The Henry Fund Henry B. Tippie School of Management Ashutosh Kumar Jha

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1 The Henry Fund Henry B. Tippie School of Management Ashutosh Kumar Jha Corning Incorporated (GLW) March 11, 2015 Information Technology Electronics Components Stock Rating Hold Investment Thesis Target Price $24.00-$26.00 Henry Fund DCF $24.36 Henry Fund DDM $20.97 Relative Multiple $32.00 Price Data Current Price $ wk Range $ Consensus 1yr Target $24.13 Key Statistics Market Cap (B) $31.28 Shares Outstanding (M) Institutional Ownership 78.7% Five Year Beta 1.29 Dividend Yield 2.0% Est. 5yr Growth 4.7% Price/Earnings (TTM) Price/Earnings (FY1) 1.55 Price/Sales (TTM) 3.20 Price/Book (mrq) 1.60 Profitability Operating Margin 18.8% Profit Margin 25.5% Return on Assets (TTM) 8.4% Return on Equity (TTM) 11.6% Corning, Inc. is well positioned to remain a market leader, however its success is largely dependent on profits from its Display Technologies segment. The growth in volume in the display segment is largely offset by decline in average selling prices. We recommend HOLD rating for Corning Inc. (GLW) with a mean target price of $25, which provides 8.23% upside from its current market price of $ Drivers of Thesis Demand for larger screen sizes. Increase in TV sizes drove sales in glass market in 2014, with screen sizes of 50-inch and more growing as much as 50%. We expect the trend to continue. We expect the decline in average selling prices of devices to remain moderate (2%) in Demand for Corning s fiber optic solutions. Wireless Distributed Antenna Systems and data centers are expected to grow at 14% and 10% CAGR respectively, from 2014 to Fiber to the-home (FTTH) network is growing at 9% per year. We expect these factors to generate steady demand for fiber optic solutions which will drive Corning s growth in Optical Communications segment. Growth possibilities in automotive market. There has been increasing trend of use of Gorilla Glass in automobile industry, which is believed to be a $7 billion market (5.5 billion square feet). Considering total Gorilla Glass market currently is just around 1 billion square feet, this will serve as a longterm driver for the Specialty Material segment. Risks to Thesis Continued pricing pressure in LCD industry. The decline in average selling prices offsets the growth in volume shipments and restricts the revenue upside for Display Technologies segment. Threat of breakthrough innovations. Although Gorilla Glass is currently market s preferred choice, any breakthrough innovations such as sapphire can compromise its competitive advantage and result in loss of contracts and market share for Display and Specialty Materials segments. Weaker demand for ultra high-definition television than expectation Earnings Estimates Year E 2016E 2017E 0 EPS $1.10 $1.35 $1.82 $2.06 $2.09 $2.37 P/E ROE EV/EBITDA growth % 23.33% 34.78% 12.94% 1.43% 13.68% 12 Month Performance (Source: Factset) Company Description Corning Incorporated is a world leader in the GLW S&P % manufacture of specialty glass and ceramics. Corning creates and makes components that 20% enable high-technology systems for consumer electronics, mobile emissions control, optical 10% 0% communications and life sciences. Corning operates in five reportable segments: Display Technologies, Optical Communications, Environmental Technologies, Specialty Materials and Life Sciences. Corning manufactures and -10% processes products at approximately 90 plants in M A M J J A S O N D J F 17 countries. Important disclosures appear on the last page of this report GLW Industry Sector

2 EXECUTIVE SUMMARY Demand for bigger screens and 100% consolidation of subsidiary Corning Precision Materials were primary driver of Corning s strong 2014 results. However, in 2015, the segment will have to deal with tough year-on-year comparisons. Consumers are trading up to larger screen sizes due to their declining prices and greater viewing pleasure. LCD glass demand will likely remain low sequentially in the first quarter due to weak retail demand in the second quarter and fewer shipping days in February but volumes should be higher year-on-year, reflecting the growth in demand for larger screen LCD televisions. We expect price declines to remain moderate going forward. In future ultra high-definition televisions, which have higher average screen size, higher resolution and more pixels is expected to become a major growth driver of the glass market. This will improve Corning s dollar content from Display Technologies segment. Increasing use of connected devices, emergence of cloud environment and change in pattern of data consumption (around 50% data used for video content) will promote demand for efficient network. Global data is estimated at 4.4 trillion Gigabytes and is expected to double every year. Number of connected devices is expected to reach 19 billion mark by Wireless Distributed Antenna Systems are expected to grow at 14% CAGR from 2014 to Data centers are expected to grow at 10% CAGR from 2014 to Fiber to the-home (FTTH) network is growing at 9%. We expect these factors to drive Corning s Optical Communication segment in next few years. There has been increasing trend of use of Gorilla Glass in automobile industry, which is believed to be $7 billion market. Corning Gorilla Glass for automotive can be used in all openings of a vehicle, including windshields, sidelights, sunroofs, and backlights. It can also be used in automotive interior touch panels. If Corning can secure a contract from certain car manufacturer for Gorilla Glass, that will serve as a long-term driver for the Specialty Material segment. Increase in number of heavy duty and light duty vehicles and restriction on emissions will create increased demand for Corning s Environmental Technologies segment products. As most of Corning s profitability and cash flow is dependent of Display Technologies segment, the decline in LCD prices is a major concern. Due to consumers trend of shifting to lower end devices in emerging markets, there is constant pricing pressure on devices manufactures, who then transfer this pressure on panel makers and glass manufacturers in order to save margins. This decline in average selling prices offsets the growth in volume shipments and restricts the revenue upside for Display Technologies segment. Also GLW is trading at price near 52 week high, providing 6% upside to target price. For these reasons we recommend a HOLD rating for Corning, Incorporated. COMPANY DESCRIPTION Corning Incorporated is a world leader in the manufacture of specialty glass and ceramics. Corning creates and makes components that enable high-technology systems for consumer electronics, mobile emissions control, optical communications and life sciences % 2014 Revenue- Segment Distribution 12.40% 8.87% 0.55% 27.30% Source: Corning Inc. 10k, 2014 Corning operates in five reportable segments: Display Technologies, Optical Communications, Environmental Technologies, Specialty Materials and Life Sciences. Corning manufactures and processes products at approximately 90 plants in 17 countries. Display Technologies 39.64% Display Technologies Optical Communications Environmental Technologies Specialty Materials Life Sciences All Other Corning s Display Technologies represented 39.64%, 32% and 36.34% of the total revenue in 2014, 2013 and 2012 respectively. Despite the fact that this segment represents less than 50% of revenue, this segment is clearly the primary driver for profitability and cash flow for the company, considering that it represented 77.13% of total Page 2

3 net income for This number for 2013 was 74.85%. This segment manufactures glass substrates for active matrix liquid crystal display (LCDs) that are used primarily in LCD televisions, notebook computers and flat panel desktop monitors. 8.11% 4.00% 10.25% 2014 Net Income (Loss)- Segment Distribution 11.55% % 77.13% Source: Corning Inc. 10K, 2014 Display Technologies Optical Communications Environmental Technologies Specialty Materials Life Sciences All Other Through the end of 2013, the Display Technologies segment also included the equity affiliate Samsung Corning Precision Materials Co., Ltd, of which Corning owned 57.5% and Samsung Display Co., Ltd. owned 42.5%. In January 15, 2014 Corning obtained full ownership of Samsung Corning Precision Materials. This organization, named Corning Precision Materials, was integrated in Corning s Display Technologies. Also, Corning and Samsung Display extended their long-term LCD display glass supply agreement through LCD glass manufacturing is a capital intensive business. Important attributes for success include efficient manufacturing, access to capital, technology know-how, and patents. As a result of the transactions with Samsung Display, Corning expects to realize increased flexibility in glass-melting capabilities, which will allow the company to re-evaluate the need for major capital expenditures for additional fusion glass manufacturing assets. Corning s Display Technologies segment is at the top of the supply chain. LCD panel makers are the primary customers for this segment, who use the LCD substrates to create LCD panels. These panels are then supplied to consumer electronics manufacturers who use it in their products. As LCD glass generates significant amount of the company s profits and cash flow, any events that adversely affect the market for LCD glass substrate could have a big impact on the company s performance. These events could include loss of patent protection, increased costs associated with manufacturing, decline in prices of LCD glass substrates, decline in average prices of LCD panels or electronics appliances using LCD glass, decrease in demand of consumer electronics leading to overcapacity of LCD, and increased competition from the introduction of new, and more desirable products. Additionally, emerging technologies could replace or reduce the amount of use of glass substrates for certain applications, including display glass, cover glass and others, resulting in a decline in demand for the products Source: DisplaySearch Display Technologies Drivers Total number of LCD shipments (Millions) Average LCD price per shipment $34.50 $34.00 $33.50 $33.00 $32.50 $32.00 $31.50 Primary drivers of revenue for this segment are Corning s market share in terms of % of total revenue of the LCD industry, total number of LCD shipments and Average LCD price per shipment. Thus, this segment is heavily dependent on end products (consumer electronics) supply and demand. The segment is also positively impacted by increase in amount of glass substrates used in those end products. The growth of screen sizes of television was the main driver for profitability during As the demand for larger screen size goes up, on one hand company benefits from extra volume sales and on the other hand it is able to reduce cost due to economies of scale. Steady decline in average selling prices (ASPs) of its end products such as televisions, tablets, notebooks etc. is Page 3

4 another factor which impacts the revenue for this segment. Source: DisplaySearch There are two primary reasons for this decline. First, this segment operates in emerging markets primarily in Asian countries such as China, Taiwan, Japan and Korea. Local companies in these regions are emerging to provide strong competition to global brands. Consumers are showing trend towards shifting to lower end devices. This puts lot of pressure on global manufacturers to reduce prices. When they eventually reduce prices their margins become narrow and then they put pressure on panel makers to reduce prices. This chain continues till it reaches the glass substrates manufacturers. Second, this industry is cyclic in nature. The demand is not consistent and as a result the supply chain often faces problems such as over capacity and scarcity. While both can lead to price volatility, overcapacity has a negative impact on revenues as the ASPs tend to go down. Source: DisplaySearch Moving forward in 2015 this segment will benefit from increasing synergies from the consolidation of Corning Precision Materials. The Segment should also benefit from increase on the number of TV shipments and the increase in average screen sizes. According to management, the demand in 2015 is expected to remain from steady to decreasing slightly. But according to DisplaySearch PriceWise published in February 2015, the demand currently in the market is week and the inventories are piling up in the supply change which can potently lead to reduced average selling prices. Panel makers (customers of Corning) sell their panels in US dollars and are benefitting from recent weakening of Japanese Yen and operating margins of Corning s competitors are such that they cannot afford to lower prices any more if they intend to remain profitable. These are the reasons for us to believe that price decline will only be moderate. We expect that the decline in the average selling prices would be moderate in 2015 and the revenue from this segment in 2015 will decrease by 2% as compared to We expect Corning s LCD market share in terms of % of revenue to remain steady and increase gradually from 4.65% in 2015 to 4.71% in We expect the total number of LCD shipments to increase at 1.61% CAGR from 2015 to 2020 and average LCD price per shipment to increase at 1.11% CAGR from 2015 to We expect revenue for this segment to increase at 3% CAGR from 2015 to Optical Communications Corning s Optical Communications represented 27.30%, 30% and 26.61% of the total revenue in 2014, 2013 and 2012 respectively. But this segment represented only 11.55% of the total net income in Optical Communications segment has evolved from being a manufacturer of optical fiber and cable, hardware and equipment to being a comprehensive provider of industryleading optical solutions across the broader communications industry. This segment, previously known as Telecommunications, is divided into two segments: 1) Carrier network and 2) Enterprise network. The carrier network product group consists primarily of products and solutions for optical-based communications infrastructure for services such as video, data and voice communications. The enterprise network product group consists primarily of optical-based communication networks sold to businesses, governments and individuals for their own use. Carrier network product portfolio consists of optical fiber products which are used in submarine networks, long-haul, regional and metropolitan networks, and fiber-to-the-home (FTTH) network applications. Page 4

5 Corning has a full complement of operator-grade distributed antenna systems (DAS), including the recently developed Optical Network Evolution (ONE) wireless platform. The ONE provides virtually unlimited bandwidth, and meets all the wireless service needs of large-scale enterprises at a lower cost than the typical DAS solution. Optical Communications segment customers purchases of products are affected by their capital expansion plans, general market and economic uncertainty and regulatory changes, including broadband policy. Sales in the Optical Communications segment are expected to be impacted by the pace of fiber-to-the-premises deployments. This segment sales will be dependent on planned targets for homes passed and connected. Changes in its customers deployment plans could adversely affect future sales. Bandwidth demand continues to driver this segment. The profit growth is driven by innovation, operations scale and complementary acquisitions. Data Creation/Consumption, Data Processing and Data Traffic are primary drivers moving forward. Global data is estimated at 4.4 trillion Gigabytes and is expected to double every year. This rise in data not only drives the sales of various devices, such as mobile phones which are growing in number and are expected to reach 10 billion mark by 2018, but also call for increase in number and coverage of wireless networks. Wireless DAS are expected to grow at 14% CAGR from 2014 to Another primary driver for this segment will be Data processing which requires increased number of data centers. Expectation is that by 2018, 40% of data will move in to the cloud and as data centers are vital for this technology, numbers of data centers will grow increasing the demand for products of Corning s Optical Communications segment. Data centers are expected to grow at 10% CAGR from 2014 to Corning s completed the acquisition of TR manufacturing in January This provides them access to Hyperscale segment. Hyperscale is also expected to grow at 15% CAGR from 2014 to Also, the global IP traffic is expected to increase by 50% by The number of connected devices in 2018 is expected to be around 19 billion. It is estimated that there would be 240 million homes connected by fiber-to-thehome (FTTH) network. FTTH is growing at 9%. This heavy data traffic will provide growth for Optical Communications segment. This growth in FTTH is driven by heavy North America deployments. We expect the revenue from Optical Communication segment to increase by 10% in We expect this segment to grow at 4% CAGR from Recently, the net neutrality bill was passed, which meant internet service providers (ISPs) will not be able to use variable pricing models. We expect this will affect the motivation level of ISPs to provide high speed networks as they will not be able to retain the same margins they used to have when they could charge customers according to their usage of data. This margin cut could potentially impact the optical fiber suppliers such as Corning s Optical Communications segment. Environmental Technologies This segment represented 11.24% of total revenue and 10.25% total net income in Corning s Environmental Technologies segment manufactures ceramic substrates and filter products for emissions control in mobile and stationary applications around the world. As global emissions control regulations tighten, Corning has continued to develop more effective and durable ceramic substrate and filter products for gasoline and diesel applications. Corning manufactures substrate and filter products in New York, Virginia, China, Germany and South Africa. Corning sells its ceramic substrate and filter products worldwide to catalyzers and manufacturers of emission control systems who then sell to automotive and diesel vehicle or engine manufacturers. Although most sales are made to the emission control systems manufacturers, the use of Corning substrates and filters is generally required by the specifications of the automotive and diesel vehicle or engine manufacturers. Moving forward the primary drivers for this segment are going to be Vehicle production, Advancing Regulations and innovations. According to IHS Automotive Jan.2015, growth in global regulated vehicles in heavy duty and light duty segments is expected to be 13% CAGR and 4% CAGR from 2014 to 2018 respectively. To ensure compliance with emission standards, automobile manufacturers resort to the use of emission control systems. As these standards get even stricter, automobile manufacturers have to upgrade to newer and effective emission control systems in order to remain compliant. Page 5

6 This has a positive impact on the automotive exhaust systems market, which includes manufacturers of automotive substrates and filters. In September 2014, the European Union implemented Euro 6 emission standards for both gasoline and diesel engine vehicles. Though is not much change for gasoline vehicle emission norms from the Euro 5, the Euro 6 standards for diesel engines have become very stringent. This is one of the primary reasons why Corning is scaling up the production of its diesel engine emission filter, Corning Dura Trap AT HP. The U.S. will be implementing its Tier 3 emission standards for light-weight vehicles starting 2017, which requires a 75% reduction in emissions. For heavy-duty vehicles such as trucks and buses, it presently follows the 2007 Heavy Duty Highway Rule. Also for light-duty vehicles, China implemented its China IV emission standards in July 2013 and is working towards implementing China 5 standards nationwide by January For heavy-duty vehicles, China is currently following the China IV emission standards and plans to roll out the China 5 standards soon. These regulations presents a global growth opportunity for Corning s Environmental Technologies, which primarily generates its revenues from automotive and diesel filters. At present, Corning occupies close to 3% of the automotive exhaust systems market. Innovations and process improvements have helped this segment to grow and cut costs. Increased process rate, yield, material and labor utilization have helped this segment to double output on existing heavy-duty assets from 2010 to Corning FLORA TM substrates was selected by Honda Motor Company for model year 2016 platform. The segment will look to partner with leading OEMs in 2015 and management believes that there would be more platform wins in material formulations for glass, glass ceramics and fluoride crystals to meet demand for unique customer needs. Consequently, this segment operates in a wide variety of commercial and industrial markets that include display optics and components, semiconductor optics components, aerospace and defense, astronomy, ophthalmic products, telecommunications components and cover glass that is optimized for portable display devices. Corning s cover glass, known as Corning Gorilla Glass, is a thin sheet glass designed specifically to function as a cover glass for display devices such as tablets, notebook PCs and mobile phones. Elegant and lightweight, Corning Gorilla Glass is durable enough to resist many real-world events that commonly cause glass failure, enabling exciting new applications in technology and design. In the fourth quarter of 2014, Corning announced its latest breakthrough innovation in consumer electronics material design, Corning Gorilla Glass 4, which delivers the highest damage resistance performance versus all alternative compositions, and has the capability to significantly improve device drop performance. Corning Gorilla Glass is manufactured in Kentucky, South Korea, Japan and Taiwan. In 2014, Specialty Materials segment improved revenues by $35 million, driven by an increase in sales of advanced optics products. Corning Gorilla Glass sales remained consistent with the prior year, with volume increases offset by an unfavorable shift in product mix and price declines. There are several drivers for this segment. Touch devices are one of the major driver. Number of Touch Devices (Billions) In 2015, we expect the revenue from this segment to grow by 1%. This is mainly because the growth from increased volume sale will be offset by weaker Euro and new plant depreciation. Without foreign currency effects the growth would have been 6%. We expect this segment to grow at 3% CAGR from Specialty Materials Corning s Specialty Materials represented 12.40% and 8.11% of the total revenue and total net income in 2014 respectively. The Specialty Materials segment manufactures products that provide more than 150 Source: International Data Corporation (IDC) Page 6

7 The growth in volume unit shipment of devices such as smartphones, tablets etc. will see increased demand for Corning s Gorilla Glass. Another driver for this segment would the increase in smartphone average screen size. According to IHS, the average screen size of smartphones is expected to increase from 5.5 inches in 2014 to 6.5 inches in Smartphone Average Screen Size (Inch) Source: DisplaySearch, IHS The cover glass market was expected to grow at 13% CAGR from 2013 to 2016 according to Corning Analysis. Also, Corning has gained additional share in cover glass market, mainly because of emergence of touch enabled Notebook market. These all factors will lead to more demand for Corning s Gorilla Glass in coming days. Corning should also benefit from its extensive marketing efforts in Chinese market to improve brand awareness. Cover Glass Market Shipment (Million ft 2 ) Source: Corning Inc., Analysis Specialty Material segment is also dependent on demand from emerging Asian markets specially China. Due to emergence of local brand in those regions, consumers are shifting to low end devices, which is putting pressure on global brands to reduce prices. When the device manufacturers cut prices, their margin reduce and they then try to negotiate with specialty material manufacturers. This leads to decline in average selling prices of materials, which limits the revenue growth for company such as Corning. But as Corning introduced Gorilla Glass 4 in fourth quarter of 2014, we expect that the prices would not decline much in 2015, as historically it has been observed that initially new technologies have been able to sustain high prices before eventually the price declines over time. Due to the superior performance of Gorilla Glass 4, Corning will have the pricing power. Corning has also made some progress on increasing its share in smartphones market in China and at the same time has maintained its own share against aluminosilicate glass competitors on devices. We expect the revenue from this segment to grow by 10% in Over the period of , we expect this segment to grow at 4.5% CAGR. Life Sciences Corning s Life Sciences segment represented 8.87% and 4% of the total revenue and total net income in 2014 respectively. Life Sciences laboratory products include general labware and equipment, as well as specialty surfaces, media and reagents that are used for cell culture research, bioprocessing, genomics, drug discovery, microbiology and chemistry. Corning sells life science products under these primary brands: Corning, Falcon, PYREX, Axygen, and Gosselin. The products are marketed worldwide, primarily through distributors to pharmaceutical and biotechnology companies, academic institutions, hospitals, government entities, and other research facilities. Corning manufactures these products in the United States in Maine, New York, New Jersey, California, Utah, Virginia, Massachusetts and North Carolina, and outside of the U.S. in Mexico, France, Poland, and China. Research is primary driver of this segment. In developed markets, research is growing at 2%, slowed by flat government funding. In emerging markets, research is growing at 8%, mainly driven my China. This segment also will be affected by weaker Euro. We expect this segment Page 7

8 revenue to grow by 2% in Also, we expect this segment to grow at 1.7% CAGR from Other Corporate Investments Corning has a 50% equity interest along with The Dow Chemical Company in Dow Corning Corporation, a company that manufactures silicones products globally. Corning s net income includes equity earnings from affiliated companies. For the year ended December 31, 2014, Corning recognized $266 million of equity earnings, of which approximately 95% came from Dow Corning. Dow corning is also the majority owner of Hemlock Semiconductor Group, which produces high purity polycrystalline silicon for the semiconductor and solar energy industries. Corning also has a 50% equity interest along with PPG Industries in Pittsburg Corning Corporation (PCC), a company that manufactures glass products for architectural and industrial uses and a 50% investment in Pittsburgh Corning Europe N.V. (PCE), which is a Belgian Company that manufactures glass products for industrial uses primarily in Europe. Polysilicone demand is growing as solar customers are expected to buy Polysilicone to fulfill their annual contract commitments. But some of the growth will be offset by increasing raw material prices. Silicone business sales is expected to remain consistent but lower tax rate and lower operating expense should increase profitability. We expect 10% growth year over year in revenues from Dow Corning. RECENT DEVELOPMENTS GTAT files for Bankruptcy One of Corning s major customers, Apple Inc., was considering replacing Corning s Gorilla Glass with Sapphire in its most popular product iphone. Apple loaned $439 million to a company known as GT Advanced Technologies Inc. last year, to bankroll sapphire production. Unable to meet its supply agreements, GTAT filed for bankruptcy in October Initially sapphire crystal were in headlines as its backers claimed it was more scratch resistant and less breakable than Gorilla Glass. Corning responded that sapphire is also much more expensive to manufacture and that it is less transparent and heavier than Gorilla Glass. Which product is more likely to scratch or break in real world is still a matter of dispute, but Gorilla Glass dominance is global smartphone market is set to continue. 4Q14 & FY14 Earnings and 2015 Guidance For 4Q14, Corning posted core revenue of $2.60 billion, which was up 32% year-over-year on a core basis and GAAP revenue of $2.40 billion was up 23%. Core EPS of $0.45 per diluted share for 4Q14 increased 56% year-overyear. The Wall Street consensus had modeled revenue of $2.49 billion and core EPS of $0.38 per diluted share for 4Q14. Core gross margin narrowed sequentially to 44.7% in 4Q14 for 45.4% in 3Q14, while rising from 40.0% in 4Q13. Core pretax margin expanded to 29.3% in 4Q14 from 25.7% in 4Q13. Margin comparisons are potentially distorted by the consolidation of SCP into wholly owned operations. On a GAAP basis, Corning reported earnings of $0.70 per diluted share in 4Q14, compared to $0.70 per diluted share in 3Q14; a year earlier, GAAP earnings were $0.30 per diluted share. Non-GAAP earnings on a core basis were $0.45 per diluted share in 4Q14, compared to $0.40 per diluted share in 3Q14 and $0.29 in 4Q13. For all of 2014, Corning s Core revenue of $10.22 declined increased 26% for $7.95 billion in Non-GAAP core earnings totaled $1.53 per diluted share in 2014, up from $1.24 per diluted share in Corning does not provide explicit revenue or EPS guidance on a quarterly or annual basis. For 1Q15, Optical Communications revenue is forecast to be up more than 10% annually in 1Q15. Environmental is guided flat, though up 5% without currency impact. Specialty Materials revenue is forecast up 10% annually. Within the framework of its revised core currency exchange rate of 99 yen, the company furnished 1Q15 line-item guidance. Core gross margin is forecast at about 43%; core SG&A is forecast at about 13% of revenue, core R&D at about 8%; and the tax rate is about 18%. Project Phire On February 6 th 2015, Corning unveiled Project Phire, a glass composite that company claims to be just as strong and drop-resistant as its latest Gorilla Glass but nearly as scratch-resistant as sapphire. Corning decision to blend Gorilla Glass and synthetic sapphire is likely to reduce the threat of its customers switching to sapphire glass manufacturers. Also, a more sapphire-like version of Page 8

9 Gorilla Glass could help Corning play in some markets where sapphire is used today such as camera lenses in some phones including iphones, Apple s TouchID buttons and high-end watches and smartwatches all of which use sapphire crystal. Corning acquired Samsung Electronics Fiber Optics Business & TR Manufacturing This acquisition should provide support to Corning s Optical Communications segment growth efforts in Asia. Samsung is a trusted provider of optical fiber and cable for customers in South Korea, China and Southeast Asia. Corning integrated Samsung s fiber optic business, with manufacturing facilities in Gumi, South Korea, as well as in Hainan, China. Corning also acquired TR Manufacturing, a move through which Corning will be able to add TR Manufacturing s fiber and copper cable/component interconnects and electro-mechanical assemblies, which it sells to OEMs that target various industry segments such as military/defense, security equipment, medical imaging and electronics manufacturing. This also provides Corning access to Hyperscale segment, which is expected to grow at 15% CAGR from 2014 to INDUSTRY TRENDS Demand for larger screen sizes This love for larger screen size is more prominent in the TV market. According to DispaySearch, the share of LCD TV 50 inches and above is expected to continue its growth in the future. This provides the display industry, the glass and panel makers with a big opportunity that could turn into their main sales driver in the future. Share of 50 and above LCD TV (Millions) Source: DisplaySearch 4K Ultra HD TV- Future growth driver A 4K UHD television set provides 4 times the total display resolution of today s full HDTV sets by doubling the number of pixels shown horizontally and vertically. It is being seen as the biggest revenue driver for the industry going forward. Looking at the forecasts for 4K Ultra HD TV, it is clear that China is the major market for this technology. In 2013, 0.9 million was the demand for UHD TV in which China accounted for 0.7 million. In 2015, the total demand is expected to rise to 23.3 million and China will make up 57% of this demand, i.e million. The UHD TV shipment in US is also expected to increase k Ultra HD TV Forecast (Million) Source: DisplaySearch Market data has shown that customers have a desire for larger screen sizes. This fact is further supported by the recent example of Apple iphone 6. The Apple IPhone unit sales increased beyond expectations even though the average selling price was increased by around 50 dollars. One reason for the unusual pattern was the increase in screen size. iphone 6 screen size was 4.7 inch compared to compared to IPhone 5 and 5s which had 4 inch screens China ROW Source: GfK, TV Demand Projector, December 2014 If the expectation does turn into reality, this will be a major driver for glass substrates industry, as volume shipment will be significantly boosted due to increase in replacement sales. But there are some concerns over the 10 Page 9

10 high prices and lack of content for this technology. Although few studios have already started developing content exclusively for this technology, general expectation is that it would take atleast 2-3 years. Also whether consumers will be convinced enough to switch is yet to be seen. In fact according to a consumer survey conducted by CEA that measured interest in 4K TVs, consumers will need to be convinced to upgrade to these technologies from the HDTVs they already know. Only 26% of the survey respondents said they were interested in 4K technology, while 49% were not interested and 25% were undecided. Demand for Fiber Optic Solutions Increasing use of mobile devices, which require efficient data transfer, is boosting demand for efficient networking systems. Also, the growth of cloud environment which boasts of infinite storage and infinite computing leads to greater demand for efficient networking systems. MARKETS AND COMPETITION Some of the most important success factors for a business in this market include having contacts in key markets, access to the latest and most efficient technology and techniques, establishment of brand names, establishment of export markets, access to skilled workforce and undertaking technical R&D and patent protection. Over the past five years, the profit margins have gone down for reasons such as weak revenue growth, overcapacity, pressure on average selling prices and restructuring charges. Cost of materials is generally high, but manufacturers with greater scale such as Corning, are likely to be in a better position to negotiate with suppliers on price and may also be in a better position to reduce unit costs. Competition in this industry is high and the trend is steady. The competition is based on price, brand recognition, innovation and international competition. Innovation is key in this market. Due to changes in customer demand, short product life cycles and fierce competition in this industry, firms must regularly upgrade existing products and successfully develop and introduce new products to remain or become relevant to customers. Moving forward, we expect Gorilla Glass to remain the preferred choice, especially considering the high cost of production of Sapphire crystals. Barriers to entry in this industry are high. The most important reasons for this is lack of access to technology and intellectual property, lack of large capital and skilled employees and dominance of existing players with brand name recognition. Another thing to note is the change in data consumption pattern. More data is being used for video content, which creates demand for faster data transfer. Since fibers are much efficient that existing copper-based networks and also support unlimited bandwidth, the demand for optical solutions is particularly strong. Corning is the largest worldwide producer of glass substrates for active matrix LCD displays. The environment for LCD glass substrate products is very competitive but Corning has sustained its competitive advantages by investing in new products, providing a consistent and reliable supply, and using its proprietary fusion manufacturing process. Asahi Glass Co. Ltd. and Nippon Electric Glass Co. Ltd. are Corning s principal competitors in display glass substrates. Competition within the communications equipment industry is intense among several significant companies. Corning is a leading competitor in the segment s principal product groups, which include carrier network and enterprise network. The competitive landscape includes Page 10

11 industry consolidation, price pressure and competition for the innovation of new products. These competitive conditions are likely to persist. Corning s large scale manufacturing experience, fiber process, technology leadership and intellectual property yield cost provide it with edge over several of its competitors. The primary competing producers of the carrier network segment are TE Connectivity Ltd., Prysmian Group, OFS (a Furukawa Company), Fujikura Ltd., Sumitomo Electric and 3M. The primary competitors in enterprise network are TE connectivity, Panduit Corporation and other number of small companies. For worldwide automotive ceramic substrate products, Corning has a major market position that has remained relatively stable over the past year. Corning has also established a strong presence in the heavy duty and light duty diesel vehicle market. Its competitive advantage in automotive ceramic substrate products for catalytic converters and diesel filter products for exhaust systems is based upon global presence, customer service, engineering design services and product innovation. Corning s Environmental Technologies products face principal competition from NGK Insulators, Ltd. and Ibiden Co. Ltd. In the Environmental Technologies segment, three customers accounted for 88% of total segment sales in aggregate. For Specialty Materials segment brand recognition and loyalty, through well-known trademarks are important. Corning Gorilla Glass is a thin-sheet glass that is better able to survive events that most commonly cause glass failure. Its advanced composition allows a deeper layer of chemical strengthening than is possible with most other chemically strengthened glasses, making it both durable and damage resistant. For this segment, Schott, Asahi Glass Co. Ltd., Nippon Electric Glass Co. Ltd. and Heraeus are the main competitors for Corning. In the Specialty Materials segment, three customers accounted for 51% of segment sales in For Life Sciences segment, Corning seeks to maintain a competitive advantage by emphasizing product quality, product availability, supply chain efficiency, a wide product line and superior product attributes. Corning s principle worldwide competitors include Thermo Fisher Scientific, Inc. and Perkin Elmer. Corning also faces increasing competition from large distributors that have pursued backward integration or introduced private label products. Peer Comparisons Company Name Ticker Market Cap (B) ($) Enterprise Value (B) ($) Price ($) EV/ EBITDA EPS($) P/E NTM Corning GLW Asahi Glass Nippon Electric Glass P/BK Display & Specialty Materials TYO: TYO: Optical Communications TE Connectivity TEL M MMM Furukawa Electric Co. TYO: Sumitomo Electric TYO: Ibiden Co. Ltd. NGK Insulators Ltd. Environmental Technologies TYO: TYO: Life Sciences Thermo Fisher Scientific, Inc. TMO Perkin Elmer, Inc. PKI Average Source: Bloomberg In its biggest revenue segment Display & Specialty Materials, Corning is the largest company in terms of market cap. It has significantly higher EPS compared to peers in this segment and trades at 15.57x, which is significantly lower that its peers. When compared to peers in Optical Communications segment, Corning appears to be trading at a bargain price. TE Connectivity, Corning s most comparable competitor in this segment has NTM P/E of 17.27x and P/BK value of 3.2 compared to 1.6 for Corning. Corning also seems to be trading at cheaper price than its peers in Environmental Technologies segment. Also forward EPS for Corning is higher than Ibiden and NKG Insulators. Corning s P/E NTM seems to lower than its peers even in Life Sciences segment but forward EPS for its peers, Thermo Scientific and PerkinElmer, is higher. In Display & Specialty Materials segment, Corning has significantly higher operating margin, net profit margin and return on equity. This could be attributed to its size, its global presence and its product such as Gorilla Glass Page 11

12 which is the preferred glass for device manufacturers and allows them to maintain healthy margins. Many high-income countries continue to struggle with the aftermath of global financial crisis. Recovery in the highincome economies has been uneven, as some countries, such as the United States and the United Kingdom, have exceeded pre-crisis output peaks, but others such as countries in Euro area are still below earlier peaks. Lowincome countries continue to grow at a robust pace, despite a challenging global environment. Company Name Ticker Dividend Yield (%) Operating Income Margin (%) Net Profit Margin (%) Net Debt/Equity (%) Capex/ Sales (%) ROE (%) Corning GLW Asahi Glass Nippon Electric Glass Display & Specialty Materials TYO: TYO: Optical Communications TE Connectivity TEL M MMM Furukawa Electric Co. TYO: Sumitomo Electric TYO: Ibiden Co. Ltd. NGK Insulators Ltd. Environmental Technologies TYO: TYO: Life Sciences Thermo Fisher Scientific, Inc. TMO Perkin Elmer, Inc. PKI Source: World Bank, GEP Forecast January 2015 According to World Bank, global growth is expected to rise in 2015 to 3% and is expected to be at 3.2%-3.3% in U.S. GDP growth was 5% in the third quarter of We expect the economy to stabilize and predict growth to settle at 3.4% in next six months. Healthy GDP growth is positively correlated with spending in consumer electronics industry and should promote growth in the industry. Average Source: Bloomberg TE Connectivity and 3M generate better ROE but they use more leverage as well as shown by Net Debt to Equity ratio. TE Connectivity is set to be Corning biggest competitor moving forward. Overall, we believe Corning is very well positioned in each of their major segment, especially in Display and Specialty materials, to remain one of the most profitable as they are historically have continued to find ways to improve their products, sales and margins despite substantial growth of competition in the last 10 years in the technology sector. ECONOMIC OUTLOOK Gross Domestic Product Source: World Bank, GEP Forecast January % of revenues in 2014 for Corning came from operations in Asia Pacific region. Healthy growth in GDP is expected in the region from 2015 to 2017, which should be increase technology spending across industry as they look to upgrade their IT infrastructure to tap the future growth. Growth in phones, tablets, high end flat panel devices will drive Corning s earnings in Display Technologies segment. Also, increased sales of automobiles will lead to sales of Corning s filter products in Environmental Technologies Segment. Optical Communications will continue to benefit from increase in spending in connected devices. Users of these devices will have increasing demand for faster and wider bandwidth that optimizes the connectivity of their devices. As this demand increases, sales of carrier and network inputs, such as optical fiber will grow, especially in emerging markets. Page 12

13 Exchange Rate Majority of companies in this industry either have foreign operations and/or depend on the foreign market. This makes these companies susceptible to exchange rate volatility. Sales in Display Technologies segment, representing 40% of Corning s sales in 2014, are denominated in Japanese yen. Corning hedges significant translation, transaction and balance sheet currency exposures and uses a variety of derivative instruments to reduce the impact of foreign currency fluctuations associated with certain monetary assets and liabilities as well as operating results including their net profits. In 2014 Japanese Yen weakened against US dollar and the negative impact of the Japanese yen versus the U.S. dollar exchange rate in 2014 was $373 million. This was offset by the positive net impact of Corning s yen-denominated hedge programs, driven by the weakening of the Japanese yen in 2014, in the amount of $560 million. Current exchange rate is $1= Japanese Yen. We expect the rate to be $1=115.75, six months down the line and $1= two years from now. Corning current hedge rate is $1=99 Japanese Yen. Thus, we expect that as long as Corning maintains its hedging policy, it should have positive net impact from Yen-denominated hedge programs. Corning is 100% hedged against yen movements in 2015, 80% hedged for 2016, and 70% hedged for Automobile Glass CATALYSTS FOR GROWTH Demand of glass in on the up in automobile industry. Automotive electronics is expected to have continued growth. The TFT-LCD shipments for the instrument cluster in automobiles are expected to grow 48% to reach 30.2 million units this year, growing further to reach 50 million units in In-Car safety innovations will drive expanded use of dashboard screens. Automakers around the world are working to reduce the weight of their vehicles to meet strict mobile emissions regulations. Corning Gorilla Glass for Automotive is now available to help automakers meet this objective by enabling a weight reduction in glazing of more than 50% versus conventional soda lime glass. Corning Gorilla Glass for Automotive can be used in all openings of a vehicle, including windshields, sidelights, sunroofs, and backlights. It can also be used in automotive interior touch panels. If Corning can secure a contract from certain car manufacturer for Gorilla Glass, that will serve as a long-term driver for the Specialty Material segment. Innovation For more than 160 years, Corning has applied its expertise in specialty glass, ceramics, and optical physics to develop products that have created new opportunities. Although Corning s overall spending level for research, development and engineering decreased slightly from 9% of sales in 2013 to 8% of sales in 2014, it maintained its innovation strategy focused on growing its existing businesses, developing opportunities adjacent or closely related to its existing technical and manufacturing capabilities, and investing in long-range opportunities in each of its market segments. All of its segments continue to work on new products, including glass substrates for high performance displays and LCD applications, precision glass for advanced displays, emissions control products for cars, trucks, and off-road vehicles, products that accelerate drug discovery and manufacturing and the optical fiber, cable and hardware and equipment that enable fiber-to-thepremises, and next generation data centers. In addition, it is focusing on wireless solutions for diverse venue applications, such as distributed antenna systems, fiberto-the cell site and fiber-to-the antenna. Corning has focused its research, development and engineering spending to support the advancement of new product attributes for its Corning Gorilla Glass suite of products. We expect Corning to continue to focus on adjacent glass opportunities which leverage existing materials or manufacturing processes, including Corning Willow Glass, its ultra-slim flexible glass substrate for use in nextgeneration consumer electronic technologies. INVESTMENT POSITIVES Increase in TV sizes drove glass market in 2014, with screen sizes of 50-inch and more growing as much as 50%. We expect the trend to continue. We expect price declines to remain moderate going forward. The ultra highdefinition televisions which have higher average screen size, higher resolution and more pixels will become a major growth driver of the glass market. This will improve Corning s dollar content from Display Technologies segment. Page 13