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A Century of Innovation at a Bargain Price

Timothy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Not too many companies have been around for over 100 years. Even fewer companies have been at the forefront of innovation year after year, decade after decade. Corning (NYSE: GLW) falls under both of these categories.

Corning is the leading designer and manufacturer of glass and ceramic substrates, with its products finding their way into displays, smart phones, tablets, automobiles, and telecommunications products to name a few. The company has constantly reinvented itself, harnessing its rich heritage of research and development to push glass to new frontiers. The history of Corning is fascinating - here are a few points.

  • 1879 - Developed the bulb-shaped glass encasement for Thomas Edison's light bulb.
  • 1908 - Developed a heat-resistant glass that can be used for baking. This leads to the Pyrex line of bakeware. Pyrex was spun off from Corning in 1998.
  • 1947 - Invents a process to mass produce TV tubes, allowing televisions to become affordable for the average family.
  • 1961- Manufactures heat-resistant windows for the Mercury spacecraft.
  • 1970 - Developed the first optical fiber cable capable of maintaining signal strength over long distances.  Leads to the commercialization of fiber optics for telecommunications.
  • 1982 - Developed the "fusion" process to make glass suitable for LCD screens.
  • 1990 - Produces glass for the mirrors of the Hubble Telescope.
  • 2007 - Developed an optical fiber capable of being bent 90 degrees with minimal signal loss.
  • 2007 - Releases Gorilla Glass, a scratch-resistant, ultra-durable glass that is used in mobile devices.

From the light bulb to smart phones, Corning has revolutionized countless industries. And in the process it has become a very profitable company.

Corning Today

Today Corning operates in five market segments:

  1. Display Technologies - Glass substrates for LCD panels and other electronics.
  2. Environmental Technologies - Ceramic substrates and filters for emission control systems.
  3. Telecommunications - Optical fiber and hardware for communications networks.
  4. Life Sciences - Optical biosensors for drug discovery.
  5. Specialty Materials - Advanced optics and specialty glass solutions, such as Gorilla Glass.

In 2011 Display Technologies represented 40% of sales, Telecommunications 26%, Environmental Technologies 13%, Specialty Materials 14%, and Life Sciences 8%. Corning constantly works to diversify its revenue streams by finding new uses for its products and technologies.

Gorilla Glass

Corning's Gorilla Glass has become the standard for mobile devices. It provides incredible durability for smart phones and tablets, allowing them to be extremely resistant to breaking upon drops. Corning's vast experience in glass making should give them a leg up on the competition. The list of products using Gorilla Glass is vast. Apple (NASDAQ: AAPL) uses gorilla glass in the iPhone. In fact, it was Steve Jobs himself who encouraged the CEO of Corning to ramp up manufacturing of Gorilla Glass for the first iPhone. This led to the glass being used in a huge number of devices, such as Nokia's (NYSE: NOK) Lumia line of smart phones and the Kindle Fire from Amazon (NASDAQ: AMZN). NPD projects smart phone shipments to top 1 billion by 2016 and for tablet shipments to hit 261 million by that same year.

<img src="/media/images/user_13886/npd-displaysearch-smartphone-shipments_large.jpg" />
  

Apple currently dominates the tablet market with the iPad, but Amazon is making inroads with the Kindle Fire. Nokia is attempting to stage a comeback with its new line of smart phones, which have gotten positive reviews. The upside for Corning is that a huge percentage of all of these devices will use Gorilla Glass. So regardless of what company sells the most smart phones or tablets, Corning will benefit.

The Stock

Shares of Corning were trading well above $25 per share before the financial crisis, and over $20 per share in early 2011.  Since then the market price has declined considerably, currently about $13 per share.

<img src="http://media.ycharts.com/charts/2cb17ce6e2a05fab68f655c2983bfd19.png" />

GLW data by YCharts

Financial Results

Let's take a look at the five-year financial results of Corning.

<table> <thead> <tr><th>(In Million $) </th><th>2007 </th><th>2008 </th><th>2009 </th><th>2010 </th><th>2011 </th></tr> </thead> <tbody> <tr><th>Revenue </th> <td>$5,860 </td> <td>$5,948 </td> <td>$5,395 </td> <td>$6,632 </td> <td>$7,890 </td> </tr> <tr><th>Operating Cash Flow </th> <td>$2,077 </td> <td>$2,128 </td> <td>$2,077 </td> <td>$3,835 </td> <td>$3,189 </td> </tr> <tr><th>Capital Expenditure </th> <td>$-1,267 </td> <td>$-1,921 </td> <td>$-890 </td> <td>$-1,007 </td> <td>$-2,432 </td> </tr> <tr><th>Free Cash Flow </th> <td>$810 </td> <td>$207 </td> <td>$1,187 </td> <td>$2,828 </td> <td>$757 </td> </tr> </tbody> </table>

Corning has grown its revenue by 34% since 2007 and its operating cash flow by more than 50% in that time. Capital expenditures rose dramatically in 2011 but are expected to decline significantly over the next two years. 

In my valuation I'll use owner earnings, a term coined by Warren Buffett, instead of free cash flow. Here is my calculation of owner earnings.

<table> <thead> <tr><th>(In Million $) </th><th>2007 </th><th>2008 </th><th>2009 </th><th>2010 </th><th>2011 </th></tr> </thead> <tbody> <tr><th>Net income </th> <td>$2,150 </td> <td>$5,257 </td> <td>$2,008 </td> <td>$3,558 </td> <td>$2,805 </td> </tr> <tr><th>Depreciation & amortization </th> <td>$607 </td> <td>$695 </td> <td>$792 </td> <td>$854 </td> <td>$957 </td> </tr> <tr><th>Stock based compensation </th> <td>$138 </td> <td>$118 </td> <td>$127 </td> <td>$92 </td> <td>$86 </td> </tr> <tr><th>Other non-cash items </th> <td>$-580 </td> <td>$-1,315 </td> <td>$-784 </td> <td>$-649 </td> <td>$-442 </td> </tr> <tr><th>Interest Payments </th> <td>$82 </td> <td>$59 </td> <td>$82 </td> <td>$109 </td> <td>$89 </td> </tr> <tr><th>Avg Capital Expenditure </th> <td>$-1,504 </td> <td>$-1,504 </td> <td>$-1,504 </td> <td>$-1,504 </td> <td>$-1,504 </td> </tr> <tr><th>Owner Earnings </th> <td>$887 </td> <td>$3,310 </td> <td>$721 </td> <td>$2,451 </td> <td>$1,979 </td> </tr> </tbody> </table>

The financial crisis of 2009 took a toll on Corning, and coupled with the drop in demand and prices for LCD displays, profitability has suffered. Going forward, Corning plans to grow its non-display businesses and further diversify itself. The short term will be tough for Corning, but the long-term outlook is bright. 

Instead of ROIC (return on invested capital), I like to use CROIC, which is the cash return on invested capital, which I define as owner earnings divided by the total invested capital. This metric tells us how efficient Corning is at generating cash.

<table> <thead> <tr><th>(In Million $) </th><th>2007 </th><th>2008 </th><th>2009 </th><th>2010 </th><th>2011 </th></tr> </thead> <tbody> <tr><th>Owner Earnings </th> <td>$887 </td> <td>$3,310 </td> <td>$721 </td> <td>$2,451 </td> <td>$1,979 </td> </tr> <tr><th>Invested Capital </th> <td>$15,215 </td> <td>$19,256 </td> <td>$21,295 </td> <td>$25,833 </td> <td>$27,848 </td> </tr> <tr><th>CROIC </th> <td>5.84% </td> <td>17.19% </td> <td>3.39% </td> <td>9.49% </td> <td>7.11% </td> </tr> </tbody> </table>

Corning's CROIC isn't great -- just 7.11% last year -- but I believe that this is a short-term problem. A 7.11% CROIC means that for every $100 of retained earnings, Corning will generate an additional $7.11 in owner earnings. A company's growth rate should be closely related to the CROIC. 

The Balance Sheet

Let's take a look at Corning's balance sheet.

<table> <tbody> <tr><th>Cash and Cash Equivalents </th> <td>$6,836 </td> </tr> <tr><th>Investments </th> <td>$4,554 </td> </tr> <tr><th>Debt </th> <td>$3,162 </td> </tr> <tr><th>Pension Obligations </th> <td>$900 </td> </tr> <tr><th>Minority Interest </th> <td>$50 </td> </tr> <tr><th>Net Cash (Debt) </th> <td>$7,278 </td> </tr> <tr><th>Diluted Float </th> <td>1,588 </td> </tr> <tr><th>Cash/Share </th> <td>$4.58 </td> </tr> </tbody> </table>

Corning has $6.8 billion in cash and $4.5 billion in investments, easily covering the debt and debt-like obligations on the balance sheet. On a per share basis Corning has $4.58 in net cash. This cash represents about 35% of Corning's market capitalization. 

Valuation

To value Corning I'll use a discounted cash flow analysis. I'll use a discount rate of both 12% and 15% and use these values to define a fair value range. Given the short-term issues facing Corning and a desire to be conservative in my valuation, I will assume that the owner earnings grow at just 3% per year, essentially no growth after inflation. Factoring in the $4.58 in cash per share and using the above parameters, I arrive at a fair value range of $15.28 - $18.85 for a share of Corning.

Corning

Corning is, and has been for the last year or so, trading at a discount to my extremely conservative fair value. As long as the global economy remains weak, shares of Corning will most likely follow suit. However, this opens an opportunity to pick up shares of a company renowned for its innovation at a bargain price. It may take a few years for Corning to find its footing in a world where LCD displays are not its main source of profit, but judging from the company's history I believe Corning has a bright future ahead of it. 

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