- The company's shares post-earnings sell-off may cause large investors to push management to make major changes in the company.
- Continuing failure by 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.
- Given GLW's size, the more likely outcome is that the company divests the profitable but price-sensitive LCD glass unit.
- Gorilla Glass innovation with respect to healthcare applications will boost GLW's performance, even if takeover/activist investor activity is not imminent.
Corning (NYSE:GLW) announced earnings recently, and the shares sold off due to investor disappointment in the company's results. While there were disappointments in the earnings announcement, certain divisions within GLW performed better than the others. In recent years, GLW shares have traded from the mid-$20s a few years ago, then down to about $10 in late 2012, then back up to $22 immediately before the 2014 second-quarter earnings, and now at slightly more than $20. We believe that if GLW management does not improve profitability and consistency in the company's earnings soon, an activist investor will become involved to pressure management to improve profitability through divestiture. A less likely possibility, given GLW's size, is that a company acquires GLW and then sells off less profitable division(s). If current GLW management is unable to move the company's shares above $25 a share in the next several months, either an activist investor or an acquiring company will enter the picture. Even if an activist investor or an acquisitive company does not pressure GLW in the near term, continued Gorilla Glass innovations will keep the company ahead of the competition and reward investors.
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. 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. 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 labware and equipment.
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 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 smartphone and tablet markets. The life sciences division generated about 9 percent of total revenue, up almost 2 percent from the 2013 second quarter.
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, while 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.
Gorilla Glass innovation relating to healthcare applications
Recent reports show that GLW, in collaboration with researchers at Polytechnique Montréal in Canada, was able to add fluid and temperature sensing capabilities to its Gorilla Glass. With the added capability to scan fluids and measure temperature, applications for GLW's Gorilla Glass have significantly increased. These significant new applications for Gorilla Glass arrive as investors are concerned that Apple, Inc. (NASDAQ:AAPL) may use sapphire crystal as the iPhone's cover glass. (Any switchover to sapphire crystal, however, will likely be limited to a select set of more expensive products, given sapphire crystal production issues that would limit a complete conversion to sapphire crystal until a later date.) Despite potential threats from sapphire glass, Gorilla Glass' health monitoring capabilities may convince AAPL to continue using Gorilla Glass.
Similar to optical fiber, waveguides are pathways that help channel information stored in beams of light. Researchers previously had found embedding waveguides within glass, however, difficult. GLW's Gorilla Glass has been found to be suitable to etch waveguides. Because of its strength and durability, etching waveguides on Gorilla Glass is easier than other glass types. Sensors that are able to recognize changes in temperature have been developed using these waveguides. A different type of sensor, using similar technology, can also be used to authenticate a mobile device, and the same researchers believe that similar technology can be used to analyze fluid samples on the screen of a handheld device.
AAPL has developed health-related applications for its iPhone, including an application named HealthKit, which helps track personal health and fitness through data collected from various health monitoring applications and devices. With waveguide-embedded Gorilla Glass, AAPL will be able to directly collect health-related data as soon as the user touches the screen, making Gorilla Glass the choice for AAPL's own wearable or mobile devices (and Samsung's health-related devices as well). With such added capabilities, Gorilla Glass would be more attractive to the handheld device industry. While the researchers believe that the Gorilla Glass waveguide technology could be used in handheld devices within a year, GLW has not announced the release of waveguide etched Gorilla Glass, and, as such, revenue from health-related applications of Gorilla Glass may be a few years away.
A takeover or a divestiture?
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 its 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 has 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.
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).
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 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 handheld device makers that use Gorilla Glass. Most Android and lower-cost handheld 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 its 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 12.60, based on currently projected 2015 earnings estimate of $1.61, 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 disagree with analysts with regard to their Gorilla Glass concerns, as such concerns are overblown given that GLW continues to innovate on the product and add new capabilities to it, as discussed above. We agree, however, 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 spin off 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 spin off parts of its business, if its share price continues to languish. This would not be the first time GLW has spun off a part of its business. Even without imminent activist shareholder or takeover activity in the near term, GLW continues to innovate and will prove to all skeptics that Gorilla Glass will continue to succeed and thrive in the face of sapphire crystal competition.