Bill Miller's Kodak Moment
The visionary fund manager is sticking with the photo giant despite its long slide.

(FORTUNE Magazine) –

For Eastman Kodak, it's been one miscalculation after another. In October Kodak (EK, $22) posted a $1.03 billion loss, its third consecutive quarter in the red and the fourth consecutive quarter in which earnings have fallen short of Wall Street targets. Among other things, the company underestimated how fast Chinese consumers would switch from film to digital cameras. Also, results from the digital-imaging-health group lagged, in part because of quality problems. In July Kodak upped its planned layoffs from 15,000 to 25,000, citing accelerating decline in sales of film products. The company says it will take $2.7 billion to $3 billion in restructuring charges from 2004 through 2006. In April Kodak's debt was downgraded to junk status, and at the end of September S&P downgraded it further.

With a sorry record like that, Kodak wouldn't merit much attention at all, except for a single big thing: One exceptionally smart investor--renowned fund manager Bill Miller, whose Legg Mason Value Trust has topped the S&P 500 for 14 years running--is still a believer. "Stocks bottom when results bottom, and we believe that Kodak's results are bottoming now," Miller says. Value Trust owns 14% of Kodak, and that position represents 3.4% of the fund's $18 billion in assets. Miller snapped up 10.6 million shares in 2000 when the stock was in the 50s, and he kept buying millions of shares a year, adding another 2.6 million this summer. His average cost per share is "in the 30s and falling," he says.

Miller recognizes that the odds against Kodak are long. "There aren't many companies that have been terribly successful making big technological transitions," he says. "How many typewriter businesses moved into computers?" But he has confidence in CEO Antonio Perez and the team of digital experts he's hired. And he values the power of Kodak's global brand. He believes the company has successfully made the jump from film to digital, noting that Kodak's camera and printer dock have a leading market share, and arguing that Wall Street overestimates the importance of the company's film business. "Kodak's earnings already took a $900 million hit as film's operating profit dropped from north of a billion dollars in 2000 to about $150 million this year," Miller says. The digital business, which posted a $46 million operating profit in 2004, "will do about $175 million this year," he adds.

Looking ahead, Miller expects big things from Kodak's commercial printing business, built up with $2.1 billion of acquisitions since 2003. "They've stitched together a commercial printing offering that is the strongest in the industry," he says, adding that it has "the potential to be extraordinarily profitable, with double-digit growth."

Strong points, but Kodak's many critics say the company's just a basket case. "How many times can a company find religion?" asks Citigroup analyst Matthew Troy. "When nonrecurring charges happen every quarter, they're recurring, that's your business model." Troy questions whether Kodak will be able to integrate the commercial print business, but a more immediate concern is whether the company will be able to expand its medical business beyond its radiography niche. "They're trying to upsell into the field with larger players with much broader expertise," Troy says, referring to companies including GE and Siemens. "They lack the comprehensive scale to compete." Deutsche Bank's Chris Whitmore argues that Wall Street's low expectations of Kodak are still too high: "They're entering markets that are highly competitive and have low margins and levels of profitability."

For Miller, there's more on the line than mere money: His streak is at stake. His 14-year run is the longest on record for a single manager at a single fund, according to Morningstar. As of Oct. 24, the fund was lagging, with a total return of --1.4%, vs. 0.4% for the S&P. That's partially because the fund is light on energy stocks and heavy on Tyco (5.6% of fund assets), which is down more than 25% this year. Of course, at this time in 2004 the fund was even further behind. But in the final months of the year it got a big boost from rallies in Amazon and Interactive Corp., among other high-tech names, and managed to edge out the S&P's 11.2% total return with a 12.4% showing. Will Miller make it again this year? We wouldn't bet against him. But chances are, any last-minute boost won't come from Kodak.