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 all Corning’s 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 ($1.15 billion in 2020) that benefit and are spread across all of its segments. Corning operates by 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 research and development 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 made up 32% of 2020 sales and 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) due to costing 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 Fiber 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 we think 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 research and development that have gone into perfecting its proprietary OVD process, we would not assign an intangible asset moat source to the company’s 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, with 28% of 2020 sales. 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 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 upwards 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 double that 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 sustainably outprofit its competition.
Finally, Corning’s display business also 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 made up 17% of 2020 sales, with the lion’s share of this revenue coming from sales of its marquee Gorilla Glass. Gorilla Glass is the protective cover glass designed into nearly three fourths of the global smartphone market (including every Apple iPhone ever made), as well as into wearables, tablets, and notebooks.
Corning invented Gorilla Glass in 2006, when Steve Jobs gave the firm six months to design a cover glass for the first iPhone. The latest iteration is Gorilla Glass Victus, which can withstand drops of up to 2 meters and boasts twice the scratch resistance of its predecessor, Gorilla Glass 6, Corning says. 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. Gorilla Glass is found in every premium smartphone on the market (iPhone, Samsung Galaxy, Huawei Mate, to name a few) while its chief competition, AGC’s Dragontrail and NEG’s Dinorex, are largely featured within 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 Gorilla 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 (12% of 2020 sales) 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. For color, 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, and 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 Corning 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, making up 9% of 2020 revenue, 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 we think 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 disruptor, and as Corning continues to take market share, we may deem its life sciences segment as moatworthy in the future.