Buying glass and other problems with interventions

intervention - royal tenenbaumsOn April 25th, 2012 Amvona published the article "Corning from another perspective”.  On May 2nd shares of Corning (GLW) were sold for investors accounts at $14.49 per share - a return of about ~13% in just over 4 months, or almost 38% annualized.  The shares were not sold because it was thought that they were overvalued, rather it was to free up capital for the growing position in Western Digital (WDC) later discussed in the follow up article "Update: Western Digital Discusses Q4 2012 Results”.

The intrinsic value of the company is probably around $18.50 per share on a DCF basis, but even if the company were worth only the sum of it's tangible assets, the price per share would be $13.50 or higher (depending on the rate and timing of share buy backs).  In the first scenario the potential price to value discount appears to represent ~59% upside, while the later is closer to ~16%.  Even at $18.50 per share the company would only be selling for 29% over book.


The position in WDC owned for investors' account were sold on August 13th, 2012 at $44 per share, and as with GLW, not because the shares were overpriced, or even at fair value (estimated at least at $68 in the above article), but rather because it was hard to recollect seeing a price performance chart which went up diagonally in perfectly straight line. 


Hopefully WDC shares can be re-aquired, but in the interim, there was suddenly much more cash available for investment after the WDC trade returned over 179% (annualized) and would have been much more in the case of one investor, whose account was "leveraged up” during June in order to buy larger and larger stakes in the company – an activity that would have continued until the margin was exhausted had the investor himself not intervened.


By the time of the June 15th intervention, which was actively protested, an unprecedented position had already been built in WDC.  At August 13th, when the shares were being liquidated (about 8 weeks later), the same investor who had "intervened” in the work was rewarded with an average return of only 172% (annualized) and a monetary gain (as a function of time and effort [not that there was any on his part, outside of the intervention, that is]) that was far greater than anything seen in his life time.  Had the management of the account(s) not been interfered with, the returns, needless to say, would have been far greater.


The sale of WDC concluded the 35th consecutive profitable trade in just about 2 years with virtually all beating the S & P 500 by a significant margin.


Getting back to GLW, the timing worked extremely well, because the price promptly declined after the shares were sold (and continued to decline for the next three months); if not humble, the trade at least looked smarter than it really was.


On August 28th, a large stake in GLW was re-acquired at $11.64, using in part the cash which had been freed up from the WDC sale.  It was a happy day, the exact same company (actually with enlarged equity and fewer shares outstanding) sold back in May, could now be reacquired at a discount of some 20%, or about $4.2 B off the price for the company as a whole.   Taking a look through the glass again, this time things looked even clearer.  In a late afternoon stroll with a friend, neighbor and investor in the humid warmth of what seemed like an endless New England summer day, the thoughts and feelings about Corning were shared in subtle technical terms that only an educated man would use; "it's another whopper".


The mind of the market’s hard to say for sure, but it appears that GLW's price swings have been driven solely by the company's sales cycle, which in the second quarter of 2012 was not exactly trending in the right direction, although at the same time the figures were nowhere near negative territory either.  There are plenty of companies who have operated at a loss, including GLW itself, yet sold at greater premiums, like just tangible equity for example.


There are not many companies whose sales figures (like their stock price) simply rise in a straight line, lending credence to the idea that most companies are indeed subject to a "sales cycle”, within the context of larger "economic cycles”.  This certainly appears to apply to Corning as well, and it does not seem at all convincing that a few quarters should constitute a bonafide "trend".


That having been said, consistency of performance is extremely valuable in understanding the prospective value of a concern.  In reviewing this "consistency" it is wise to look back at least ten years. 


In Cornings case, this meant a net loss in the FYE 2002-2004, yet curiously by the end of 2003, the share price was about the same as it is today (although fewer shares were outstanding) – however presently, there is no loss, nor is a loss anticipated in the foreseeable future, the company has massively more security backing the share price and yet through parts of 2004, another year when the company operated at a loss, the share price often traded higher than it does today, even though total equity in the firm at the time was less than a third of what it was on August 28th, 2012.   In sum, not only is the stock much cheaper today than it was then, but indeed in many ways it’s the cheapest it’s been (by a considerable margin) in ten years.


Corning's market price appears to be acutely sensitive to the company's sales forecasts, even if it is cyclical. Further market sentiment, and collective anticipation of a negative future for global economics, also appear to be playing a significant role in the discount.


The question is, at what part of the "cycle”, are the shares most likely to be attractively valued (if that is what one is looking for)?  What would the market sentiment be like in a true bargain situation? 


You mean your supposed to buy low and sell high? things will punish a stock more than a large, old, stable, and maybe boring company which appears to be in a secular decline.  That would mean the stock is (are you sitting down?)  "unpopular".  In the near term, think of it as a beauty pageant, and Corning apparently didn't look that good when the shares were being bought back on August 28th, 2012.  However, as buyers of the Facebook (FB) IPO will probably attest, the most beautiful contestant is not necessarily the most virtuous.  But if the object is fidelity to a value orientation, that is to say an effort to buy productive assets below their "intrinsic value” (and exploit price/value disparities in the process), with a particular focus on future value, than it seems logical that a trough in the sales cycle, particularly within the greater context of negative sentiment about the global economy at large, would be precisely the event that might afford such an opportunity. 


One way to bring things into focus, is to consider the possible perspective (looking back) ten years from now, in all of the inflation-adjusted-touch-screen-everywhere glory of 2022 as an owner of Corning which was bought for just 80 cents on the tangible dollar way back in 2012 – it may well be one of those "would’ve, should’ve, could've” moments which invariably appear more clearly in the rear-view mirror.




There is no way to know the future, so look at the security underlying the issue


It seems logical to deduct a secular decline in demand for Cornings products as the particular culprit behind the recent discount in the shares, because the very nature of what the company produces is in a way becoming more and more ubiquitous.  New applications are emerging all the time and the company has invested heavily in important research and development as well as CapEx in order to maintain a market leading position.  It is not as if a start-up tomorrow in silicon (no pun intended) valley could simply decide to "compete” with an altered business model when considering the distribution networks, joint ventures, intellectual property, and infrastructure required to produce the company’s technologically advanced products, all of which are excluded from the market price in addition to the 20% discount off tangible assets, when the shares were being reacquired. when using Assistive Bird Entrail Technology (ABET), chart reading can not in fact reveal anything about the future price performance of a stock.  This may be disappointing to learn to an entire segment of the investing community.  However charts can play a role in aiding the quick display of large amounts of comparative data to those who are more visually inclined, and it seems reasonable to think that even Ben Graham, "the Dean of Wall Street" himself, might have made greater use of them, had there been an easy way to produce them quickly in his day.


Here are a few worth looking at for GLW, not for future price performance postulation, but for value assessment:


Chart 1:  In the last ten years the delta between GLW’s price and its cash and short term Inventory has never been greater.  Particularly in the last 18 months, when cash and short term Inventory continued to climb, the price of the shares continued to decline - all the while the company was buying back its own shares.



price to cash and short term investments


Chart 2:  In the last ten years the delta between GLW’s price and it's value on a Discounted Cash Flow basis (DCF) has never been greater.  Particularly in the last 18 months, the DCF value for GLW continued to climb steadily while the price of the shares continued to decline - all the while the company itself was in the market buying back shares from Corning owners.  At only one other time in the last ten years did the share price dip below the DCF value, and that was in 2009, and it took nothing short of a historic economic crisis, credit freeze, and nearly unprecedented decline in the major indexes to get it there, despite all of that, the price of GLW declined only slightly below it's DCF value at the time - hardly the same can be said today.


(2002-2004 DCF values are zero due to negative earnings in those years)


price to DCF



Chart 3:  Ben Graham himself would be proud... (although he would have had much stricter NCAV requirements) because in the last ten years, the delta between Cornings NCAV (Net Current Asset Value) and it’s price has also never been greater.  Particularly in the last 18 months, when the NCAV value for GLW remained in positive territory (a historical anomaly for the company) the market price of the shares continued their downward swoon - all the while the company continued to mop up its own shares.   Going back further than 18 months Corning had a negative NCAV figure, yet the price was often more than double what it was on August 28th, 2012.      


price to net current asset value



Chart 4:  The last ten years also brought the delta between Cornings Revenue Growth and it’s share price declines to new levels.  Particularly in the last 18 months when Revenue continued its upward trend to new heights, the market price of the shares continued to head south - all the while the company was trading cash for its own shares as fast as it could.   For example in 2006 when revenue (~5174 M) was about 35% lower than the TTM (7790 M), the shares were about 150% more expensive.  To use the colloquial expression;  "Go Figure".   


price to revenue


first light bulb 2Chart 5:  For hard core balance sheet investors it may have taken ten years, but venerable Corning with it's 150 year operating history finally went on sale for less than just tangible assets.  To put the company in a historical context, Corning helped a young inventor named Thomas Edison make his electric light a commercial success by producing the first glass light bulbs.   


Despite this, in the last 18 months when Tangible Book continued its upward momentum to new heights, the market price of the shares continued in the opposite direction - all the while the company was trading part of it's tangible book (aka cash) for its own shares, after all why not trade 80 cents for dollar bills?  It seems like a sound business proposition.  Add in even a modest premium for minor things the company has as a going concern such as customer relations, intellectual property, etc. etc., call it just 20 cents in value, and chances are for every 80 cents the company puts up for it's own shares, its likely getting $1.20 in value.  Even late in 2008 when the world seemed to be heading for financial Armageddon, the shares couldn't bust through the Tangible Book barrier as they have in late 2012. 



price to tangible book


Chart 6:  For those who are less interested in the complexities of subtraction and addition that constitute balance sheet math (besides charts look impressive), the following will be indispensable.  Total Assets (Green) continued to climb while Total Liabilities (Red) remained largely static.  Price (Blue), particularly as a function of the value of (A) minus (B) has never been lower.  The only line missing is what could have been (imagine Purple) shares outstanding.  

price to total assets and total liabilities



Chart 7:  Last but not least the sum of all parts or Price to Total Equity (which is nearly all tangible).  In ten years the blue line has never gone below the red.


price to total equity 



The "Pros"


“We had a solid second quarter in terms of sales and earnings performance. We achieved much more moderate price declines for our LCD glass as set forth in our goals that we shared in February. Additionally, LCD glass retail and supply chain market statistics were generally in line with our expectations. As a whole, our other businesses grew 2% year-over-year.”

Source: Q2 2012 Earnings Release


There are a few other "Pros" a well.  As mentioned above, the company has an aggressive share buy back program (look at Q2).  Since Dec 2011 the company has brought the share count down from 1,572 M to 1,518 M a decrease of 540 M shares or 3.4% of the shares outstanding, and fewer than the company had outstanding at FYE 2005 (almost seven years ago) while every other important financial ratio (see above) has increase dramatically in the same time frame.   More specifically the company bought back 314 M in shares just in Q2, or an annualized rate of ~1.2 B, which is significant given the company's enterprise value is just around 15 B.


In other words, the company is not only cheaper than it’s been in ten years in terms of value, but also in terms of relative (to shares outstanding) financial strength.  Further, Price declines in the display business (the largest segment) did slow exactly as management said, so it can not be said that any decline in the Display business has been a surprise, but more importantly these price declines have slowed as management takes steps to bring costs in line with the sales "cycle", that is to say, it is not as if costs are fixed - as James B. Flaws, the company's CFO recently indicated:


"Today, I'm delighted to tell you that our quarter 2 price declines for LCD glass were indeed much more moderate than the previous 2 quarters' average. And just as important, we now believe price declines in quarter 3 will also be moderate. Now we need to continue to repeat this over the coming quarters while we execute our cost reduction projects."

Source: Q2 2012 CC


The price to tangible book, as illustrated above, does seem a bit extreme. There has been no clear indication as to why the company should be offered at a discount indicative of a potential liquidation situation, when the company is yet healthy, viable, growing and very profitable.  However for ongoing owners of the company, nothing could be more brilliant, because depressed share prices in the context of a share buy back are de facto increases in pro-rata stakes for long-term owners.  Further the delta between tangible value per share, and market price (when market price is lower) is like a tax free dividend to the same folks - strange and counter-intuitive though it may seem, these owners are being paid to increase their stake in the company when such financial dynamics exist.


The company also does have somewhat of a defensible moat – it is a large technical business, producing a tangible product with high utility - reproducing such an operation would require large amounts of capital, organizational know-how and time - incidentally, there are just not that many existing or potential competitors.


Here are a few other important and positive points to consider:

    • Free cash flow is very high.   In the last twelve months the company's operating margin was greater than 20% but even more importantly the operations threw off 3.4 B in cash or over 22% of the Company's enterprise value.
    • The company books almost nothing for intangibles – not even "Good Will", with a mere 253 M on the books (less than 1% of total assets)
    • The Becton Dickinson (BDX) deal not yet closed / accretive (will expand Corning Life Sciences annual revenues by 40% and move the segment toward its goal of being a $1 billion business by 2014)
    • In the last 14 quarters the company has never missed estimates, and six of those quarters (~43% of the time) the company beat them.



More importantly a look at "The Cons”


“Third, we told you in the last call, we are very alert for potential worsening economic headwinds. We are now experiencing those headwinds. We have seen lower sales of light-duty Environmental products principally in Europe, and we believe the economy could start to impact heavy-duty diesel soon. We've seen lower order rates than expected for some Telecom products, not fiber, but in connectivity products due to project slowdowns.”

Source: Q2 2012 Earnings Conference Call 


lipstick on a pig"Straight from the horses mouth" as the saying goes.  Display business is still the company's largest segment, and experienced a 16% YoY decline - and yes it is hard to simply put "lipstickonsome things - but the glass price declines were much more moderate in the most recent quarter (think gross margin), a trend expected to continue.  If what the company has to say regarding "cost reduction" measure indicated above is accurate, than margin should improve, even if revenues from this segment do not (although it is possible that one of Cornings newest products "Willow Glass" may actually reverse the revenue trend for Display Tech.  In the interim the other business units should continue to grow to offset any losses to contribution margin.  Even if 16% is a large decline in this leading segments revenues, the LCD glass business is still highly profitable.


However, perhaps of greater concern is the fact that the rate of growth for the other segments is now slowing as well, according to the company the following is expected:


Telecommunications:   2% YoY

Speciality Materials:    10-15% (sequentially)

Environmental Tech:    Same as Q2

Life Sciences:              Same as Q2 to up slightly


Finally it is worth considering that if consistent performance is important, it must be remembered that GLW lost money in the 2002-2004 period.


What’s really the Thesis?


Display glass price declines are moderating, gross margins are improving across the board, and the other segments are still growing, and where they haven’t there are sound explanations (it's worth reviewing the Q2 CC transcript for more detail).  The thesis put fourth in the April 25th Amvona article still appears to hold true, that is the other segments are growing, even if LCD glass prices have declined, making GLW a more diversified business less dependent on a single sector, that can be purchased at an extremely good value.


Nothing jumps out as “unusual” or worse yet “problematic” - in other words, it looks like the normal "cycle" of your typical 150 year old company.  In fact, all the negativity seems very mild, and precisely the sort of bad news a true value investor hopes the market will overreact to, particularly if buying the shares means getting a tax free dividend to increase your stake, even while equity in the company continues to grow.


Here is a chart to illustrate the "other segments" argument:


Segment Q1 % of total Q2 % of total Q3 (est.) % of total
Display Tech. $705 36.7% $641 33.6% $675 34.1%
Telecom. $508 26.5% $559 29.3% $559 28.3%
Specialty Mat. $288 15.0% $296 15.5% $333 16.8%
Environmental $263 13.7% $249 13.1% $249 12.6%
Life Sciences $155 8.1% $162 8.5% $162 8.2%
Total $1,919   $1,907   $1,978  

*figures are in Millions      

**Q3 fig. based on management comments in Q2 CC


As can be seen in the chart, the percentage of the display business relative to the whole is indeed declining, while Specialty Materials, for example, is trending up and is forecast at about ½ that of Display Tech. by Q3.  Telecom, as another example, is already nearly (83%) the same size as Display Tech. as of Q2.


How low can you go?


.80 of tangible book is cheap by any measure.  How low can the stock price go before it enters “entirely ridiculous” territory, if it isn't already there?  Corning is a 150 year old company, backed by massive assets, that is well run, and hasn't experienced a loss in about 8 years.  Actually without their products, perhaps more than a billion people would be very frustrated with the devices they use every day.  The risk of buying the shares seems more than reasonable in light of the value a received as of the end of August 2012, and chances are whatever the swings in the marketplace at large may bring, GLW's price will eventually rise, and rise significantly, but in the meantime, as long as the company is buying back shares from disinterested owners, a low price should be welcomed. 

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