3D Systems: On The Road To Fair Value

Summary

• DDD is to face lower margins due to important patent expiration and stronger competition.
• Exposure to consumer market and questionable acquisitions have a potential to destroy shareholder value.
• Development of the balance sheet positions such as “goodwill” and “inventories” are the first warning signs.

As a private investor searching for the "next big thing," I started following the 3D printing industry some time ago with a hope of finding an investment opportunity for myself. The more I learn about the industry and its main players, the more I realize how dangerous the situation for private investors is getting. Stock prices of 3D printing companies are running ahead of the industry by many years.

One such stock is 3D Systems (DDD), and in this article, I would like to explain what considerations affected my originally bullish expectations and turned me into a bear.

Expiring patents and strong competition:

Some very important patents expired or will soon be expiring starting this year. For example, "selective laser sintering patents." The video provides a detailed explanation of what it means for 3D Systems.

Patent expiration and growing competition will most likely cause lower margins in one of the main profit sources for 3D Systems - industrial 3D printing. Margins from consumer 3D printing have a high chance of being affected even stronger with numerous competitors coming from Asia this year.

Consumer market exposure:

3D Printing is coming to the consumer market. That is a known fact, but its popularity is still a question mark from my point of view. In order to become profitable, consumer 3D printing has to offer more than an expensive way to print cute but mostly useless plastic forms. Moreover, 3D printing software is not easy to use and materials are expensive. 3D systems have new products in the pipeline for 2014, which they will have to market and sell. This can prove more challenging especially considering the following statement in the latest earnings call:

"Despite posting impressive year-over-year total revenue gains for the quarter, services and consumer performed below our expectations." (Source: Avi Reichental)

Acquisitions:

Acquisitions are a double-edged sword; on one hand, a company acquires know-how and technology, but on the other hand faces challenges of organizational integration. There are many examples of mergers and/or acquisitions, which have gone wrong. Here is some statistics to prove my statement:

A study by PricewaterhouseCoopers showed that fully 50 per cent of mergers and acquisitions in North America end up destroying shareholder value....

...According to PricewaterhouseCoopers, of the 50 per cent of mergers that don't destroy value, 33 per cent manage only to retain it. (Source:Mergers and acquisitions are fraught with peril)

Taking into account that 3D Systems acquired plenty of companies (all very different, within a short period of time), the chances are high that integration of those will prove more difficult and more expensive than anticipated. Not to mention that the expected synergies are yet to be achieved and monetized.

Questionable spending apart from acquisitions:

Making a pop star your company's Chief Creative Officer is an expensive and a bad marketing move, as proved by BlackBerry's stunt with Alicia Keys. 3D Systems is following that path with someone called "will.i.am." His deep understanding of 3D printing and its possibilities are astonishing to say the least… You can watch it here.

Taking these points into consideration let's try to look at the quantitative side of the bear equation.

Recent numbers already deliver the first warning signs:

Rising Inventory:

Rising inventory means that 3D Systems might be facing trouble selling some of its products. Taking into consideration that they are introducing new products in 2014 it is realistic to assume that they will have to write down the unsold inventory.

Rising Goodwill:
Goodwill is basically a premium that a company pays for the acquisition of another company over and above its book value. This means that 3D Systems have paid dearly for its acquisitions and that goodwill might be subject to impairment in the future.

Revenue Growth vs. OpEx growth:

In its earnings call, 3D Systems CEO states:

"Our 2013 revenue grew 45% to a record $513.4 million and gross profit margin expanded 90 basis points to 52.1%. Our total operating expenses increased 55% to $186.7 million from our increased investments in sales, marketing, infrastructure, talent and accelerated R&D expenditures."

(Source: historical earnings)

This statement basically says that DDD's costs are rising faster than its revenue. This is another indication of lower margins in the future.

Conclusion:

Normally each of these indicators alone could be disregarded but in combination they mean a high probability of a not so rosy future for 3D Systems, and by the way, we are talking about a company trading at a current P/E of 149.58 (at the time of writing). Not to mention that the market cap of roughly $ 7B which is roughly the same as the projected size of the entire 3D printing industry for the year 2018.

(Source: Rob Wile Sep. 17,2013)

In other words I see no way 3D Systems can meet the current sky-high expectations. As a result, I expect a continuing pullback of the stock price with a few recoveries in between. I am not setting any price target, because I think it is simply impossible for this stock, but I wouldn't be surprised if we see it trading in the $30-40 range during 2014.

By Dmitry Kovalchuk

Source:seekingalpha.com/article/2083633-3d-systems-on-the-road-to-fair-value