2HRS2GO: Corning should do well with Oak
The first time I suggested Corning (NYSE: GLW) ought to be considered a major stock in the technology and communications sector, a couple of ZDII folks laughed. They're not the only ones.
"The last three months I've been covering the stock, people who don't actually own it come up to me and say 'You cover communications, why are you following Corning? Don't they make glassware and breast implants and medical equipment,' " says Charlie Willhoit, communications component analyst with J.P. Morgan Securities. "And I say, 'They used to.' It's been big education process."
But I can't fathom their disbelief. As Willhoit points out, Corning's relation to networking and the Internet is no secret; Business Week even did a story on the phenomenon last year.
The company gets more than half its revenue -- actually 58 percent in the first nine months of this year -- from networking fiber, optical equipment, and photonics technology. That telecommunications division saw sales increase more than 34 percent year-over-year through the first three quarters.
Corning investors have been rewarded. Since in the fall of 1998, the stock price rose from the mid-20s to an all-time closing high of 90 3/8 on Friday.
Perhaps Corning was due for a bump. Shares are down slightly today on heavy volume following news of Corning's $1.8 billion plan to buy Oak Industries (NYSE: OAK), whose products include devices that boost the capacity of fiber lines. Merrill Lynch analyst John Roberts lowered his intermediate-term rating on Corning to "neutral" from "accumulate" before the market opened.
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Issuing $1.8 billion in stock obviously means a bit of dilution for shareholders of a company with a market cap of about $22 billion. And you can be sure there'll be acquisition-related charges and such.
Still, it's hard to complain about the Oak acquisition from a long-term perspective. Fiber has always been something of a commodity business, which means price pressure sooner or later. Corning got a taste when its fiber revenue fell "substantially" last year.
"The continued reduction in optical fiber prices is the result of overcapacity in the worldwide optical fiber market, which was exacerbated in 1998 by the economic events occurring throughout the Asian marketplace," notes Corning's 1998 annual report.
Things have improved this year -- in three quarters, Corning's telecommunications division has already almost matched revenue for all of 1998. But price wars will return at some point as the fiber industry matures; Corning's growing hardware line not only lessens the company's reliance on one product, but also provides a higher margin business for Corning. Oak's technology bolsters that further.
"By taking Oak's capabilities, Corning has a broader product portfolio," says Schroder & Co. analyst Stephen Koffler, who likes the deal because of Oak's strong fit with Corning's line.
Corning had to act before the optical equipment industry's current wave of consolidation takes out all the good candidates, say Koffler and Willhoit. "If they didn't buy Oak, someone else would have, so Corning had to pay a premium," says Willhoit, referring to the purchase price, which was about 50 percent above Oak's Friday close.
Both analysts raised their price targets on Corning stock, with Koffler's going to $105 from $85, and Willhoit's to $130 from $90. Also reacting positively was SoundView Technology Group's Kevin Slocum, who boosted his Corning target to $125 from $100, and Warburg Dillon Read, to $115 from $86.
The upgrades don't come from baseless optimism, because Oak offers something all-too-rare nowadays among acquired technology companies: profits. Oak earned $8.6 million on revenue of $108.6 million in the latest quarter reported; its gross margin has generally been in the mid to high-30s, roughly in the same range as Corning's. And applying Corning's sales and distribution muscle should further boost sales of Oak's optical products.
Assuming the acquisition closes on schedule, it will add to Corning's earnings sometime next year. For an investor, that's not a long time to wait.
Other issues:
Not a bad move, but considering that investors in recent months have mostly been interested in Global Crossing as an acquisition target, the question should be asked: does this enhance the company's appeal for a would-be buyer, or does it just make Global Crossing even more expensive to buy? I'm leaning toward the latter.