Narrow-Moat Corning Is Set Up for Growth and Operating Leverage Across Diverse End Markets

Analyst

William Kerwin

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Corning is a materials science behemoth with differentiated glass products for televisions, notebooks, mobile devices, wearables, optical fiber, cars, and pharmaceutical packaging. In its 170 years of operation, the company has constantly innovated (including inventing glass optical fiber and ceramic substrates for catalytic converters) and oriented itself toward evolving demand trends that it can serve through its core competency of materials science. Most recently, we point to Corning’s domination of the smartphone cover glass market and deals with U.S. network carriers to supply fiber for 5G buildouts as evidence of the pivot toward growth. 

Corning is able to use its scale to invest heavily in research and development—$1 billion or more per year—and spread these expenses across its five segments. We think centralizing R&D allows the firm to manufacture products for a materially lower cost than its competitors, all while using this hefty investment to maintain an innovation lead that results in leading share positions in its end markets. Corning’s cost advantage and intangible assets result in a narrow economic moat, in our view. 

We expect Corning to continue focusing resources on opportunities that align with secular trends toward connectivity and efficiency. We view the firm as a key enabler of 5G networks and hyperscale data centers, providing the fiber backbone to network operators. We also expect Corning’s ceramic substrates and gasoline particulate filters to enable automotive OEMs to achieve rising efficiency standards around the world. The firm is also poised to continue dominating the market for thin display glass as it operates three of the world's four Gen 10.5 plants—the cutting edge for 65-inch and 75-inch screens. Finally, we think the firm’s pharmaceutical glasses will continue to disrupt the market for applications in vaccines, genomics, and drug development.

Business Strategy & Outlook

We award Corning a narrow economic moat rating, based on a firmwide cost advantage and intangible assets in certain segments. The combination of Corning’s competitive advantages across its business gives us confidence that it will earn returns on invested capital in excess of its cost of capital for the better part of the next decade. 

Corning has five segments: optical communications, display technologies, environmental technologies, specialty materials, and life sciences. While the segments sell into very different applications, Corning is a leader in each one because of its proficiency in materials science, gained through 170 years of operation and innovation. These markets are typically characterized by specialized competition, and Corning is the only company that plays in all five, boasting a leading market share in all but life sciences. 

As a result of diversified end markets with a common theme of materials science, Corning benefits from a cost advantage through massive and centralized annual research and development expenses (more than $1 billion) that benefit and are spread across all of its segments. Corning operates in a so-called 3-4-5 framework, with three core technologies (glass science, ceramic science, optical physics), four manufacturing and engineering platforms, and five market access platforms. Management focuses 80% of its resources on opportunities that leverage at least two of these technologies and platforms. The firm credits this strategy for numerous product innovations, including iterations of its marquee Gorilla Glass and advances in optical fiber. Overall, we think this strategy means that Corning can consistently outspend its competitors on R&D to maintain its leading share in most markets while still producing its products at a lower cost. We point to Corning’s gross margins and operating margins leading every single one of its competitors across end markets as evidence. 

Corning’s largest segment is optical communications, which revolves around the manufacture of optical fiber. Optical fiber is a broadband solution made out of strands of glass or plastic thinner than a human hair, which offers superior performance to incumbent copper cabling in broadband networks. Corning’s fiber transmits data by coding it into pulses of light that are sent through pure glass, compared with copper, which transmits electrons. This allows data transmission at the speed of light, with high bandwidth and low loss. While optical fiber was initially used in niche applications (after Corning invented it in 1970) because it cost more than copper, bandwidth needs of the 21st century and reductions in cost are making it the new standard in broadband access. Corning is working with cellular networks like Verizon and AT&T to provide a fiber backbone to their 5G network buildouts as well as providing fiber to the home to cities and communities to improve their home broadband. The firm also works with hyperscalers to input optical fiber into data centers. 

Corning is a vertically integrated optical fiber manufacturer, controlling every part of the process from taking raw materials and producing a final optical fiber cable, even manufacturing its own furnaces and machines for production. Corning invented and uses to this day a process to create its fiber called outside vapor deposition, or OVD, to produce its fiber. This is a lengthy process that involves coating a “bait rod” evenly with a vapor solution that gets heated layer by layer to create a “preform”—essentially a thick tube of glass—that then gets heated and purified into a “blank,” where impurities are measured in parts per billion. Finally, the blank is suspended several stories in the air and the tip is heated to the point where a gob of pure liquid glass drips down, thinning and solidifying as it does. This becomes a hair-thin strand of optical fiber. According to Corning, a single blank (the size of a tube of salami) can produce a few thousand kilometers of optical fiber. While many firms produce their own optical fiber cabling (by outsourcing for the fibers themselves), there are only about 15 firms globally that manufacture fiber from scratch, with vertically integrated leaders Corning, Prysmian, and Yangtze Optical Fibre and Cable taking up about 40% of the market, according to Network Telecom and Thomas Publishing. Corning sells optical fiber at every stage in the process. It sells preforms and finished spools of optical fiber to third-party cable manufacturers and manufactures its own fiber cables as finished products, along with cable assemblies and accessories. 

Corning is constantly refining its OVD process to produce more fiber from a single blank, and it is able to leverage its centralized R&D spending to do so. Management has credited investments in the 3-4-5 framework for doubling the length of fiber produced from the same-diameter blank. We think this continued innovation results in a persistent cost advantage for Corning’s optical business, with gross margins consistently more than 1,000 basis points above those of YOFC, its closest peer in global market share. Although Corning has decades of R&D that have gone into perfecting its proprietary OVD process, we would not assign an intangible asset moat source to its optical segment, as competitors like YOFC have also developed optical fiber that meets the needs of many customers in the marketplace—just at a higher cost. 

Corning’s second-largest segment is display technologies. Within display technologies, Corning supplies flat-panel glass into liquid crystal display and organic light-emitting diode televisions, as well as into notebooks and other displays. 

To produce flat-panel glass to be used in televisions, Corning uses its proprietary “fusion draw” process. The fusion draw entails pouring molten glass into a pentagonal trough until it spills over the edges and drips down a height of six stories slowly through open air, thinning and solidifying as it descends. The ingenuity of this process is that the glass never touches another surface during its formation, greatly reducing surface imperfections and the need for additional polishing. This is in contrast to the traditional “float method” used by competitors Asahi Glass Co. and Nippon Electric Glass, where glass sheets form over a bed of molten tin before getting polished and finished. 

We think Corning can produce these high-quality glass substrates at a lower cost than its competitors as a result of its centralized R&D. Corning uses the same fusion draw process to make glass substrates for both its display technologies and specialty materials segments, which it credits for saving upward of $1 billion in investment, on top of the money it saves per substrate on refining and polishing. We think these dynamics exhibit themselves in industry-leading margins far and away above Corning’s nearest competitors. Corning’s gross margins come in consistently in the upper 30s (barring an exceptional 2020), while AGC and NEG are stuck in the mid-20s. Corning’s operating margins are stable in the low to midteens compared with AGC and NEG, which are stagnant in the high single digits. This is all while Corning more than doubles the R&D spending of these competitors, both on an absolute basis and as a percentage of sales. 

We also think that Corning enjoys a virtuous cycle in its glass production between its cost-advantaged position and intangible assets in the production of thin glass substrates. Corning invents and manufactures all of its own equipment and machinery for its fusion draw, which produces best-of-breed display glass, which we think has resulted in its leading market share. Glassmaking is a high-fixed-cost business, with more than half of Corning’s manufacturing costs being fixed. The display glass market is an oligopoly, with Corning, AGC, and NEG taking up an estimated 95% share, of which Corning accounts for half. Because Corning’s sales are double those of its closest competitor, AGC, it can spread its fixed costs over a larger volume, resulting in an enduring lower average cost per glass substrate. Corning can then use the money it saves to reinvest in innovating its production processes even more and continue to reliably outprofit its competition. 

Finally, Corning’s display business presents meaningful switching costs to its customers as a result of co-location and co-investment, although we can’t say that all of Corning’s businesses benefit from similar switching costs. Due to the inherently fragile nature of sheets of glass as large as 100 square feet in area and as thin as 0.5 millimeters, the firm’s display plants are located next to customer facilities to reduce the risk of lost inventory and to save on travel time and expense. Additionally, when Corning builds a display glass plant, it secures over 75% of the initial investment outlay from customers and partners. These plants can cost up to $7 billion to build (and often a 10-year supply agreement), creating a strong incentive for customers to maintain their relationship and earn a return on their large investment. We think panel manufacturers that partner with Corning would be hard-pressed to lose the sunk cost of a billion-dollar investment and reduce their own production for multiple years to arrange for a new source for glass.

Corning’s specialty materials segment features sales of its marquee Gorilla Glass and its exclusive arrangement with Apple for Ceramic Shield. Gorilla Glass is the protective cover glass designed into nearly three fourths of the global smartphone market (including every Apple iPhone before the iPhone 12, which first featured Ceramic Shield), as well as into wearables, tablets, and notebooks. 

Corning invented Gorilla Glass in 2006, when Apple's then-CEO Steve Jobs gave the firm six months to design a cover glass for the first iPhone. Gorilla Glass is known in the industry as best of breed, and we think this is exemplified by its stranglehold on the global smartphone market, with a 73% share in 2016, according to EMR (the latest share data we can find). Corning cover glass is found in every premium smartphone on the market (iPhone, Samsung Galaxy, Huawei Mate, to name a few) while its chief competitors, AGC’s Dragontrail and NEG’s Dinorex, are largely featured in economy phones. 

We think the firm’s specialty materials segment enjoys the same cost advantage in the production of glass as it does in its display technologies segment. Corning’s Gorilla Glass is produced using the same proprietary fusion draw process as it does for display glass, which again has helped save $1 billion in investment and allows the firm to save money on refining and polishing versus the competition. We credit these dynamics for resulting in industry-leading gross margins well above those of AGC and NEG. Corning’s synergies between display and specialty materials, along with its unparalleled scale in the cover glass market, allow it to consistently achieve operating margins 500-plus basis points above its chief competitors. 

We also think Corning’s 15 years of dominance in the premium smartphone market reflect the same virtuous cycle of intangible assets and a cost advantage in durable cover glass production. Corning claims its sales of cover glass are 10 times that of the nearest cover glass competitor, meaning it can spread its fixed costs over a large production volume even more so than it does in display glass, reducing its average cost per substrate and allowing the firm to reinvest money saved to maintain its innovation lead over the industry. 

Corning’s environmental technologies segment sells ceramic substrates and particulate filters into the catalytic converters for gasoline- and diesel-powered cars and trucks. Corning invented ceramic substrates for emissions control in 1970 following the U.S. Clean Air Act. Gas and diesel engines produce toxic pollutants that can render air harmful to breathe, and the Clean Air Act was the first legislation to target a reduction in those emissions. Substrates and filters are a one-two punch to accomplish this, with substrates removing gaseous pollutants and filters taking out toxic particulates. 

Substrates are a solid ceramic in a honeycomb shape coated in catalytic materials that turn harmful gases like carbon monoxide and nitrogen oxide into gaseous nitrogen, water, and carbon dioxide. Corning can pack a surface area the size of a football field into a product roughly the size of a can of soda. Currently, while most diesel engines use a substrate and filter, most cars only use a substrate. However, the demand for gasoline particulate filters, or GPFs, is greatly expanding as a result of global emissions regulation. The typical internal combustion engine emits trillions of particulates every mile, and regulations like Euro 6 and China 6 require a 99% reduction, which only an advanced GPF can accomplish.

We think Corning benefits from a cost advantage in substrates and filters, again stemming from its centralized R&D spending, as well as a virtuous cycle with intangible assets in ceramic substrate production. Corning occupies a plurality of the GPF market, with 27% share; the top three firms combined made up 60% of the total market in 2019, according to 360 Research. Corning invented this industry, and after five decades of innovation, we think it possesses intangible assets in ceramic substrate and filter production that have resulted in its leading share. Similar to the dynamics in its glass businesses, Corning can divide hefty fixed costs across a greater volume than its competition, resulting in materially lower average costs and industry-leading margins. Among its competition, it is rivaled only by NGK Insulators in margin performance, and we think the two hold a cost advantage over the rest of the field. Both Corning’s and NGK’s operating margins have trended around 15% of revenue since 2015—more than double that of the next largest firms by market share, Ibiden and Faurecia—all while they dwarf their competitors’ R&D expenditures. 

Corning’s final segment is life sciences, where the firm produces glass equipment for pharmaceutical research, development, and production. The firm’s marquee product in this segment is Valor Glass, which reduces particle contamination in pharmaceutical packaging and elevates production throughput via reduced breaking or cracking compared with incumbent pharmaceutical glass. 

While we think Corning’s life sciences segment benefits from its centralized R&D spending (which led to the invention of Valor Glass), we don’t consider this segment moatworthy in isolation. It is already a $1 billion business for Corning but goes up against massive incumbents like Thermo Fisher and Danaher, which generate several billion dollars in revenue from pharmaceutical packaging alone, on top of massive R&D budgets and lasting customer relationships. Still, we think Valor Glass could be an industry disrupter, and as Corning continues to take market share, we may deem its life sciences segment as moatworthy in the future.

Narrow

Economic Moat

Corning

Gorilla Glass is a brand of specialized toughened glass developed and manufactured by Corning, now in its fifth generation, designed to be thin, light and damage-resistant. Gorilla Glass is unique to Corning, but close equivalents exist, including Asahi Glass Co. Dragontrail and Schott AG Xensation.

Gorilla Glass

Corning, Inc. engages in the provision of glass for notebook computers, flat panel desktop monitors, display televisions, and other information display applications, carrier network and enterprise network products for the telecommunications industry, ceramic substrates for gasoline and diesel engines in automotive and heavy-duty vehicle markets, laboratory products for the scientific community and polymer products for biotechnology applications, optical materials for the semiconductor industry and the scientific community, and polycrystalline silicon products and other technologies. It operates through the following segments: Optical Communications, Display Technologies, Specialty Materials, Environmental Technologies, and Life Sciences. The Optical Communications segment is classified into two main product groupings: carrier and enterprise network. The carrier network group consists of products and solutions for optical-based communications infrastructure for services such as video, data, and voice communications. The enterprise network group consists primarily of optical-based communication networks sold to businesses, governments, and individuals for their own use. The Display Technologies segment manufactures glass substrates for flat panel displays, including organic light-emitting diodes and liquid crystal displays that are used primarily in televisions, notebook computer, desktop monitors, tablets, and handheld devices. The Specialty Materials segment is involved in the manufacture of products that provide material formulations for glass, glass ceramics and crystals, and precision metrology instruments and software. The Environmental Technologies segment focuses on manufacturing ceramic substrates and filter products for emissions control in mobile applications. The Life Sciences segment develops, manufactures, and supplies laboratory products. The company was founded by Amory Houghton Sr. in 1851 and is headquartered in Corning, NY.

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