Focus Article: Corning, Inc. (GLW)

Corning, Inc. (GLW) $13.29

Picking a company for this week’s focus article was challenging because there were two interesting companies with insider purchases that looked attractive. Both companies are trading just below book value, both  have strong balance sheets and unfortunately both are experiencing a decline in their core businesses. The two companies I considered were newspaper company A. H. Belo (AHC) and Corning (GLW).

A. H. Belo has an asset rich balance sheet with several real estate assets as well as an equity stake in a company called Classified Ventures, the owner of Cars.com and Apartments.com. My back of the envelope calculations puts the Classified Ventures stake at $45 million. AHC also has $57 million in cash and $163 million in land, building and equipment on its balance sheet. They have no debt but they do have $146 million in pension liabilities. The company generated $47.7 million in adjusted EBITDA last year and has a market cap of just $113 million.

Unfortunately like the New York Times (NYT), it also has two classes of stock and even though management owns less than 5% of the company, they retain voting control through non-public Class B shares that give them 10 votes per share when compared to a single vote for each Class A share. This structure along with a declining core newspaper business tipped the decision in Corning’s favor.

The Company:

Corning is a specialty glass and ceramics company that celebrated its 160th year anniversary last year. The company became a household name thanks to its CorningWare and Pyrex dinnerware and bakeware products but sold that division over a decade ago. The company now operates in five primary divisions called,

i) Display Technologies that manufactures LCD screen glass in a joint venture with Samsung called Samsung Corning Precision Materials Co. Ltd (SCP).

ii) Telecommunications that manufactures fiber option cables and wireless products.

iii) Specialty Materials that includes the popular damage-resistant Gorilla Glass.

iv) Environmental Technologies that produces products used in automotive catalytic converters and diesel filters.

v) Life Sciences that manufacturers drug discovery tools and research products.

The company derives more than 70% of its $7.9 billion in annual revenue from outside North America. Corning hit a record in terms of revenue and operating income in 2011 and expects to achieve $10 billion in annual revenue by 2014. So why exactly is a company that is growing its top line by 19%, sports operating margins of 23% and has a strong balance sheet trading for less than book value?

The answer lies in the Display Technologies division, which was formed as a 50% joint venture with Samsung in 1995. It is both the biggest division of the company representing nearly 40% of overall revenue and is also the most profitable. While Display Technologies revenue posted 7% year-over-year growth in Q4 2011, it experienced a 19% decline in revenue on a sequential quarter basis due to weak demand for glass used to manufacture LCD screens.

As you can see below, the company expects global retail glass demand to continue to rise through 2014 and plans on scaling back production in the near term to stabilize prices.

However the company also realizes that the LCD glass business is essentially in “run-off” as new technologies such as OLED TVs eventually replace LCD TVs. The other factors that are weighing in on Corning include business weakness in its 50% joint venture with Dow Chemical (DOW) called Dow Corning that manufactures amongst other things polycrystalline silicon for use in the solar industry.

A further blow to earnings in 2012 will come from a higher tax rate of about 20%. In the words of management, Corning plans on a “reset” of their LCD business, find “bottom” and head higher based on their other lines of business such as their Gorilla Glass business that saw a 86% jump in 2011 sales to over $1 billion. While earnings are going to be lower, free cash flow may not suffer as much, as Corning plans on scaling back capital expenses over the next two years as you can see from the chart below. The company will also get a boost from higher dividends from Samsung Corning Precision Materials (SCP).

The company recently launched the next version of its Gorilla Glass called Gorilla Glass 2 that is 20% thinner and 20% stronger than the previous version. If you use an Android based smartphone, there is a very good chance your phone has Gorilla Glass in it. The company also launched another joint venture with Samsung to manufacture OLED screens for mobile devices.

Corning bumped up its dividend by 50% to 30 cents per share, pushing the yield over 2% and is buying back shares under a $1.5 billion share buyback program. Corning also plans on using M&A to achieve its goal of $10 billion in revenue by 2014. In many ways, Corning reminds me of where Gilead Sciences (GILD) was a year ago (low valuation, strong balance sheet, a pipeline at risk). I hope the company does not make large acquisitions at large premiums in its quest for top line growth.

Business Statistics and Financials:

For the full year 2011, Corning posted a 19% increase in revenue from $6.6 billion in 2010 to $7.9 billion in 2011. Earnings per share of $1.77 in 2011 were 21% below 2010 earnings primarily on account of a $900 million special dividend paid by SCP to Corning in 2010 and also on account of a higher tax rate.

The company trades for 6 times EBITDA, sports a dividend yield of 2.3% and has $3.4 billion in net cash on its balance sheet. Reflecting the challenging environment Corning is expected to face in 2012, analyst estimates for earnings per share are $1.36 in 2012 and $1.50 in 2013.

I have broken down the revenue and growth numbers for each of Corning’s five divisions in the table below.

Competitors:

Given the diverse lines of businesses Corning engages in, it is hard to find another company that can be called a direct competitor of Corning. Japan’s Asahi Glass Company (TYO: 5201) recently unveiled its “Dragontrail” glass that is both scratch resistant and appears to be as strong as Gorilla Glass 2. Asahi expects to generate over $350 million in revenue from this product in 2012.

Another company that is not a direct competitor but worth keeping on the radar is Research Frontiers (REFR) that was founded in 1965 by an ex-Corning employee. The company licenses its light sensitive glass technology to various companies and received a lot of attention last year when the 2011 Mercedes-Benz SLK featured a smart glass roof that can change color at the touch of a button. Given Research Frontier’s enterprise value of just $61 million, this could easily be a nip-tuck acquisition for Corning.

Insider Buying:

Two insiders purchased stock on the open market over the last six months as listed below. You can view a list of all insider transactions for Corning here.

Conclusion:

Perception is usually stronger than reality especially when it comes to investing. Despite the potential of increasing cash flows in the next couple of years, there is a good chance the Street will be focused on declining earnings and the stock is likely to be dead money for a while. I believe a lot of the bad news has already been factored into Corning’s price and the downside risk appears to be limited. Potential upside from Gorilla Glass 2 (especially if Apple picks it for future versions of the iPhone/iPad), the new OLED venture with Samsung as well growth in the other business lines like fiber optics is being discounted by the Street.