Corning - A Shattered Company

Includes: AUO, GLW
by: David Segelov

On August 22, 2006, Sanford C. Bernstein & Co. LLC, produced a report which brought together the thinking of their U.S. retail analyst Colin McGranahan, and Jeff Evenson, their U.S. data networking analyst. With regard to Corning Inc. (NYSE:GLW), the report argued a few essential points:

• In 2007, demand for LCD TV screens would be higher than anticipated because 25% of TV demand stems from North America, where LCD TV penetration is low. Bernstein anticipates it will be in the low 40s. As of the end of Q2 2006, LCD penetration sits at 19%. S-Curve adoption rates, according to Bernstein, make Corning a buy.
• Corning will benefit from supplying the key players.
• 42-inch will emerge as the size of choice for LCD TV, replacing 32-inch. Corning stands to benefit from this in two ways: 1) By increasing glass sales per TV set dramatically. And 2) A dramatic surge in unit-volume sales as demand ascends the S-Curve.

However, reading the Corning conference call transcript from Q2 2006, the issues do not appear to be at all what Bernstein purports:

1. Corning has limited visibility. The conference call made it clear that it took 3-months from order-desk to the retailer’s floor. For this reason Corning gave much wider guidance than in previous quarters.
2. Bernstein states the following: "What smart people are missing is that in the old-days the size of your TV depended on the size of your floor and the size of your door - in the flat-panel world, it depends on the size of your wall."
What Bernstein seems to miss is that the 42-inch screens are $1,900, which they hope will fall to $1,600 by year-end - still a hefty price tag. Price declines seem critical to the shape and steepness of the S-Curve, and hence Corning's future success.
3. Glass sales to TV makers are dependent on a select few manufacturers, such as AU Optronics (NYSE:AUO), who accounts for almost 20% of Corning's TV-glass sales. For the small but ramping Gen 8 that focuses on TVs 40-inches and larger, Sharp is everything to Corning.
4. With computer LCD penetration at over 80%, Corning is a consumer play strictly on LCD TVs.
5. Corning is not a fibre play. According to 10K, in 2005 Corning had $1.6 billion in sales of fibre-optics, yet made less $36 million in net operating profit. I have seen many investors tout GLW as a play on fibre-to-the-home [FTTH]. Yet when a friend down the street got his dedicated-fibre line, the street had already been laid with fibre. More importantly, only the local copper loop to his house (less than 30ft) was replaced by fibre.
4. Whether Corning hits or misses their number has little to do with the size of wall or the door, but rather with the complex relationship between volume growth and price declines, tempered by the effect of exchange rates. Corning's ability to cut their cost-curve is critical to their success.

I therefore remain negative on GLW. Corning is a company making bigger and bigger bets. This year, capital expenditure [CAPEX] on screens is greater than $1 billion. Generation 8 is a huge bet. It reminds me of Micron in the 1990s, as fabs became more and more expensive. Like Micron, with each successive generation, the margin of safety diminishes – yet all this remains mostly invisible to investors.

Disclosure: David Segelov holds a short position in GLW.