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Corning's biggest bet yet? Diesel-filter technologies

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Corning Inc. (NYSE: GLW) has survived for 157 years by betting big on new technologies, from ruby-colored railroad signals to fiber-optic cable to flat-panel TVs. And now the glass and ceramics manufacturer is making its biggest research bet ever.

Under pressure to find its next hit, the company has spent half a billion dollars -- its biggest wager yet -- that tougher regulations in the United States, Europe and Japan will boost demand for its emissions filters for diesel cars and trucks.

"This is the biggest cash hole we've ever been in," says Corning President Peter Volanakis.

Corning reached a milestone in January as its $370 million factory for truck filters reached full capacity. The company has made filters for gasoline engines since the United States' Clean Air Act of 1973. Believing that diesel filters, which are more profitable, would eventually be required in many countries, Corning in 2002 broke ground on the truck-filter factory in Erwin, N.Y.

The company was slower to develop filters for diesel cars and had no product ready to sell when demand arose suddenly in 2003. It had less than a year to work out design and production kinks. At one point, the filters were shattering in the kiln because they were too wet for firing. To solve that, Corning managers redeployed assembly-line workers to shuttle the cylinders from dryer to dryer and then to the kiln, often to the strains of heavy-metal music. "We called it 'Win Ugly,'" says Jim Nagel, chief technologist for the environmental-technologies division.

Corning, which went public in 1945 and has a market capitalization of about $36 billion, has survived -- and often thrived -- in recent decades by following a playbook that Wall Street and corporate America deems outmoded. While companies like Xerox Corp. (NYSE: XRX) scaled back long-term research, Corning stuck with the old formula, preferring to develop novel technologies than buy them from startups.

An investment 25 years ago has turned Corning into the world's largest maker of liquid-crystal-display glass used in flat-panel TVs and computers. But another wager, which made it the biggest producer of optical fiber during the 1990s, almost sank the company when the tech boom turned into a bust.

In Erwin, a few miles from the company's headquarters in Corning, the glassmaker is spending $300 million to expand its research labs. There, some 1,700 scientists work on hundreds of speculative projects, from next-generation lasers to optical sensors that could speed the discovery of drugs.

"Culturally, they're not afraid to invest and lose money for many years," says UBS analyst Nikos Theodosopoulos. "That style is not American any more."

Corning also goes against the grain in manufacturing. While it has joined the pack in moving most of its production overseas, it eschews outsourcing and continues to own and operate the 50 factories that churn out thousands of its different products.

Corning argues that retaining control of research and manufacturing is both a competitive advantage and a form of risk management. Its strategy is to keep an array of products in the pipeline and, once a market develops, to build factories to quickly produce in volumes that keep rivals from gaining traction.

But because Corning often depends heavily on a single product line for most of its profit -- 92 percent of last year's $2.2 billion profit came from its flat-panel-display business -- it is vulnerable to downturns. Even small movements in consumer demand for or pricing of its LCD-based products can cause gyrations in its stock price. During the dot-com meltdown when the market for fiber-optic cable crashed, Corning was brought to the brink of bankruptcy and by 2003 was forced to lay off half of its workers. Today it has 25,000 employees.

Corning's roots go back to 1851, when Amory Houghton, a 38-year-old merchant, bought a stake in a small glass company, Cate & Phillips. For most of Corning's history, a Houghton was either chairman or chief executive. Even today, Corning, population 12,000, is very much a company town. The original Houghton family mansion, still used for company meetings, overlooks the quaint downtown, which is punctuated by a white tower from one of Corning's original glass factories. Most senior managers have spent their entire careers at Corning.

When Corning broke ground on its truck-filter factory at the height of the dot-com crash, it guessed correctly that it would have a few years to ramp up production before the U.S. tightened pollution rules for trucks. A different drama was brewing with filters for diesel cars. European auto makers had begun installing Japanese-made filters for "green" consumers, even though they weren't required by law, and designing engines around those filters. They were made from silicon carbide, a competitor to Corning's preferred material, aluminum titanate.

Corning, which wasn't yet mass-producing aluminum-titanate filters, thought it would be locked out of the market. Then, in 2004 it got a lifeline: A worldwide shortage of silicon carbide prompted Japanese filter makers to raise prices, causing European auto makers to balk. Volkswagen AG agreed to try the new material, a heat-resistant version of a material designed for airplane-starter turbines, if Corning could mass-produce the filters within a year. Corning spent $100 million to expand a plant in Erwin.

Its engineers, meanwhile, developed a process -- as part of the $30 million Corning had spent on developing the filters -- to force a ceramic paste through metal dies, creating a honeycomb whose walls were dense enough to trap soot passing through and resilient enough to withstand the heat when the engine later burned off the soot.

Within 10 months of nearly walking away from the business, Corning was mass-producing car filters. Last year, the diesel group sold $249 million of filters, up from $164 million in 2006 but less than it had hoped. Big customers include Hyundai Motor Co. (PNK: HYMLF) and Kia Motors Corp. for cars and Cummins Inc. (NYSE: CMI) for trucks. The market is expanding fast, with the United States last year tightening regulations on diesel trucks and tougher rules coming next year for light-duty vehicles in Europe and Japan.

Corning says it already leads the market for diesel filters for heavy-duty vehicles but won't disclose sales or market share. Other major diesel-filter makers include Japanese firms NGK Insulators Ltd. and Ibiden Co.

"Corning's investment is paying off," says Jeff Evenson, an analyst at Sanford C. Bernstein & Co. "We believe that Corning already leads the heavy-duty segment, but customer skepticism of their new material is likely to make share gains gradual in light-duty."

About half of European vehicles are diesel, largely because European governments subsidize diesel fuel. Globally, sales of diesel vehicles will rise as countries increase efforts to cut tailpipe emissions and improve fuel economy.

Corning predicts world-wide demand for diesel filters will reach $2 billion by 2011. The company says it will consider the bet a success when it is the global market leader.

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