Carestream: A Negative Film

Welcome to the 194th Pari Passu newsletter.

Today, we are looking at Carestream Health, a global provider of X-ray imaging systems and solutions for medical diagnostics and industrial non-destructive testing. The company has been at the forefront of medical imaging for over a century, originally founded as the healthcare division of Kodak, the iconic American photography giant that first put cameras in the hands of everyday consumers. Carestream was created when private equity firm Onex acquired the division from Kodak in 2007, at a critical time when film-based X-rays were being rapidly replaced by digital technology, threatening the core of what had historically been the business's most profitable product line.

In the following decade, Onex retained ownership of the company and, in 2013, executed a dividend recapitalization that extracted $725mm for itself while leaving Carestream with approximately $2.5bn in debt. While the debt load was manageable at the time, it left the company with very little financial flexibility at a moment when its core film business was in a long and irreversible structural decline. This would ultimately prove consequential, as the combination of declining revenues and a heavy debt burden would force the company into Chapter 11 bankruptcy in 2022. Even more, the company’s capital structure after Chapter 11 would not prove sustainable either, forcing it into another restructuring in April 2026, this time a multi-step LME that consisted of a divestiture followed by a combination of discounted debt buyback and a significant maturity extension.

Business Model 

If you have ever had an X-ray taken at a hospital or clinic, there is a good chance the machine was made by Carestream. The company is primarily a manufacturer of medical X-ray systems, with around 80% of its sales coming from a portfolio of medical equipment, including stationary and mobile digital X-ray systems, printer systems, and films used to print physical images from digital imaging equipment such as digital X-rays and MRIs [1]. Besides that, Carestream manufactures X-ray imaging systems for the industrial sector, primarily used to inspect materials for cracks and defects. 

To go more in-depth, the company’s business comprises four segments: Medical Digital, Medical Film, Non-Destructive Testing, and Contract Manufacturing. Let’s break these down in detail. 

Carestream's Medical Digital segment manufactures digital X-ray systems in both mobile and full-room configurations. Full-room systems are permanently installed in a dedicated radiology suite and are used for scheduled, high-volume imaging such as chest X-rays and orthopedic scans. Mobile systems, on the other hand, can be moved to the patient's bedside, making them essential in emergency rooms, intensive care units, and operating rooms where moving the patient is not practical. For context, digital X-rays are the latest evolution of medical imaging technology, having largely replaced traditional film-based X-rays starting in the early 2000s. Before, in the 20th century, X-rays were entirely analog, using film to create images. In that process, the patient was positioned between the X-ray emitter and an image receptor with a special film covered in silver halide crystals. When the X-ray emits microscopic radiation, it passes through the patient's body, strikes the film, and interacts with the silver halide crystals, which darken upon exposure and produce an image.

Nowadays, most clinics use digital X-rays, which, instead of using film behind the patient, use a special receptor panel that captures the X-ray beam after it passes through the patient and instantly converts it into a digital image that appears on a computer screen. This process is much faster and more accurate, eliminating the need for analog X-ray film to create the image. To show the scale of this equipment, Carestream's flagship full-room X-ray system, the DRX-Evolution Plus, carries a list price of approximately $240,000 to $270,000. The company also offers mobile X-ray systems, such as the DRX-Revolution, which has an average list price of about $125,000. Essentially, these are high-level, expensive machines that are core to the clinic’s ability to diagnose patients. The sales of this equipment accounted for 35% of Carestream’s revenue in 2021. 

The second segment is Medical Film, also called the Value Segment, which includes printer systems and films used to print physical images from digital imaging equipment, such as X-rays, MRIs, and CTs, and accounted for 44% of the company’s revenue in 2021. These film products should not be confused with the analog films that were used in the 20th century to create the actual image. The printer solutions were all focused on converting digital images into hard copies that could be analyzed and shared among doctors. This equipment is interesting in its nature, as it essentially served as a bridge between digital X-rays and the incomplete medical software in the 2000s and 2010s. Printer solutions were needed because, while digital X-rays were available, there was no complete, unified software available that allowed doctors to diagnose patients on a computer screen and share them. As a result, doctors were still printing radiographs even when they were captured digitally. We will discuss what this bridging nature would mean for the business later when doctors’ offices become digitalized. 

In addition to these medical-focused segments, Carestream leverages its imaging systems technology for two other verticals: industrial applications, under the Non-Destructive Testing (NDT) segment, and Contract Manufacturing. 

NDT is a portfolio of digital and film-based imaging devices used to test the quality and integrity of materials and structures, such as aircraft and bridge components. As a note, non-destructive testing is a group of analysis techniques used to evaluate the properties, condition, or structural integrity of materials and components without causing any damage. Ultrasonic and radiographic (X-ray) testing are the two main techniques that essentially allow engineers to see through the components. Carestream primarily manufactures equipment for radiographic testing, and a good example is the Industrex bendable detector, which can wrap around a tube and provide a high-quality image of its structural integrity. 

Finally, the Contract Manufacturing segment monetizes its expertise in precision coating technology, originally developed for X-ray film production. To note, precision coating is the application of a highly controlled, uniform layer of specialized material onto a surface. It is used to dramatically enhance the functionality, durability, and performance of products across industries like medical devices, aerospace, and electronics by providing specific benefits such as corrosion resistance, non-stick properties, and reduced friction.  Examples of products include battery and fuel cell membranes, as well as anti-counterfeit security films used in banknotes and identity documents. NDT and contract manufacturing each accounted for roughly 10% of the revenue in 2021. 

Corporate History

Before understanding what went wrong, it is important to review Carestream’s history, which dates back to the 19th century, when it was part of its predecessor, the Kodak Group. Kodak was founded in 1880 by George Eastman in Rochester, New York, and revolutionized the imaging industry by making photography accessible to everyday consumers. Before Kodak, photography was an expensive and technically complex process reserved for professionals. 

Over the next century, the company grew into a large international conglomerate with four segments: Consumer Digital Imaging Group, Film and Photofinishing Systems Group, Health Group (Carestream’s predecessor), and Graphic Communications Group. Broadly, these segments focused on manufacturing imaging and photographic products across both traditional film-based and digital technologies, serving a wide range of customers, from everyday consumers to medical professionals.

Kodak Health Group introduced the first X-ray imaging system in 1896, shortly after the discovery of X-rays. Over the decades, Kodak's specialized films have been developed for applications like cardiology, dentistry, and oncology. As the business continued growing in the 20th century, Kodak Health Group became involved in solving various problems. For example, in the 1940s, the company’s films were used to detect radiation exposure for workers developing the atomic bomb. Later, a pivotal moment in medical imaging came in 1956, when Kodak introduced the X-OMAT Processor, a machine that could process an exposed film to develop a finished radiograph in just six minutes. By replacing tedious, manual, hour-long darkroom processes, it drastically improved hospital efficiency. Within a decade, that processing time had been reduced to 90 seconds, transforming the speed at which doctors could diagnose patients.

By the mid-2000s, Kodak’s health group generated ~$2.5bn in annual revenue; however, the segment was already showing warning signs due to a shift from film-based X-ray imaging to newer digital technology, as we described earlier. In 2007, Kodak sold the Health Group to Onex Corporation for $2.35bn in cash, reportedly a slightly less-than-5x EBITDA multiple [8]. To fund the transaction, the company issued a $150mm RCF, a $1,500mm 1L term loan, and a $440mm 2L term loan, resulting in $1,940mm of funded debt and an approximately 83% LTV [7]. This transaction also led to the business being renamed Carestream Health, as it is known today.

Onex took on the task of carving out a struggling unit within a conglomerate to allow it to operate independently and more freely.  This is very similar to what happened with LifeScan, where Platinum Equity bought a diabetes management carveout from Johnson & Johnson at a similar multiple in an attempt to turn it around when its existing technology was becoming obsolete. In the case of Carestream, management was clear-eyed about the need to transform the business, and as it stated at the time, the company was "fundamentally changing its portfolio," implying it was actively entering the digital imaging market. Moody's initial 2007 rating noted the duality of the business: digital imaging equipment and information systems were experiencing double-digit revenue growth, while the core medical film business was deteriorating rapidly [7].

Six years later, in 2013, news outlets reported that Onex was trying to sell the business for approximately $3.3bn [6]. In 2013, the business generated $457mm in adjusted EBITDA, indicating Onex was targeting a 7-8x multiple. By that time, the business had developed a decent digital imaging portfolio, but sales of film printing solutions continued to decline in developed markets, which is why EBITDA declined overall. 

Despite multiple attempts and late-stage conversations with sponsors, Onex was unable to find a buyer willing to pay the desired price. At the time, private equity firms had a dim view of Carestream’s valuation due to the challenges of transitioning from film-based to digital X-ray technology, particularly in international markets [9]. These concerns likely reflected the need for high R&D spending to develop innovative systems capable of competing with much larger companies like Philips, GE Healthcare, and Siemens. 

When the sale fell through, Onex had another available option: a dividend recapitalization. In 2013, interest rates were near zero, making debt a particularly attractive source of capital and creating an easy opportunity for sponsors to perform dividend recaps without burdening the business with high interest payments. As a result, Carestream borrowed a new $150mm RCF due in 2018, a $1,850mm 1L term loan due in 2020, and a $500mm 2L term loan due in 2020 to lever the business up to 5.5x EBITDA. The proceeds from the new $2.5bn of debt were used to fund a $725mm dividend to shareholders and refinance $1.5bn of old debt, meaning the recapitalization added around $1bn of additional debt to the balance sheet. Combined with the previous distributions, Onex received a total of $1.2bn, representing a 2.6x gross multiple on invested capital (MOIC) and a 22% IRR. Even without a sale, the investment yielded a solid return to the sponsor. 

Three years later, in 2016, Onex considered breaking up the business and selling the dental imaging and legacy film & digital X-ray businesses. The film business was declining at the time due to the ongoing shift to digital, while the smaller dental digital segment, which manufactured X-ray systems for dental imaging, was seeing rising sales as dental clinics increasingly adopted digital imaging systems.

One of these initiatives came to fruition when the dental imaging business was sold to CD&R for ~$1bn in 2017, or approximately 11x EBITDA multiple, much higher than the overall Carestream business, which struggled to even get 7x in 2013 when Onex tried selling it. The divestiture also marked the beginning of Carestream Dental as a separate business, generating ~$400mm in sales, and approximately $85mm in EBITDA [17]. Carestream Health used substantially all after-tax proceeds to repay a big portion of its 1L debt. Effectively, Carestream sold off its most profitable and fastest-growing segment and kept the legacy X-ray business, which was on a downward trajectory. Moody’s reported that film accounted for more than half of the total $1.5bn sales after the spinoff, effectively making the majority of the business structurally declining [10].

This is where we can finally discuss how Carestream Health came to acute distress over the following years.

Path to Distress

Structural Shift

Carestream’s problem is that almost half of the company’s revenue in the 2010s and early 2020s depended on print solutions, which, as we alluded to, were just a bridge to the inevitable digitalization of clinical workflows. 

As hospitals adopted the Picture Archiving and Communication System (PACS), which allowed radiologists and referring physicians to view and share radiographs electronically, the need to print physical copies almost entirely disappeared. As a result, Carestream's digital print film sales in developed markets fell to just 4% of total film revenue in 2021, down from 24% in 2011. PACS adoption was highest in the US and Europe, so those markets exited first, leaving Carestream almost entirely dependent on emerging markets where digital infrastructure lagged. This is why an overwhelming majority of Carestream’s business was international as of the early 2020s.

As Carestream itself was shifting to sell fully digital X-ray equipment in developed markets, EBITDA was getting hurt because digital represented a one-time equipment sale, whereas traditional film systems provided Carestream with a recurring high-margin consumables revenue stream. This dynamic resulted in overall declining profitability over the years. 

Even in emerging markets, the business was experiencing pricing pressures. Specifically, in 2018, the Chinese government established the National Healthcare Security Administration (NHSA), which used volume-based procurement strategies to consolidate purchasing power among healthcare buyers nationwide, forcing suppliers like Carestream to accept lower prices to retain access to one of their largest markets.

Along with these developments, in 2018, Carestream had to address the upcoming maturities of its first-lien and second-lien term loans, which were originally due in 2019 and 2020, respectively, as part of the 2013 recapitalization. In December 2018, the company executed an amend-and-extend transaction, pushing the first lien maturity to February 2021 and the second lien maturity to June 2021. Notably, the extension did not come with an immediate interest rate increase. Instead, lenders built in a step-up mechanism whereby if the company failed to refinance the facilities by the end of 2019, it would face material increases in interest expense as well as minimum debt amortization requirements, which illustrated the pressure from lenders who demanded an exit option through a refinancing ahead of further business deterioration [18]. 

Heavy Competition

While the film business was in decline, the digital imaging segment was also facing intense competition. From the moment Carestream was carved out of Kodak in 2007, competition in its digital radiography business has been a constant constraint on the company's growth prospects. Moody's flagged it in its very first rating assignment, noting that the digital imaging and information systems businesses were "highly competitive" with suppliers including "substantially larger and better capitalized players" such as GE Healthcare, Philips, Siemens, and Fuji [7].

The company was spending approximately 3-5% of revenue, or $35mm-$70mm, on R&D between 2019 and 2021, and its structurally declining revenues constrained R&D spending and the ability to develop the best technology in the market. For comparison, we can take a quick look at Philips, where half of the $22bn in total 2020 revenue came from the Diagnosis & Treatment segment, which manufactures various digital imaging devices such as MRIs, CTs, and X-rays. Philips spent ~$1bn on R&D in the Diagnosis & Treatment segment alone in 2020, which is 20x what Carestream spent and highlights the competition it faced from much bigger players. In fact, in a 2020 report, Moody's noted that Carestream had been "losing market share as competitors have introduced more innovative products.” [14] This was particularly damaging because the digital imaging business was supposed to be the company’s growth driver, offsetting the structural decline in film. This all resulted in organic revenues declining by $100mm between 2018 and 2022, excluding divestitures [2].

Strategic Attempts

In 2020, the COVID-19 pandemic exacerbated the challenges already facing Carestream's business. Restrictions imposed during the pandemic directly impacted volumes, as routine medical exams were delayed and dental operations were closed. At the same time, the company had upcoming maturities of its 1L and 2L term loans due in February 2021 and June 2021, respectively, as it was unable to refinance the instruments following the 2018 extension. In May 2020, the company and its lenders successfully amended both facilities, extending the first lien maturity to May 2023 and the second lien maturity to August 2023. In return, the 1L term loan spread was increased by 0.5% to L+6.75%, and 2L was changed from all-cash L+10.5% to cash L+4.5% and 8% PIK, which was all-in 2% higher rate than before. The rising cost of debt was just a reflection of the increasing perceived risk of the credit and the company's solvency. 

After extending the maturities, it was still clear that the company was declining to unsustainable levels. In 2020, the company generated $1,150mm in sales, which stayed flat in 2021. At that point, the business was generating approximately $200mm in EBITDA and had ~$1bn funded debt, implying total leverage of about 5x. While this was the leverage the company carried after the 2013 recapitalization, the company’s multiple likely contracted to below 5x by then, as all strong-performing assets had been sold off, meaning that LTV was therefore much higher than before. 

As a result, Onex hired Houlihan Lokey to explore strategic alternatives for Carestream, including a potential sale of the company. Beginning in February 2021, Houlihan Lokey contacted more than 145 financial and strategic buyers. Ultimately, every bid received came in below the principal amount of the company's funded debt, showing that the market viewed Carestream's enterprise value as insufficient to fully repay its lenders. With a sale off the table, the company pivoted to a restructuring solution.

It is important to note that this restructuring was not driven by cash burn, as Carestream was generating neutral-to-slightly positive cash flow, but rather by the inability to refinance. In fact, Moody's reported that at the end of September 2021, the company had $88mm available under the $118mm RCF and $45mm in cash, for a total liquidity of $133mm.

In September 2021, an ad hoc group of first-lien and second-lien lenders, referred to as the Crossover Group, organized and engaged advisors to begin negotiations with the company regarding the terms of a comprehensive restructuring transaction. As a note, a crossover group usually forms when the same investors hold positions across multiple tranches of a company's debt stack; in this case, both 1L and 2L. This creates a unique dynamic because these lenders have economic interests in more than one class of debt, giving them a broader perspective on the overall capital structure and more flexibility in negotiating a restructuring solution. Following months of negotiations, on April 22, 2022, the company and certain first-lien and second-lien lenders entered into the Initial RSA. The Initial RSA contemplated a toggle approach, meaning an out-of-court voluntary debt restructuring if certain consent thresholds were met, or an in-court Chapter 11 process if the out-of-court path could not be achieved.

Under the out-of-court path, the company would pay all first-lien claims in full from the proceeds of a new first-lien term loan facility, while second-lien lenders would exchange their claims for a new subordinated secured debt facility and 100% of the reorganized company's equity, leading to a $220mm reduction in debt. It is interesting that Onex didn’t try to pursue a more aggressive LME that could help retain its ownership. The most likely reason is that the documents were tightened along with the two amend and extend transactions, which limited the sponsor’s ability to perform a more aggressive, viable liability management exercise that would have allowed Onex to keep the keys. As part of the negotiated transaction, certain lenders committed to backstopping the new 1L term loan, but this was contingent on Carestream achieving satisfactory credit ratings.

However, by July 2022, US credit markets had shifted dramatically, demand for similar refinancings had dried up, and the resulting facility could not achieve the credit rating required to trigger the backstop commitment, leaving the company with a $142mm funding shortfall it could not fill.