Who says that the market doesn't trade off of inside information?
The short interest in glass and fiber maker Corning (NYSE: GLW) more than doubled in the two weeks ended Oct. 31, to 83 million shares. (Data were released Nov. 11.) The short-interest surge came just days before Apple (Nasdaq: AAPL) said Nov. 5 that it was going to work with GT Advanced Technologies (Nasdaq: GTAT) in the production of touch screens at an Apple manufacturing facility.
To be sure, the deal was a great win for GTAT, as my colleague David Goodboy noted a few days ago.
But GTAT's win shouldn't be seen as a real impediment to Corning. And short sellers, even as they traded on this news early, will still likely get burned -- because Corning is shaping up to be both a deep value play and a growth play.
Merrill Lynch's Wamsi Mohan was one of the first analysts to weigh on the Apple/GTAT linkup: "This announcement does not change our opinion of the current limitations of Sapphire (or of) the price and feature advantage of Gorilla Glass. In our view the applications are likely to be more niche and Gorilla's position in the touch market relatively unchanged." He has a "buy" rating and $22 price target, representing 30% upside.
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Mohan's specific concerns: The Sapphire production process is "orders of magnitude more expensive than Gorilla Glass," which would likely add $20 to the cost of each iPhone if it were used in that device. The high cost relates to low manufacturing yields and arduous production techniques, he notes, adding that "Sapphire is heavier than Gorilla and does not perform as well in drop and tumble tests." That's why Mohan expects the AAPL/GTAT linkup will likely serve a small niche product, such as the iWatch.
The key takeaway: Corning lost a chance for incremental revenue gains from Apple, but it's unlikely to lose its supplier role with Apple's existing products. And Corning still is the key supplier to many other smartphone and tablet makers anyway.
Equally important, Corning has been talking about new product rollouts in 2014 that will put Gorilla Glass in cars, among other applications. And the company's Willow glass is expected to open many new opportunities where flexibility is required.
Remember too that Corning is still a major player in the flat-panel TV arena. Unit sales of LED TVs aren't growing, but the size of the TVs are. That's why Corning recently told analysts to expect high-single-digit growth in this vertical in 2014. Corning's telecom unit is also quite healthy: Demand for its telecom fiber rose 24% in the third quarter, to $650 million.
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To be sure, it's unwise to think of Corning as a great growth stock. But the company has a proven knack for offsetting price declines in key markets by expanding its addressable markets. Revenues are expected to be flat around $8 billion this year before surging to $10 billion next year. An inventory correction among leading Gorilla Glass customers explains why sales are flat this year, even as the overall smartphone and tablet glass markets grow.
The expected revenue spike in 2014 is largely a function of more normal inventory levels and a resumption in growth back to end-market growth rates. After that, mid- to upper-single-digit revenue growth is feasible as the company's R&D labs crank out new products.
Still, the company generates great returns on that revenue base. Profit margins are on the mend after pricing pressures caused a dip in 2012. And free cash flow is likely to exceed $2.5 billion in both 2014 and 2015, according to UBS. That works out to be a projected free cash flow yield in the 6% to 7% range, which is among the higher figures you'll find when valuing large industrial firms.
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Corning is also in the midst of a massive $2 billion share buyback plan which could shrink the share count by nearly 10%. Buyback programs can create havoc for short sellers as they stimulate demand for shares right at a time when shorts are betting that demand for shares will diminish.
Risks to Consider: Corning's growth would peter out if the flat-panel TV market slumps again, or spending on telecom fiber decreases.
Action to Take --> Short sellers have made a huge bet against Corning, but this is about as solid a ship as you're going to find. The company's exposure to multiple end markets -- and its solid margin profile in each of those markets -- ensures steady and predictable results in the quarters to come. If a short squeeze ensues, this stock could quickly surge toward the $20 mark.