Cross-Examining Corning's Flaws

"We'd like to remind investors that, historically, TV sales are not usually impacted by recessions."

-- Jim Flaws, CFO

Seeing that line culled from Corning's (NYSE: GLW  ) post-earnings conference call Tuesday, I'm awfully tempted to reply: "Yeah, Jim. But historically, TVs haven't cost a thousand bucks a pop." Yet Corning's numbers on Tuesday looked so darn good that I find it difficult to argue with Flaws' assertion. Now, I have another arrow in my quiver that we'll pluck in a moment. But first, here's a quick rundown of the good news:

  • Sales for the first quarter of 2008 grew 24% to $1.62 billion.
  • Profits more than tripled to $0.64 per share, helped by a $327 million pretax, non-cash credit "related to the pending Pittsburgh Corning Corporation bankruptcy proceeding." Contrary to my prediction, therefore, Corning's contribution to the asbestos-settlement fund added to the company's net profit. However, this further proves my point that until the settlement thing gets resolved, you need to judge Corning by its operating results, and not its net.

Speaking of which, with Corning's factories churning out LCD TV glass at full capacity, gross margin hit a record high of 52% last quarter. Back out the asbestos-related costs, and Corning's operating margin was 27.8% for the quarter, a 910-basis-point increase over last year's Q1.

Corning's flaw
Now, to address the issue that continues to nag me about Corning -- free cash flow. Flaws predicts that his company will generate "at least $500 million" in FCF this year, but Corning's off to another rough start. Although operating cash flow swelled 53% in comparison with Q1 2007, capital expenditures are rising even faster -- up 78%. As a result, the company generated negative FCF in Q1.

Don't expect that to change in the near term. With Corning's factories pushed to the limit already, Flaws says the company needs to invest further in expanding capacity. All told, Corning may sink as much as $2 billion into capex this year.

The future
And don't expect that situation to change in the long term, either. A little more than two years ago, I quizzed Corning CEO Wendell Weeks on a whole host of subjects, including FCF. I said to him: "Over each of the past seven quarters, your capital expenditures have far exceeded your depreciation costs, with the result that free cash flow is often less than reported profits. What are you spending all the cash on, and how long do you expect this trend to persist?"

His reply:

As a technology innovation company that focuses on materials conversion, Corning is a capital-intensive company. We plan to spend [billions on] ... LCD glass manufacturing capacity expansions in our display technologies segment. ... Our expansions in ... display ... will be paced with market growth.

Sound fair to you? It does to me, too. Weeks is honest, forthright, and unapologetic about the need to continuously invest to keep on the cutting edge of display technology. But investors have to wonder: Is this a business model we want to own?

One word: No
Here's the problem with Corning's LCD glass dominance, as I see it. A few months back, I penned a short piece on the subject of technological change in the television industry. Sony (NYSE: SNE  ) had just announced its exit from the rear-projection TV business and its entry into the "organic light-emitting diode" (OLED) TV market.

As you know, cathode-ray tube television lasted 70 years and is on life support as we speak. Rear projection was aged 35 when Sony wrote its obituary. Flat-screen TVs came next and are already on their way out, with a lifespan, perhaps, of a decade. It all gets this Fool to wondering how much longer LCD and plasma TVs have before they're shown the door as well.

Newfangled OLED technology is already knocking on that door, with backers such as old-guard players Kodak (NYSE: EK  ) , Xerox (NYSE: XRX  ) , and Matsushita's (NYSE: MC  ) Panasonic demanding entry, along with new kid on the block and Motley Fool Rule Breakers recommendation Universal Display (Nasdaq: PANL  ) .

Meanwhile, Corning continues to invest heavily in what looks to me like the next "new" technology due to become "old." How many years do plasma and LCD have left in the sun? Five, perhaps? Ten? I'm guessing, based on Intel (Nasdaq: INTC  ) co-founder Gordon Moore's famous law of accelerating change, 15 at the most -- half the lifespan of projection TV.

Whenever the changeover happens, I fear that it will bring accompanying writedowns on the very LCD glass-producing assets that Corning's investing so much money in. And mind you, growth in these assets underlies the price-to-book value calculations that provide the only argument I've yet found in favor of Corning's being undervalued -- and that leaves this Fool, for one, bereft of a buy thesis for Corning.

What did we expect out of Corning last quarter, and what did we get? Find out in:


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