Little Left to Lose

Corning may or may not have hit bottom, but it’s 90% closer than when Apogee Research suggested to its readers that the lights would be going out.

At the height of the New Economy, few technology stocks inspired such allegiance as Corning Inc. And why not? With nearly 150 years of history behind it at the turn of the millennium, the company was the revered elder in a sea of brash young techno geeks.

From the old Corning Glass Works, whose product enveloped the white-hot filaments of Thomas Edison’s first light bulbs, had emerged an Internet-savvy maker of the optical fiber and components that were at the very heart of the telecommunications revolution.

Trouble was, the "revolution" had run amok but the faithful minions on Wall Street were too enraptured to notice. "Even as the lights dim in the fiber-optic sector, investors still hold a candle for Corning," we said back on Dec. 15, 2000, as a prelude to our in-depth analysis of all that was about to go wrong at "Glowworm."

Just before our original piece appeared, Corning had proclaimed itself "positioned for growth." We had our doubts, and said so in a story entitled "Lights Out." Giving rise to our suspicion were the money problems plaguing Corning customers and the plunging price of bandwidth: "…Chairman Roger G. Ackerman’s main gripe these days," we said back then, "is that he can’t make fiber cable and optical components fast enough to satisfy all the demand.

"Accordingly, the mood was upbeat Thursday in the Terrace Room at the Plaza Hotel for CEO-to-be John Loose’s pronouncement to the assembled analyst-fans: ‘If there’s one recurring theme today, it is that this company is well-positioned for sustainable growth.’ Growth? Yes. Sustainable growth? We are skeptical. Consider the signs: Many Corning customers are running a little light on funds. Worse, the price of bandwidth is falling rapidly. Corning shareholders may want to savor the sugarplums this year. Its economic Advent calendar will contain fewer goodies next year."

Our grim prognosis for Corning, cited by Alan Abelson in the Dec. 18, 2000, issue of Barron’s, proved correct. The stock, which changed hands at $69.62 when our story ran, has collapsed a staggering 90% since then, to $6.67 per share. Just like its plummeting share price, Corning’s growth profile has toppled from the lofty vistas of the New Economy and landed with an ignominious and resounding thud on the post-bubble moonscape.

To be sure, whatever hope there might be is not reflected in Corning’s recent results. Revenues in the 2002 first quarter slumped 53% from the year before.

Earnings vanished as well. On a like-for-like basis, last year’s first-quarter profit of $268 million was replaced this year by a loss of $132 million. Not surprisingly, the company is bleeding cash – $400 million in the latest quarter alone. Interest-coverage ratios are also suffering. Corning’s EBIT/interest expense ratio has tumbled from 10.9 times in 2000 to a negative 1.8 times in 2001, and to a negative 3.8 times in the first quarter of 2002.

And, of course, there are the requisite restructuring charges – $961 million in 2001 and $600 million announced (so far) in 2002.

And let’s not forget the massive job losses – 12,000 in all last year, and the axe will probably lop off about 4,000 more heads this year.

Net-net, for all of its proud heritage and Internet-era promise, Corning looks today like just another over- hyped flameout. Apogee Research was one of the very few research shops foolhardy enough to predict imminent problems for Corning when investors were still besotted.

This was probably the least-popular story we ever produced. Some subscribers posted hostile comments on our message boards to ridicule our self-evident stupidity. But however unpopular our conclusion, our thesis was strikingly straightforward: "If demand is not sufficient to arrest plummeting bandwidth prices (so far, it is not), and if fiber-optic customers are bleeding cash and unable to secure financing for their efforts (many are), how long can Corning remain unscathed?"

"Optimistic projections of bandwidth demand have incited a frenzy of capacity expansion," we observed. "Laying a few thousand kilometers of fiber-optic cable somewhere is as trendy as buying second homes in the Hamptons (What! You don’t have a network?)" Therefore, we went on, "Current supply greatly exceeds current demand, as plummeting bandwidth prices testify…[U]nless demand skyrockets to profitable proportions for the bandwidth providers, Corning may find that it is merely arming all sides to wage a grim war of attrition – a lucrative endeavor, but only so long as the combatants remain standing.

"Indeed, some telco soldiers have already won their purple hearts…The unfortunate result is that many Corning customers are running low on funds. The weakening bond prices of major fiber-optic players evidence, in real time, a diminishing ability to finance additional fiber and component purchases. Witness the bonds of Corning customers Williams Communications and Level 3, which are tanking even while GLW’s share price hangs tough."

In response to our skeptical questions, Corning’s vice president of investor relations, Katherine M. Dietz, boasted of Corning’s "blue chip" customer list. She rejected the notion that the plummeting bond prices of both Williams and Level 3 presaged any cause for concern at Corning. "I’m not aware that they have a cash-flow issue," she said. "Level 3, in particular, has…signed up with us as their fiber supplier for the next four years."

"But four years is a long time in telecom land," we noted, "and in the high-yield debt markets in which both Williams and Level 3 troll for funds, it is an eternity." One of these "blue chip" telecoms – Williams – is now in bankruptcy court, of course. The good news is that Corning is unlikely to follow. Although the fallen hero is reeling, as predicted, he remains on his feet. The company will likely finish 2002 with about $1 billion in cash and a $2 billion untapped revolving credit line.

To repeat, if there is any upturn, it is not yet visible in Corning’s main areas of operation. But the company’s CFO, James Flaws, told Dow Jones Newswires that the first-quarter results indicate that, "at least in fiber cable, we have reached a bottom."

We are prepared neither to believe nor disbelieve Flaws. Rather, we would agree with a Merrill Lynch analyst’s recent assessment: "The company will survive and eventually thrive…"

Indeed, no less a luminary than James Grant wrote in the latest issue of Grant’s Interest Rate Observer that "Glowworm will shine again." Saying that "the news is horrific, the sentiment is black," Grant nevertheless reminds us that "the technology is as wonderful as it was at the top (more wonderful, in fact, as science doesn’t know about the bear market)".

He goes on to note that "the essential bullish case on Corning is that management is correct, that the broadband era has only just begun (less than 2% of the world’s population has access to broadband, the [company’s] annual says) and that Corning will emerge, as it submerged, as the dominant low-cost industry leader." (Alan Abelson, too, saw fit to mention Corning in a promising light in the latest issue of Barron’s.)

Yet Grant hastens to caution that he is a "bull-in- waiting," mindful of Corning’s deteriorating balance sheet and the possibility for a two-notch downgrade of its debt to "within one notch of junk."

So if the lights are starting to flicker back on at Corning, that’s ample reason to close out short positions. But it’s still too early, we think, to join a new bull run.

Stay tuned.

Eric Fry,
your eyes and ears on Wall Street…
May 01, 2002 — New York City, New York

P.S. Since Abelson warned Barron’s readers about our grim prognosis for Corning, the stock, which changed hands at $69.62 when our story ran, has collapsed to $6.67. But we think the lights will eventually come back on at GLW, so we suggested to Apogee readers on Friday that now seems like a fine time to close out short positions and take their 90% gains off the table.

Eric J. Fry, the Daily Reckoning’s "man-on-the-scene" in New York, is the editor of Apogee Research (formerly Grant’s Investor) – an online investment publication devoted to hedge funds and other professional investors. Mr. Fry was a professional portfolio manager for more than 10 years and authored the first comprehensive guide to American Depositary Receipts, International Investing with ADRs.

Gold dropped yesterday, by more than $2 an ounce. But gold stocks are still nearly 50% higher than they were at the beginning of the year.

The dollar and the Dow, meanwhile, are struggling. The Dow lost 4.5% in April. The dollar fell 3.6% last month against the euro.

Why is the dollar falling? Because, so far this year, the U.S. stock market is the worst performing market in the modern world. And because short-term interest rates in the U.S. are among the world’s lowest. And because the price of U.S. financial assets is high, while the quality is increasingly suspect.

Worldcom, for example, the nation’s second largest telecom company, is down this year. Its bonds trade at 50 cents on the dollar. Many people think the company won’t make it.

And while S&P stocks sell for more than 40 times earnings, only 8 major companies in America have AAA bond ratings, against 27 in ’90.

Who would want to buy the dollar or dollar-based assets under these conditions?

Deutsche Bank studied the dollar’s movements since it was loosed from gold and allowed to float freely in 1973. The currency has since enjoyed two bull markets, and suffered the same number of bear markets. It went down 7 years from ’73 to ’80…then up 5 years to ’85…then down 10 years till ’95…and has been going up for the last 7 years.

It has now gotten into "significantly over-valued territory," says the report, in which "financing an ever-widening U.S. external balance is not likely to be as easy as it was in recent years."

U.S. financial assets are falling into disfavor – for all the reasons you read about in the Daily Reckoning. "Downward pressure on the dollar appears to have already begun," says Deutsche Bank. If the trend follows the pattern of the last 30 years, the dollar will drop by 40% over the next 7-10 years.

Over to you, Eric…


Eric Fry in New York…

– Like the crazed Glenn Close springing from the bathtub in "Fatal Attraction," the stock market came screaming back to life yesterday.

– The Dow bolted 126 points higher yesterday to 9,946, while the Nasdaq leapt nearly 2% to 1,688. Maybe Abby Joseph Cohen was right after all. Maybe the shares of highly leveraged companies selling for 40 times earnings ARE a terrific investment, and maybe they DO deserve to trade 20% higher…to 50 times earnings.

– Then again, maybe the stock market is less like Glenn Close than it is like a chicken that has just lost its head to an axe. (I realize that gruesome barnyard spectacles, like the slaughtering of hogs and chickens, are part of Bill’s "beat", not mine. But even a city boy knows that a headless chicken’s scamper around a barnyard can look amazingly lifelike – except for the minor detail that it has no head.) Like a beheaded chicken, the stock market’s latest scamper seems more mindless than rational.

– But lest we forget, the action on Wall Street does not always reflect – at each and every moment – the economic trends on Main Street. Certainly corporate profits show little sign of rebounding as strongly as hoped.

– "A rebound in the U.S. economy has not been strong enough to lift corporate profits out of the current slump," observes Moody’s John Lonski. "Weak corporate earnings, thin profit margins, and low rates of capacity utilization continue to weaken corporate credit quality."

– Confirming Lonski’s dim prognosis, durable goods orders continue to sink. The rate of order growth fell by half from the fourth quarter of 2001 to the first quarter of 2002. The year-over-year numbers look even worse.

– "March’s 7.4% drop marks the 16th consecutive month of a year-to-year decline for durable goods orders," says Moody’s. An especially miserable performance from the high-tech sector has been weighing down the overall trend. Orders for high tech equipment skidded almost 20% in the first quarter. Is it therefore any wonder that profits have been slow to recover?

– Amidst the profit woes besetting many US corporations, however, many retailing companies remain unscathed, especially high-end retailing companies. Just last week, Williams Sonoma raised its earnings outlook for the year. Likewise, Tiffany’s bumped its earnings forecast for this fiscal year.

– "The strong recent performance of luxury-goods stocks – LVMH has doubled in price since its September low – shows that many investors anticipate a recovery," the New York Times reports. "But are they anticipating too much?"

– Maybe so. But one portfolio manager admits that he is unwilling to bet against the desire of shoppers to keep spending. He tells the Times, "People tend to underestimate how resilient consumers are. There seems to be no end to the pickup in appetite for these products."

– Or maybe the end simply hasn’t arrived yet.

– Ironically, consumer spending remains buoyant, even though spending on advertising has been falling for months. (Imagine how much more stuff companies could sell if they didn’t advertise at all!)

– "Hopes of an imminent recovery in the advertising market were dashed [last week] as chief executives of two of the world’s largest advertising companies warned there was no clear evidence of an upturn," the Financial Times reported recently.

– Michael Bungey, CEO of Cordiant Communications, complained, "Conditions are likely to remain difficult in 2002." The fact that so many companies are reining in their ad budgets suggests that very few CEOs are able to see the recovery that so many Wall Street analysts predict.

– Here’s a new take on the torrid housing market: Maybe housing is not in a "bubble" at all. Maybe housing is just one hard asset among many that is signaling a coming inflation. In a macroeconomic environment in which oil, gold, and numerous other commodities are rallying strongly and steadily – and in which long-term interest rates are climbing – and in which the U.S. dollar is beginning to weaken one, might deduce that a new inflationary cycle is underway.

– If the prices of other hard assets are climbing, why shouldn’t home prices rise as well? The median home price jumped 8.5% year-over-year for the three months ending in February – the steepest such advance since 1988. Maybe the soaring home prices are telling us that the CPI is about to start climbing a lot higher.

– As Moody’s observes: "The fastest rate of home price inflation in 14 years, as well as 2002-to-date’s price advances for industrial metals, oil, and gold, may be the precursors of a higher rate of poor CPI inflation."


Back in Baltimore…

*** Jean-Marie Le Pen has enraged the chattering classes all over the world. "France’s Shame" pounds the front cover of this week’s Economist. Hardly a newspaper or magazine in the entire world has missed the opportunity to compare Le Pen to Hitler.

*** Le Pen gave a rousing speech in which he used the phrase which I already quoted to you: "I am socially a leftist, economically a rightist, and politically I am French."

*** The phrase had a Hitlerian ring to it, which few journalists missed. For Hitler was fundamentally a leftist…a socialist…a little detail of history that the Left would rather forget. But Hitler rarely met a social program he didn’t like. He favored everything from controls on working conditions to banning tobacco to confiscating fire arms. What was the Holocaust, after all, but an ambitious, murderous social program?

*** But Le Pen set the world straight a day or two ago.

*** "It was not from Hitler that I got the idea for the phrase," he explained. "It was from Mr. Bloomberg, the mayor of New York. You can find it yourself, in this month’s Air France magazine, in which Mr. Bloomberg claims that he is ‘a democrat socially and a republican fiscally.’"

*** Le Pen’s anti-immigrant stance is also a hot subject in the U.S. "Any expression of displeasure with another group is punished," writes Fred Reed, who points out that he has gone on vacation and "temporarily can’t be screamed at." "We brainwash our children with an almost North Korean intensity to persuade them that groups should cuddle and value one another. And still it doesn’t work. Might it not be just a bad idea? What if we are wrong? What if different kinds of people just plain don’t want to live together?"

*** "Look, it may not make sense," said a friend at lunch yesterday, "but these terrorists incidents are not going away. Did you hear about the Arab guy they found in a container in Italy? He had a little apartment set up – and was using the container to smuggle himself into the U.S. A very expensive and sophisticated effort. And how about that woman in Arkansas. She was creating phony passports for Arabs. She was arrested. And the day before she was supposed to face questioning, she died in a mysterious auto fire. We don’t know what was going on – but something definitely was.

"Maybe only 0.5% of the world’s population is nuts. And maybe there’s always been 0.5% of the population that is nuts. But never before have they had the ability to cause so much destruction.

"You can go into the library and find out how to make bombs out of fertilizer and sugar…and how to do cyber- terrorism…and you can shut down the world’s biggest and most sophisticated economy.

"Something very important has happened…never before was terrorism a serious threat. We used to talk about bombing countries ‘back to the stone age.’ Well, now terrorists can virtually send us back to the stone age.

"A couple of Chinese generals actually wrote a book explaining how China could bring the U.S. to its knees using cyber-terrorism. The Chinese have millions of world’s cleverest computer whizzes. They could shut down the trains, the airlines, shipping, even the highways – just using cyber-terrorism. In a matter of hours, people would be without food or water…I mean, this is not some fantasy…is it a contingency plan of a major nation!"

*** "Bill, you said: Sartre and Simone [de Beauvoir] were walking the streets of Paris like rock stars," writes a friend who has lived in Paris for many year. "Well…not really."

*** Here at the Daily Reckoning, we get away with nothing.

*** "I remember…," he continues, "I live in a little apartment on a quiet street near the Odeon, the rue de Conde, you know it maybe…This street was taken regularly by Sartre. I would see him often in the gray Paris evening, arm in arm with Simone, wrapped up in gray coats, hats and scarves… proud like the petit bourgeois they were."

The Daily Reckoning