Newsletter Value Investor Insight carried an interview November 29th with Leon Cooperman, who runs Omega Advisors, along with Steven Einhorn, Mark Cooper, Michael Freedman and David Mandelbaum. Omega manages $5 billion, and its flagship fund has earned net returns of 16.3% per year, versus 10.6% for the S&P 500, according to Value Investor Insight. Here's the excerpt from the interview in which they discuss Corning (GLW), which was trading at $21.49 at the time of the interview:
Describe the opportunity you’re finding in “quality-growth” companies.
LC: As I mentioned earlier, we often find opportunity when our view of the value of a company's growth prospects differs from the market's, which is the case today with some very high-quality companies.
Michael Freedman: Stocks go up for one of two reasons: growth or multiple expansion. Growth investors who are not price sensitive are playing for business growth. Value investors often play for multiple expansion and are not overly concerned with growth. We try to look for situations where you can benefit from both – that gives you two ways to win. Good, growing businesses tend to be cheap either because they’re overlooked or out-of-favor. With our asset size, we’re more likely to put capital to work in highquality growth companies that are out-offavor and in Mr. Market’s penalty box. Fortunately, short-term, momentum investors can drive down growth-company share prices, providing plenty of opportunity for those with a longer-term focus to buy on the cheap.
Let’s talk about one of the specific growth companies you see as out-of-favor, Corning (GLW).
MF: Corning’s biggest and highest-profile business is providing the glass used in making screens for a wide variety of consumer electronics, most importantly liquid- crystal-display monitors and TVs. Consumer adoption of LCD TVs is now hitting its acceleration zone, as prices come down. I looked up and down the industry’s food chain for the best way to play this explosion in consumer adoption and landed on two areas – supplying the liquid crystal and supplying the glass for screens. In each case there are very few suppliers and the manufacturing process is very difficult, making the potential upside very interesting as demand grows 40-50% per year.
The LCD panel itself is essentially a sandwich, with two sheets of glass and all the electronics and lighting behind it. The glass – Corning’s business – has to be absolutely perfect, with no deviation in thickness or any imperfections throughout the entire panel, and it has to be able to withstand high temperatures in the fabrication process. Given how hard that is to do, there are only three main players in the market: Corning, with 60% of the market, followed by two Japanese competitors, Asahi Glass and Nippon Electric Glass. Corning has been the technology leader, which gives them a pricing advantage until the competitors catch up. They’re also the most flexible and cost-efficient manufacturer and their glass runs up to 15% more efficiently through the customers’ fabs. That’s why they’ve been able to maintain market leadership and another reason they get premium prices.
What is the market concerned about?
MF: Some of it has been over the timing of seasonal orders, which I think is irrelevant. There may be variability in consumer – and therefore TV-manufacturer – demand, but it has no effect on longer term demand for LCD glass.
The market also seems very concerned about pricing. Every year the price of LCD glass on a per-inch basis goes down, as is typical in consumer-electronics businesses. This year the price per-inch will probably be down about 15%, which is more than the market expected. I don’t consider that a big deal for two reasons. One, a big part of this year’s decline came from Asahi and Nippon catching up in quality in certain glass sizes, wringing out some of the premium Corning was able to command in those sizes. To the extent the premium has been wrung out in those products, it can’t be wrung out again, so there’s no reason to consider the 15% price drop a trend.
Second, Corning seems to get little credit for that fact that they’ve been reducing manufacturing costs in the mid-teens also. This highlights one of their primary competitive advantages: they spend 10% of sales on research and development, working on both inventing the next big thing as well as driving down costs of existing products. That’s a lot more money on R&D than their competition can afford.
How attractive do you consider Corning’s other business lines?
MF: LCD glass is the major driver today, but I consider the two other main businesses to be excellent call options for the future. The telecommunications business is basically a play on more optical fiber being employed. During the Internet bubble, a lot of long-haul fiber was laid, but it can’t be taken advantage of until new short-haul connections – utilizing Corning products – are in place. As demand for Internet video increases, you’re eventually going to need that fiber capacity available. This business is breakeven now, but if orders picked up it would be very profitable, very quickly.
Their other interesting business is making emissions-control products for car and truck engines. New environmental regulations in Europe and the U.S. requiring cleaner-burning diesel engines in heavy-duty trucks go into effect on January 1. The rules basically require a scrubber on the engine and Corning has the best product on the market. They’re booking small revenues now, but have signed deals that will show up materially next year. Corning believes this can be a $500-600 million revenue business within the next few years, and they tend to guide conservatively.
More generally, Corning’s heavy spending on R&D would suggest they may have several blockbuster products in their labs right now, from things like solar cells, green lasers or ultracapacitors.
Trading recently at around $21.50, how are you looking at valuation?
MF: The company trades at about 16x consensus 2007 earnings estimates, which I think are conservative. If you look at 20 of the best name-brand technology companies, like Cisco, Nokia and Microsoft, the median P/E on next year’s earnings is 17.9x and the median expected long-term annual growth estimate is 14.6%. So Corning is trading for a lower multiple while its consensus growth estimate is higher, at 17.3%.
Looking to 2008, I think the company can earn north of $1.50 per share. At the 18-20x multiple a company with these growth characteristics should have, we have a target price for next year of around $30.