Corning: A Real Glass Act With A Ton Of Upside

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 |  About: Corning Inc. (GLW)
by: Douglas E. Johnston

We've liked Corning (NYSE:GLW) for a few quarters now (link, link) and continue to believe that GLW will perform well going forward. With the recent "buy-out" of Samsung from their LCD joint-venture (Samsung-Corning Precision, aka SCP), Corning's earnings should get a boost in '14/'15 even with very little to modest growth within GLW's display segment. Along with a long-term contract with Samsung and an announcement of a further $2bn in incremental buybacks, investors in GLW celebrated as the stock moved up handsomely recently. Even so, we believe GLW's share price is still significantly undervalued and we target a $25 price target in 2015 implying a 44% total return upside from today's level.

The Samsung transaction details are available on GLW's website (here). In exchange for a $2.3bn investment in Corning by Samsung, in the form of convertible preferred shares, Corning will buy-out the 50% stake in SCP they do not currently own. In addition, GLW and Samsung will enter into a 10-year supply agreement, that has adjustments to smooth out price/volume/exchange rate volatility, and a joint technology agreement. This investment and agreement solidifies, if not cements, the relationship between the two companies. Based on transaction economics, GLW appears to have paid 6-7 time earnings, quite reasonable. The preferred shares have an interest rate of 4.25%, a premium conversion price of $20, are non-convertible for 7-years, and have an equity stake limit cap of 9%. All in, we believe this is a decent way to lever up GLW's fairly benign balance sheet. As an illustration of their balance sheet strength, all of their liabilities, sans accounts payable, are covered by cash and short-term investments. We estimate that, after the transaction, tangible book value will be ~$15/share.

Disregarding synergies, which include the ability of SCP to expand beyond the Korean peninsula, EBT should increase by about $800mn next year, $600 from the complete ownership of SCP and the balance from a modest 4% growth in top-line revenue. In addition, we expect gross margin to begin to creep back up towards 44% over time as cost of revenue continues to get checked. Our model suggests that net income, fully diluted for the SCP preferred shares, would increase to $1.50 per share in 2014 from an estimated $1.25 in '13. Even with a boost of capex to $1.75 bn (from $1.3bn this year), free-free distributable cash flow to common shareholders should be about $1.6bn or $1.18 per share. This would be a 12% boost from last year and helps to explain the move in the share price, post transaction, from its recent $15 level. The distributable cash flow yield, a useful metric for peer comparisons, is near 7%. Basically, GLW is levering up with the low-coupon preferred shares to boost cash flow for common shareholders. With $1.18 in free-free cashflow, GLW more than covers their dividend and we expect the dividend to be raised to 12c/quarter sometime mid-2014 and they will remain on track to buyback $1bn in stock in 2014 and $3.5 bn over the next four years.

Our assumptions are based on zero revenue growth (volume x price) for the display segment in 2014 and reduced expectations for their other segments (e.g., special materials up 10% vs 30% in '13). Compared to overall revenue growth expectations of 6+% this calendar year, we are forecasting a more modest 4.5% for 2014. While there are many that believe that the LCD business will be moribund, we are more agnostic although we believe the shift to larger screens, the natural refresh cycle, and the move into developing markets, will buoy demand in outer years. In 2015, we forecast 1.5% in display and 5% overall revenue growth which should feed into the bottom line for $1.75/share fully diluted. Given a reasonable market multiple and expectations of continued earnings growth, we see no reason for GLW not to trade in the mid 20s a few years from now. While there are always risks in any trade, our view is the upside potential in GLW is visible and management is of the mind set to achieve. We are with them, trading from the long side.

Disclosure: I am long GLW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.