Inside Analysis of the Kodak and KPG Deal

By Cary Sherburne, Senior Editor

Announcement Reflects Kodak’s Commitment to the Graphic Communications Market

January 13, 2005 -- In a move long anticipated by industry watchers, Eastman Kodak Company announced yesterday that it will become the sole owner of Kodak Polychrome Graphics (KPG) through redemption of Sun Chemical Corporation's 50 percent interest in the joint venture. Kodak and Sun Chemical each own half of KPG currently, a joint venture established in 1998 with an original ten-year term. The transaction is expected to close in April 2005, and Kodak expects the acquisition to be accretive in 2005. Kodak indicates that KPG CEO Jeff Jacobson and his team will remain intact.

Under the terms of the transaction, Kodak will redeem all of Sun Chemical's shares in KPG by providing $317 million in cash at closing, $200 million in cash in the third quarter of 2006 and $50 million in cash annually from 2008 through 2013, for a total of $817 million. Kodak will fund the redemption through internally generated cash flow.

According to Barbara Pellow, Chief Marketing Officer for Kodak’s Graphic Communications Group, “Kodak clearly understands the need to have the best distribution in the industry, and the acquisition of KPG will substantially enhance our go-to-market strategy across all product lines. It opens the door to global distribution based on resources they have in field.”

KPG revenues for 2004 are expected to be $1.7 billion. Kodak expects this transaction to add approximately $1.1 billion to Kodak's revenue in 2005, reflecting approximately nine months of Kodak ownership and the elimination of inter-company sales from Kodak to KPG. In 2006, Kodak expects approximately $1.4 billion of incremental revenue, reflecting a full year of ownership and the elimination of inter-company sales. The deal appears to be a well-struck deal for both parties, with Sun Chemical intending to reinvest proceeds in its core business, and Eastman Kodak gaining full control of a valuable resource whose earnings will be accretive during the first year and whose revenues will easily fund future payments. Kodak indicates that the rate of return for this acquisition is expected to be well above the company’s established hurdle rate.

Based in Norwalk CT, KPG is a leading supplier of products and services to the graphic communications market, with operations on six continents and an extensive global sales force, with nearly 1,000 employees interacting directly with customers. In addition to being the world leader in sales of digital computer-to-plate and monitor and remote proofing solutions, KPG supplies graphic arts film, conventional lithographic plates and digital color proofing products. KPG's customers include commercial printers, newspapers, publishers and packaging printers. KPG has approximately 4,000 employees worldwide.

The acquisition will increase the number of employees in Kodak’s Graphic Communications Group to about 8,000, and, according to Jim Langley, President of the Graphic Communications Group, the group anticipates achieving revenues of approximately $2.5 billion in 2005 as it transitions into profitability during the year.

An Unmatched Product Portfolio

When Kodak’s Graphic Communications Group was launched about 18 months ago, it consisted of one wholly owned subsidiary (Encad) and two joint ventures—NexPress Solutions and KPG. Langley said, “We have accomplished a great deal in that timeframe, growing from a few hundred million in revenue to a business on the order of $2.5 billion, transitioning to profitability in 2005. We acquired Versamark and we acquired Heidelberg’s interest in NexPress Solutions. We are in the process of rolling Kodak’s Document Products and Services (DPS) operations into the Graphic Communications Group as well. Adding KPG will have a major impact on our distribution strategy and will double the number of customer-facing employees in the organization.”

With this acquisition, Kodak will have the broadest product portfolio in the Graphic Communications marketplace, with solutions focused on the commercial print, quick print, in-plant print, data center printing, digital service bureau, packaging and newspaper markets, including:

• Encad, HP and Epson wide format solutions, including ink, media, software and print engines
• The NexPress family of color and monochrome digital printing solutions
• Canon CLC 1180 and CLC 5100 in the production color copier space through a distribution arrangement with Canon
• High-speed continuous inkjet solutions from Versamark
• Computer-to-plate systems for the commercial print, packaging and newspaper markets
• Direct imaging presses through its distribution arrangement with Presstek
• Digital and analog printing plates, including its new VioletNews plates for the newspaper market
• A wide range of digital, analog and monitor proofing solutions, including RealTime Proof and the Matchprint Virtual family
• Mass storage solutions through its arrangement with ExaNet
• A robust line of workflow and color management solutions
• A full line of scanners and document management solutions
• A global sales and service force of 2,000 people

The company also plans to enhance its professional services offerings to better help customers configure the best possible solution from this huge product portfolio. Langley said, “We have a strong professional services consulting organization within NexPress run by Chris Bondy, and KPG has a well-developed professional services program as well. This is one of the areas where, by putting the pieces together, we will be able to have a deeper, richer offering. We are going to invest in this area, strengthening it and making it more robust.”

Organizational Structure

Langley indicates work is currently underway to determine what the ultimate organizational structure of the Graphic Communications Group will be with the full integration of this and other acquisitions, but stated that integration activities are ahead of plan. “We have already made significant progress in our business integration efforts. When we acquired the other half of NexPress last May, we created 276 transitional service agreements with Heidelberg, largely for back office functionality, order to cash and service parts warehousing, since manufacturing and sales had been operated by Heidelberg. All of those transitional service agreements have now been integrated into Kodak resources around the world. Additionally, we made offers to about 300 sales and service personnel formerly employed in Heidelberg’s digital business, and we had a 98% acceptance rate of those offers.”

Langley stated that the bulk of the integration activities that have been undertaken—and the most important to Kodak—are customer facing, saying, “We want integration to occur before we go to customer, not at the customer site. We will build on the regional structure already in place with KPG and the other businesses we have acquired, and move to an integrated sales force with strong account management backed up with equipment specialists from various product lines. And there is a tremendous amount of opportunity for back office integration as well. As an example, today we have multiple order-to-cash systems, and we will be moving to one.” The company indicated it would be migrating all of the organizations to its SAP infrastructure, with full ERP integration expected to be completed in 18 to 24 months.

One Face to the Customer

Kodak clearly intends to integrate its sales activities under one umbrella. Langley said, “Each acquisition we made had its own sales structure to varying degrees. With NexPress, we had the sales and service without the back office; Versamark was a self-contained functioning business. With KPG as a joint venture, we put in place financial incentives for cross-selling and lead generation and also engaged them to sell the NexPress product line, an initiative that is planned to roll out this year. We are looking at a couple of potential organizational structures. Since we haven’t settled on one, I am not at liberty to talk about what those are, but suffice to say that we will ultimately integrate the sales function under one person in the organization.”

From a channel perspective, IKON and Danka are carrying only one product family from Kodak, that being the Digimaster. Pellow said, “We are working aggressively with enterprise partners, including IKON and Danka, in the corporate in-plant space. Clearly we would like to have these partners carry as much Kodak product as possible. At this time, there is nothing we can say other than we are working hard to make sure we have good coverage through a strong set of partners in that space.” When asked whether Kodak plans to sell directly into the corporate in-plant market, Langley commented, “We have in place important partnerships that can serve the in-plant and corporate markets, There is bound to be some spillover, but this will not be our primary area of focus for direct sales.”

KPG: On a Path to Digital

KPG’s Jacobson indicated that approximately two-thirds of KPG’s current revenues come from digital solutions, including digital computer-to-plate, prepress and workflow solutions, remote and monitor proofing, digital print engines and direct imaging presses, an aspect of the business that bears a 12% annual growth rate. The other third of the business is comprised of traditional film, which is declining at a 12% annual rate. The digital portion of the business also yields higher margins than the analog business; thus, over time, KPG’s overall growth rate, currently estimated at about 2%, is expected to increase.

Jacobson said, “We have been aggressively moving down the digital and business solutions path and this move will enable us to accelerate that strategy by about two years. Prior to the acquisition, we had a limited capacity to expand these services outside of the United States. With the new product specialist infrastructure Kodak will be putting in place, those limitations will no longer exist.”

Looking Toward the Future

In a financial briefing in September of 2004, company executives indicated that there were two acquisitions built into its financial model. When asked about the second acquisition, and specifically whether that acquisition might be Creo, which is currently embroiled in a proxy fight, Chief Financial Officer Robert Brust cited Kodak’s policy not to comment on rumors or speculation in the marketplace, but added, ”When we first started this whole program of redoing the company strategy, said we would get to $16 billion by 2006, and we are set to get there. But to get to where we want to be by 2007, there may very well be another acquisition coming down the road.”

From a branding perspective, Pellow said, “As we move forward into a fully integrated business, Kodak will be the primary brand We will have some sub-brands, and the KPG brand will be used where appropriate, but you can expect to see it used less and less over time. Over the next several months, you will see an integrated face to the marketplace. We still have details to work out, but that is our strategic intent.”

Jeff Jacobson summed up the value proposition for the combined organization by saying, “If you are building a successful business, do you want to deal with twenty different vendors, or do you want to talk to one vendor who makes it all work together for you, delivers the exact product set you need and presents you with one invoice? I look forward to doing my part to unlock the value offered to our customers by this combination.”

With the completion of this acquisition in April, Kodak will be uniquely positioned to be that one vendor...making good on its promise to demonstrate an unparalleled level of commitment to the graphic communications industry. There is no question that Kodak is a player to watch and that the company is well-positioned to have a significant impact on the graphic communications industry as both the company and the industry continue their digital transformation.

This report was written by Cary Sherburne. She can be reached via email at cary@sherburneassociates.com, online at www.sherburneassociates.com and by telephone at 603-430-5463.