greatest fund manager of the modern era, having beating the S&P 500 for 13 straight years. To Denton's great delight, Legg Mason is Kodak's largest shareholder, with more than 10% of the stock. Miller began buying in 2000, when the stock was in the low 60s, so Legg Mason has lost tens of millions on Kodak so far. Miller had been Denton's great ally in the Aetna battle--under pressure from shareholders, the company eventually restructured--and according to Denton, the word from Miller's people suggested that the fund manager was keenly interested in his ideas for shaking up Kodak. At Denton's shareholder meeting Miller had conspicuously sat in the front row. A very good sign.

Denton had also learned that his friend Carl Icahn was buying the stock. Denton phoned him. "It was typical Icahn," recalls Denton. "Carl said, 'Yeah, maybe.' " But then an Icahn associate called Denton, and they had several meetings. Icahn soon received regulatory approval to buy up 7% of the stock; according to the Wall Street Journal, he now owned between 1% and 2% of the stock. Another promising development. "Being a Carl Icahn target is not something any company wants," Denton chortles.

With his allies in place, Denton was feeling large and in charge. "We can be very constructive to Kodak," he says as our interview comes to a close. He pauses for dramatic effect. "If they understand that."

"I saw my first digital camera at Kodak 20 years ago," recalls Daniel Carp. "I was 35. I knew right then that this company was going to transform itself." Carp is sitting in the conference room of a New York City hotel. Just as Bert Denton is talking to institutions and the business press, so is Carp. By now he has received Denton's list of demands. Though he declines to discuss them, he seems entirely comfortable with his company's new strategy--and the situation he finds himself in.

It took far longer than Carp ever imagined for Kodak to fully commit to digital technology, but he understood what had held his predecessors back: Traditional film generated most of the company's revenues. As long as the business was growing, they had to keep supporting it. In the mid-1990s Kodak began making digital cameras. It acquired Ofoto, its popular online service, and made other forays into digital imaging. But none of that came at the expense of film. After 9/11, Kodak had a big drop in film sales--as did its competitors--but it was unclear whether that was an aberration or a peek into the future. By the end of 2002 there was no doubt: The film business was, as they say, in "secular" decline, which meant it wasn't coming back. "When I saw film in secular decline," says Carp, who became CEO in early 2000, "it was the most empowering moment of my career. I could stand in front of the whole organization and say, 'We have to make our move now.' It was like a weight coming off my back."

Carp is an unusual CEO for Kodak--a lifelong insider with an outsider's mentality. He replaced executives, changed the culture, and dramatically cut costs. (He did not buy a $50 million jet.) He is adept at dealing with Wall Street. When the Street reacted badly to his fall announcement, he knew he needed to explain it better. That's what he's doing now.

Growth? Yes, it will be just 5% to 6% for the next few years--but without the new strategy, it would be much worse. As for the notion that Kodak should go into a kind of a liquidation mode, sucking cash from the film business and giving it to shareholders, Carp has an answer tailor-made for Wall Street. "I went to business school, and I heard about that as a theoretical exercise," he says. "In reality, it's not practical, because your customers are making this evolution from film to digital, and they expect you to help them make the evolution." His explanation is not so much that liquidation is heartless but that it won't work: Customers would take their film business elsewhere, and the cash would quickly evaporate. Similarly, reducing the dividend is simply a matter of facing reality. Kodak needs cash to fund its new strategy, and it makes more sense to cut the dividend than to borrow money. Kodak still has a dividend--albeit one a lot closer to the average of most other S&P 500 companies.

Carp says he isn't hearing many questions about the strategy itself. The questions are now about execution--but institutional holders seem inclined to give Carp time to play the hand he's dealt himself. "Some investors won't wait," he concedes, "but others will figure it out and come back to the stock."

Carp is right. By Thanksgiving the investment community is behind him. Bert Denton, with his loud voice and his small stake, is just a nuisance. Denton was wrong to say it doesn't matter how much stock he owns. It matters a great deal. Without a large stake, he can't do much more than complain to the press about Kodak. Denton likes to talk about his "constituency," as he calls the institutional investors in his Rolodex. But the fact that he can't legitimately claim to represent shares he doesn't own--because of the "no pooling" rule--is a big impediment. His habit of dropping names like Bill Miller and Carl Icahn has led many people on Wall Street to see him as someone who claims more support than he in fact has. When I visit him, for instance, he shows me a list of his "board members" that includes Rich Koppes, a lawyer who a decade ago was a high-profile activist with Calpers. But when I call Koppes, he says he doesn't know anything about Denton's board; Koppes has since told friends that he intends to ask Denton to quit using his name.

The most controversial aspect of Denton's modus operandi is the way he is paid. Earning money as a shareholder activist has always been a problem, especially for the smaller players. "Shareholder activism doesn't make economic sense," says Robert Monks, a godfather of the movement. Yes, there are times when a company restructures and the stock rises. But there are plenty of other times when the company successfully resists. "If the stock doesn't go up, you're screwed," adds Monks. Shareholder activists also face what Nell Minow, head of the Corporate Library, calls the free-rider problem. "Whoever is active is fronting 100% of the costs and only getting a piece of the upside," she says. "Everyone else is riding free."

Denton has devised several ways to make money. Sometimes he asks institutional investors to run trading commissions through him on stocks he's targeting. Legg Mason has paid him commissions from time to time. Other times Denton has received fees from the companies themselves. HealthSouth paid him $50,000 for his role as an advisor to a corporate-governance committee. He used a similar tactic with Kodak: When he asked the company to convene a shareholder committee to review strategic alternatives, Denton hoped to be named an advisor to the committee--and to be paid by Kodak for his work.

Minow and most other shareholder activists I talked to are sympathetic to Denton's desire to make money, but they disapprove of his method. "He's figured out a way to get paid that I'm not comfortable with," says Minow. Adds Ralph Whitworth, a principal at Relational Investors: "This discredits all of us."

Denton finds the criticism infuriating and unfair. "We haven't taken money," he says angrily. "We've earned it. In 90% of the cases, including Aetna, Tyco, you name it, we only made money if the stock went up. This is not an extremely lucrative business. We're doing it because we think it is the right thing to do. If we wanted to make a lot of money, we'd be an investment banker at Morgan Stanley." But however vehemently he protests, the payment issue has stuck to him--and hurt his credibility.

In the Kodak battle something else hurt him even more. Most investor activists believe there is a line they shouldn't cross in challenging a company. Denton crossed it. He isn't merely saying Kodak management has done a poor job and should be replaced. He's saying Kodak shareholders should be allowed to second-guess management's strategy and create their own plan for running the company. Carp counters by arguing that it's the board's job to represent shareholders. "The board will spend enough time debating the strategy to reach a conclusion as to whether they agree with the general direction," says Carp. "If they don't, they will change management, right?"

That view is shared by many investor activists. "Shareholders shouldn't run companies," says Monks. "They pay other people to run companies. When I hear a shareholder say he doesn't like a strategy, I want to run for the exits. That is what the board is supposed to do." Shareholders, he says, should be willing to take on governance questions, and if the board isn't doing its job, they should be willing to mount fights to replace the board. Whitworth agrees: "If we aren't happy with a board, we seek board representation. If you are upset about the decision-making process, that's one thing, but if you are trying to inject yourself into the decision itself, that's another. We have been very careful to avoid micromanagement."

Even Miller thinks Denton is going too far. Miller is hardly averse to taking advantage of companies under assault from unhappy shareholders. Though he was what Minow would probably label a "freeloader" in the Aetna battle, Miller made money thanks to the activists--including, in his view, Bert Denton. "He did very good work," Miller says. But as a general rule, challenging companies isn't how Miller makes money. He likes to take large positions in controversial stocks and then wait for them to move in his direction, as he famously did with Amazon. Miller began buying the stock in earnest in June 2000 at $44.78 (split-adjusted) and kept buying until October 2001, when the price was $7. Today, with the stock nearing $50, Amazon is one of Miller's biggest winners.

He hopes history will repeat itself at Kodak. "We own this stock for the same reason we own everything--we think it's mispriced," Miller says when I see him in early December. He concedes that he'd made a mistake buying Kodak in 2000. "In retrospect, we shouldn't have bought a stock whose core business was in secular decline at the peak of an economic cycle. I wouldn't do it again."

One thing he's not about to do is second-guess Carp's strategy. "Bert is asking for a level of detail that would be unprecedented," he says. Miller wouldn't want those details even if they were handed to him; they would handcuff him because he would have to sign nondisclosure agreements. If Miller hadn't liked Kodak's new strategy, he would probably have sold the stock. What he's doing instead is betting that the company will succeed and send its stock higher. He compares Kodak to IBM in the 1990s, when its mainframe business was in decline. Those who bet on IBM, including Miller, won big.

As a large investor, Miller has gotten to know Carp: "I'm impressed with how he thinks about the business. He's honest and straightforward. He's not deluding himself." After the September presentation, Miller met with Carp to ask his own questions. He came away satisfied: "It's pretty clear they aren't going to do anything stupid."

Miller does disagree with Carp about one thing: the decision to cut the dividend. "We thought they would have been better off borrowing to fund their strategy. Our analysis suggested they could have easily afforded to do that. But they chose another path." Miller shrugged. "We're just outside shareholders."

The last time I speak at length with Denton, he sounds bitter. In early December the Wall Street Journal roughed him up in a Heard on the Street column, suggesting that his October shareholder meeting had been a fiasco ("a complete mischaracterization!" says Denton) and noting that Denton hoped to be hired by Kodak to advise the shareholder committee he wanted the company to convene. ("Of course we want to be paid! We're not running a charity here!") Denton had recently returned from Rochester, N.Y., which had only added to his misery. He had gone to Kodak Park--four square miles, not 12--for a three-hour dog-and-pony show. But when he met with Carp and once again pushed his four-point plan, the Kodak CEO flatly turned him down. "No, no, no, no," is what Carp said, according to Denton.

The unkindest cut came when Legg Mason said it would back Carp. In a Dec. 4 Bloomberg story, Nancy Dennin, one of Miller's portfolio managers, was quoted saying, "The value of Kodak is higher than where it is currently trading. That value will be evident in the next 12 months."

Denton feels betrayed by his erstwhile allies at Legg Mason. "For them to back out in midstream--it's never happened to me before," he moaned. "Miller had his meeting with Carp, and he changed his mind. He's entitled to do that, but I was blind-sided." He added: "When Bill's organization came out in support of the company, that about cut the heart out of anything we had to say."

After he was turned down by Carp, Denton sold his stock; he says he made about $2 a share. But he's still "monitoring" the situation. He may have lost Miller, but Icahn is still out there. "I bumped into Carl the other day," Denton says. "He told me that if this stock falls into the high teens, it might be a good investment. Let me tell you something. If Icahn decides to make a move, Dan Carp will deserve whatever he gets."

And what does Carl Icahn say? He had a friendly meeting with Carp. He believes the Kodak plan has possibilities. He has no intention of "targeting" Kodak.

Oh, well.