- The post-earnings sell off in GLW shares is overdone and now is the time to establish a long-term position in the company’s shares.
- Concern over sapphire crystal replacing Gorilla Glass in hand held devices is overdone given an increasing market for Gorilla Glass in non hand held product markets.
- Any failure of GLW management to maximize shareholder value may result in large investors calling for a break up of GLW or in a company taking over GLW.
Corning (NYSE:GLW) announced earnings about a week ago and the shares sold off over 9 percent the day of the earnings announcement and remain at that level. While there were disappointments in the earnings announcement, we believe the immediate and sharp sell off was no more than profit taking as the shares had risen over 50 percent in the previous year. Let us look at GLW, their earnings announcement and recent developments for the company.
GLW is divided into the following divisions: display technologies, optical communications, specialty materials, environmental technologies, and life sciences. The display technologies division represented 32 percent 2013 sales and the products of this division are used primarily in notebook computers, flat panel desktop monitors and LCD televisions. The optical communications division represented 30 percent of GLW's 2013 sales and the products from this division include optical fiber and cable, and hardware and equipment as well as optical solutions for the broader communications industry. The environmental technologies division represented 12 percent of 2013 sales and the products from this division include ceramic substrates and filter products for emissions control in mobile and stationary applications. The specialty materials division represented 15 percent of 2013 sales and the products from this division include material formulations for glass (including Gorilla Glass), glass ceramics and fluoride crystals. The life sciences segment represented 11 percent of 2013 sales and the products from this division include general lab ware and equipment, as well as specialty surfaces, media and reagents.
Second Quarter Earnings Announcement
In late July 2014, GLW reported second-quarter core earnings of 37 cents on revenue of $2.48 billion, up 25.2 percent from the year ago period. The display technologies division generated around 40 percent of total revenue. The division was down 4.1 percent sequentially and up 56.4 percent from the 2013 second quarter. (This revenue included the acquired portion of the Corning-Samsung joint venture in late 2013. The inclusion of CPM helped revenue in the last quarter and management stated that the CPM integration was going ahead of plan.) The optical communications division generated 28 percent of total revenue and grew 14.1 percent from the 2013 second quarter. The environmental technologies division generated about 11 percent of total revenue and grew 25 percent from the 2013 second quarter. The specialty materials division generated 12 percent of total revenue, up about 14 percent sequentially and down 1 percent from the 2013 second quarter, missing management expectations of a 20 to 25 percent sequential increase. The weakness in this division during the quarter was due to softening demand and lower-than-expected sell-through in the important smart phone and tablet markets. The life sciences division generated about 9 percent of total revenue, up almost 2 percent from the 2013 second quarter. During the quarter, GLW spent $175 million on share repurchases and $151 million on dividends.
For three of GLW's divisions, guidance for the remainder of 2014 for four of GLW's divisions was as follows: 1) for the display technologies division, the TV market would remain strong in 2014, with average screen sizes continuing to increase with desktop monitor and notebook markets would be flat; 2) the optical communications division's would rise in the mid-single digits; 3) environment division sales are expected to be up 20 to 25 percent; and 4) life sciences division revenue would rise slightly. The specialty materials division is expected to rise 10 percent sequentially on higher Gorilla Glass sales due to the launch of new products. Management's guidance for the covered glass market (which includes Gorilla Glass sales) was very cautious, particularly with respect to the tablet and touch notebook markets given lower-than-expected growth in these markets.
Investor's Gorilla Glass Anxiety
Currently, GLW provides their Gorilla Glass for the displays of numerous hand held device brands, including the Apple, Inc. (NASDAQ:AAPL) iPhone. Recently, AAPL has taken steps that have fueled rumors that the iPhone 6, expected in fall of 2014, would have a sapphire screen. Sapphire, however, is known to have many disadvantages when compared to Gorilla Glass. Sapphire is about ten times more expensive and is about 1.6 times heavier. Making Sapphire is environmentally unfriendly as it takes about 100 times more energy to generate a sapphire crystal than it does glass. Sapphire transmits less light, which means either dimmer devices or shorter battery life. Regardless of concerns over some companies switching from Gorilla Glass to sapphire crystal, the uses for Gorilla Glass is expanding outside of the handheld devices market and any switchover will likely be limited to a select set of more expensive products.
GLW faces competitive and non-competitive risks that include: 1) the profit margin for LCD Glass, which represents a substantial portion of GLW sales, has been affected by significant price declines (but GLW expects the price declines to be moderate in the future); 2) the fluctuating value of the Japanese Yen can negatively affect margins, (but GLW hedges such risk by reducing their exposure to foreign exchange risk); 3) the possibility that handheld device manufacturers will use sapphire crystal for their screens instead of Gorilla Glass (but GLW recognizes that sapphire crystal has significant disadvantages and that use of Gorilla Glass in non handheld device markets is expanding); and 4) the failure to invest resources in research and development to compete in and establish product markets (but GLW has a long history of recognizing the value of investing in research and development).
Outside Investors May Pressure GLW Management
If GLW shares continue to underperform in the near term, investors with significant holdings in the company may become anxious and impatient with GLW's management. There are analysts who believe that, under different leadership, GLW could be transformed into a faster growing company or the company could be broken up. Those analysts believe that GLW's share price could rise significantly if the company divested itself of their large LCD glass division. The market for LCD glass, while expected to continue growing, is becoming more competitive. GLW's LCD glass division continues to be profitable and such profitability makes a sale or spin-off of the division possible. Revenue from the other GLW divisions are in more growth oriented markets, including cell phone glass, ceramic materials that reduce car emissions, and proprietary photonic equipment used in telecommunications. Each of these GLW divisions have the potential to grow by 15 percent to 20 percent a year and would allow GLW a much higher price to earnings multiple if the LCD glass division were no longer a part of the company.
Some commentators and analysts believe that GLW is a takeover candidate. Those analysts believe that a private equity firm or a corporate buyer may be interested in such an acquisition given that GLW has a strong free cash flow yield, proprietary products, a relatively depressed market valuation and potential for a turnaround. For example, with Samsung holding a 7.4 percent stake in GLW, some analysts are asking whether Samsung will acquire the company.
Analysts' Views and Our Views
GLW's second-quarter results were in line with analysts' expectations with respect to all of the company's divisions except the Gorilla Glass business in the specialty materials division. Although GLW did not lose market share, slower than expected market growth is impacting the company's Gorilla Glass revenue. Some analysts believe that the potential for AAPL to use sapphire crystal instead of GLW's Gorilla Glass (GG) does not bode well for the company's Gorilla Glass sales and the company's future. There are other analysts who believe, however, that the concern regarding Gorilla Glass sales is overstated given that AAPL is just one of several hand held device makers that use Gorilla Glass. Most Android and lower-cost hand held devices continue to use Gorilla Glass. In addition, GLW's specialty materials division represents a small portion of GLW's total revenue and the rest of their divisions are performing well. Among the more bullish GLW analysts, current price targets range as high as $27 a share.
GLW has a trailing price to earnings ratio of about 16.15. The forward price to earnings ratio is about 12.25 based on currently projected 2015 earnings estimate of $1.60, reduced from $1.67 a share prior to second quarter earnings. GLW also has a 1.80 dividend yield and continues with substantial share buybacks. We strongly believe that GLW will make an excellent long-term investment for anyone purchasing GLW shares at the current price. With the shares falling off sharply after earnings were announced, we believe now is the time to establish a full or half long-term position in GLW. We also agree with those analysts and commentators that, if GLW is unable to maximize shareholder value in a sufficient time frame: 1) a large investor may push GLW management to spinoff parts of the company; or 2) a large company such as Samsung may takeover GLW. GLW already bought out Samsung's share in their LCD glass joint venture (as we discussed in an earlier article on GLW) and we believe that GLW may divest through sale or spinoff parts of their business if their share price continues to languish. This would not be the first time GLW has spun off a part of their business.
Disclosure: The author is long GLW. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.