Chances are you have some Corning ceramic cookware at home. And chances are you have LCD TVs, smart phones and laptops. And chances are you don't know the same Corning making the cookware is the same company which commands 50% of the world market of the glass substrates used in LCD/LED panels.
Corning (GLW) consists of 3 main business entities:
- The parent company Corning:
- involves in LCD panel, Environmental (car exhaust converter), optical fibre in telecom, Life Science (e.g Pyrex) and the most sexy Gorilla Glass (the tough glass used on Android phones).
- In dot.com days, it nearly went bankrupt because of over expanding in fibre optics.
- Dow Corning:
- 50% non-controlling join venture with Dow Chemical. Make silicon products.
- It went bankrupt in 1995 because of law suit on its silicon breast implants
- Samsung Corning Precision (SCP):
- 50% non-controlling join venture with Samsung.
- It makes LCD glasses
I believe the best way to value GLW is to do a sum-of-parts valuation of its 3 business entities:
Here are a few observations worth mentioning:
- The income before tax figures are normalised, baised towards more conservative figures. See details below.
- SCP which makes the glass panels for LCD screens is the actual gem. So, it should command a higher multiple. And since its earning and revenue grow consistent over the years, I use its 2010's earning figure instead of multi-year average when I calculate its normalised EPV.
- Tax rate is a key factor. SCP's foreign earning is on average taxed at only 15%. But after capex, the cash needs to be brought onshore in order to realise the value and will incur tax liability.
- Corning is sitting on some $3B worth of deferred tax credit.
- Capex is huge across all 3 entities. They are 2-4x average depreciation. There is no way to work out which portion is maintenance capex and which portion is growth capex. (When a factory is retooled to make Gen10 LCD glass panel instead of Gen8, that's as much maintenance -- maintaining profitability -- as growth.) Again, SCP looks best here as its ROA over the years stays pretty consistent. That implies it can maintain its incremental ROE. On the other hand, Dow Corning itself has bumpy ROA. Anyway, I factor in a "cash conversion rate", basically a FCF/accrual earning factor, to cater for the capex.
- Interestingly, Dow Corning has relatively high ROE. It is achieved with gearing, but it's not debt. Instead, it has customer pre-paid deposit sitting on the book. That's interest free loan from the customers.
- GLW is also low in debt and has truckload of cash on its book. (50% of its cash are offshore.)
Refer to the table above of the 3 different scenarios. So here we have a range of earning-based valuation between $10-20. (EPV = earning power value)
A quality business
On the qualitative side, without doubt, the world will have more flat panels and touch screens in 10 years time. This is high margin business (gross margin ~60%). GLW currently commands 50% of the worldwide market share. There are a couple Japanese competitors which have comparable technologies. Can GLW maintain its profitability? Apart from the its proprietary know-hows and patents, both supply-chain management and scale matter in this business. It appears GLW excels in both. Its cash conversion cycles are pretty consistent even through the 2008 recession.
GLW is a Buffett/Fisher kind of business. It spends 10%+ on R&D.
I reckon my valuation is conservative. I haven't factored in the huge growing potential of Gorilla Glass and GLW's environmental products in Europe, both have no material contribution to GLW's bottom-line at the moment. And I discount heavily of the growth potential from its capex. I read other analysts gave it a target price of ~$25. It's aggressive but achievable.
Talking about Gorilla Glass. Gorilla Glass is currently used on smart phones. Since GLW sells glass by sq metres, it needs to sell a lot of them to move the needle. The bright future comes from the next generation of LCD/LED TVs which will have full glass cover edge-to-edge for pure aesthetic reason. We know Steve Jobs loves glasses. (Just look at the Apple Stores.) Apple TV is around the corner.
Wait, there is more.
In the height of GFC in Nov 2008 when a few of GLW's insiders (including the CFO) bought the shares, the price was at around $10. At the time, GLW's book value was $8.50. They were paying 1.25x book value. First forward to Aug 2011. The CFO bought at $13.50. (A much smaller stake. Granted.) Guess what the book value was? It was $13.40. The book value hasn't change much since then. We are now paying ~1.0x book value. Besides, in October last year, GLW instituted share buyback. That instantly put a floor on the share price.
We are talking about a company with ROE in the range of 17-25%, not under any business threat, with low debt and with many future potentials. It's nonsense it's trading at 1.0x book value.
* * *
I was wrong that GLW wasn't under any business threat.
It was revealed in the fourth quarter a "big customer" walked away from their contract. Although no name was given, it has been reported elsewhere LG had been working with a German company in partnership to produce LCD glasses. In the conference call, GLW management said there would be a "reset in the margins" in the industry, whatever it means.
The LCD glass market has been an oligopoly. Profitability is maintained when the players don't get into a price war in order to grab market share. That's the win-win situation. The risk here is the LG venture tries to fight for market share at any cost and flood the market with supplies. That doesn't just put pressure on the margins. It'll destroy the industry.
Where does this leave us?
I think this doesn't change the main value proposition. However, it does increase the risk.