3D Printing Is About To Enter A Cool-Down Phase
My underlying investment philosophy involves finding disconnects between underlying reality and the investment sentiment which, at times, represents it. I have written about it in the past, in my introduction to SA readers, including to go so far as to mention what I am going to make the focus of this week's article - 3D printing, its foreseeable future, and how understanding the modern sentiment cycle towards emergent technology can yield long-term wealth for patient, prudent investors.
At this time, 3D Systems Inc (DDD) is undergoing a "blowoff" movement, the final move in a long term trend before a cyclical reversal and downside prices. We recently saw sentiment in Apple stock (and the reason I am technically bearish on their stock (Earnings Smash has occurred since I drafted this article)) reach exuberant highs before reversing and catching ever-onward long investors in a hard-hitting blindside that has shaved almost 32% off of the invested principal of the many who were piling into the peak. I believe such a story is playing out for long holders in DDD and other 3D printing stocks right now, where we will see a huge shake-up followed by the opposite sort of price/fundamental disconnect - similar to the story that has been playing out with our excellent graphite gains of late.
We are seeing similar action in both expectations and sentiment for 3D Systems and other 3D printing stocks. A huge disconnect between real, underlying fundamentals, and the buying and selling activity of shares which are supposed to represent this underlying fundamental foundation. I am going to focus on 3D Systems today, and make the case for why long shareholders should really think about selling their tremendous gains, and traders can begin getting set up for a short-sell opportunity.
3D Printing And Its Long Term Potential
3D Printing, which is something I've been watching for a few years now (I am a tech geek at heart, after all), really took off in 2012. News mentions skyrocketed this year:
People, and investors, got really interested in 3D printing - 2012 was the "hype" year for 3D printing, and we saw share prices of companies involved in the field outperform the market staggeringly. There is a good reason for it - 3D printing is absolutely amazing.
For those of you who aren't very familiar, the more technical term for it is "additive manufacturing". 3D printers work by taking a digital blueprint or CAD document and "printing" it out, layer by 3D layer. The current range of materials is fairly limited, especially for consumer model 3D printers, but it is ever-expanding, and new methods for introducing materials are being devised all the time. The most versatile 3D printers on the consumer market thus far are models made by Stratasys (formerly Objet).
I highly encourage you to watch Stratasys' presentation on their 117-material 3D printer, and see what kind of amazing things this machine is capable of. The video can be found here. The scale on which 3D printers can actually work continues to grow smaller and smaller, increasing their application in a host of value-added and highly specialized industries.
Here are a few of the most amazing things that 3D printers have done in the last couple of years:
-Printing off support devices for people with disabilities, for up to 90% off the cost of comparable technology using traditional methods of manufacturing. (this is a beautiful story, in and of itself, and demonstrates how wonderfully the market provides for people when it is unhindered)
Those are just a fraction of the incredible and new things that 3D printing has enabled and accomplished in the past few years. It truly is an amazing story, and I think we are just at the tip of the iceberg in terms of long term accomplishment. You could say that I'm "uber-bullish" on the very long term prospects for 3D printing and the kind of prosperity it can create for humankind. This is about the most efficient voluntary resource allocation potential on the planet, where scarce goods are concerned, and the market and its relentless quest towards the most desired resource allocation (when unfettered) will make 3D printing a reality for millions more people in the years and decades to come.
However, there are some major landmines on the road to progress, and human optimism has a tendency to outrun reality.
Since the advent of copyright, it has seems that virtually any industry that attracts the love of its customers begins to go into civil-war mode. Gone are the days of simply out-competing a rival for your customer, replaced by the days of lawsuits and attempts at crippling within a massive web of patent and copyright laws. It is estimated that just copyright and patent trolling have cost society over $500 billion since 1990. This is not accounting for stifled innovation and hampered production, all of the could-have-been opportunity costs and artificial barriers to entry that patents and copyright impose.
Luckily, business seems to be progressing faster than the patents. The real issue is going to be on the design/software side of 3D Printing. We are already seeing patents on 3D Printing DRM by one of the worst patent troll of modern history.
This could create a bit of a tricky area for consumers who don't have the design skills to make their own products, but don't want to download a design for fear of getting charged with copyright violations. After all, in the modern era, governments are attempting to impose laws that jail you longer for illegally downloading music than for manslaughter. Consumers, who are estimated to be the major new market for 3D Printing in years to come, might be deterred in their purchases if individuals are being jailed for downloading infinitely-replicable, non-scarce goods to use in their 3D Printers.
Furthermore, there is not just risk of design-side litigation gumming up the industry and dragging innovation to a standstill, but the true Sword of Damocles to the ultimate disruptive, wealth-generating technology of 3D printing is, in fact, the laundry list of major established industries that stand to lose enormous revenue streams if this marvelous technology is ever to become a household mainstay. You can expect armies of lawyers across thousands of industries to be licking their chops at the idea of suing 3D printer manufacturers for enabling the "theft" of non-scarce, artificially-denominated goods that their machines use.
Hype is Vastly Outpacing Sales
Sales have been booming on the consumer end, even while more and more businesses are integrating 3D printing into their existing business models. However, sales are still a tiny sliver of actual consume market penetration, with 15,000 home 3D printers sold in 2011, and 60,000 sold in 2012. 3D Printing is very emergent stuff that the market is currently pricing for immense and immediate growth, and with hardly a hiccup.
This is where we come back to the classic Gartner Hype Cycle, where expectations outstrip reality, come crashing down to a level of pessimism, and the fundamental situation continues to improve and roadblocks are overcome. Total 3D Printer sales for the entire consumer market are expecting to be around $1.3 billion for 2012. When stacked up against the market cap of 3D Systems, just one market participant in a market with ever increasing competition, at $3.61 billion, we need to see many more years of amazing growth to justify current prices.
A Completely Different Business Model
3D Printing, for all of its amazing accomplishments, still has serious roadblocks to overcome. For one, its cost-savings effectiveness is actually measured in the exact opposite way that the cost-effectiveness of traditional manufacturing is measured. Namely - traditional manufacturing makes sense when products are fairly simple, because economies of scale work in these types of environments.
In 3D printing terms, the actual cost to produce something is measured in how much "ink" or medium is used. In traditional manufacturing, the total cost is affected by the number of value-adding inputs are required to make a finished product. The two are completely opposite.
The general principle is that, the more internally complex something is, the more "white space" there will actually be, thus requiring the printer to use less "ink" than would be required in the same number of printer head passes to make a more "simple" object that will have less "white space". Think the difference between injection-molding a plastic handle for a vacuum cleaner, versus designing that handle to be an aesthetically pleasing complex lace of plastic. More material would actually be used for the plain handle, making it more expensive to print with a 3D printer. However, to traditionally manufacture a complex lacework design in plastic requires far higher input costs in terms of molds and fabrication.
In order for 3D Printing to become effective for consumers to use en masse, we will need to see two things happen. Costs of the actual materials that 3D printers use must come down much further to justify in-home manufacturing of goods, and designers and engineers will have to re-think the way they put products together to make in-home fabrication more plausible than mass production.
I believe both of these things will happen, but the market is currently pricing itself way ahead of the development curve, as we have seen time and again with emergent tech, and we are likely to see a slow-down period very soon where price action will come back in line with fundamentals.
Sort of PC-ish, But Not Really
Personal computers were responsible for ushering in the digital age, moving many scarce goods into the non-scarce realm and freeing up hundreds of billions of dollars of resources over the past few decades. 3D printers will likely have a similar revolutionizing effect. Just as software has continued to come down in price over time, mostly due to more and more closed systems accommodating themselves to open, free/low-cost software that is instantly and infinitely-replicable, we will continue to see the cost of the raw materials that 3D printers require continue to fall.
That being said, running a 3D printer is still a very expensive proposition right now. This is an ongoing cost barrier that will keep adoption rates far lower than that of PC's, because 3D printing must still rely on the ongoing input of various scarce goods. The price-demand curve of materials will take longer to reach a level of broad market penetration, simply because the units themselves must continue to go down in price along-side their usable materials. Since we have growth dependent upon two simultaneous systems of production that are both scarce (the printers themselves and their technology, and the ongoing use of materials required by these printers), adoption of 3D printers will occur at a much slower pace than PCs and their progeny, which are scarce objects using non-scarce digital goods.
Many pundits within the 3D printing sphere have been calling for PC-like adoption and growth rates. This will not be the case until more of a technology plateau is reached in terms of what a typical machine can do, and until the cost of ongoing inputs comes down to a level that justifies consumer-use on a mass scale. We are still many years away from this.
DDD - A Very Expensive Stock
3D Systems is a component of the S&P 600 Small Cap Index. Since being added to the index on April 11, 2012, when its market cap was at $1.34 billion, it has skyrocketed up to top-ten market cap on the index. The average market cap of an S&P 600 Small Cap component is $923 million, putting 3D System's current $4 billion market cap over 400% greater than an average component.
DDD is currently trading at an extremely rich P/E of 100, with a forward P/E of 43.73 as of Dec 31, 2012 - Today's forward P/E sits well over 50. This means that shareholders purchasing this stock are betting that revenue to will continue to grow at its blistering pace, and a perfectly happy that it will take almost 3 years of current revenue growth at these share price levels to bring its P/E below 20.00 and into "conservative" territory.
On a historical basis, DDD has never been close to as expensive as it is now:
They have also increased their debt levels in-line with the increases in their revenue, which means they have to ensure they don't fall into the trap of increasing debt and debt service costs, and diminishing returns on R&D and Innovation. The next year or two will be very telling, but current share prices are reflecting an exuberance that does not bode historically well for longs.
3-D Systems is exhibiting classic patterns of a blow-off peak right now. These types of moves are very difficult to pin down, because they tend to be exhaustive - volume has spiked dramatically along with the exponential nature of the rise, and internals are just starting to show signs of cracking. We could still see another $10-$20 move up from here, but we are beginning to look exhaustive with this monthly and weekly gap. The next few days will tell us if this is a classic Island Reversal pattern on a gap lower into next week.
DDD has broken out of the constraints of all upper trend line and channel lines, and is now engaged in what is known as a "throw-over", the final move of a long term trend before a swift reversal back within the confines of its historical price action.
Internal measures of buying and selling momentum are waning off, indicating that this move, when it does reverse, will do so swiftly and take many long investors by surprise. Initial target range is at previous support of $32.35 and resistance of $29.35, with greater bearish potential from there. Traders may target a short, upon confirmation of a reversal with an island-gap early next week, to this range.
While I am a huge fan of the technology of 3D printing and its potential to raise human living standards drastically, I cannot let that get in the way of the reality of the situation - 3D printing still has huge leaps and bounds to go before it can fundamentally justify the exuberance and high prices we are seeing in 3D printing stocks today. The disconnect between fundamental realities and asset prices will narrow, as it always does, and we will likely see some great buying opportunities within this sphere over the next 12-24 months.
If there is going to be a catalyst that will bring 3D printers closer to a PC-like potential adoption rate, it will likely happen when these stocks fall out of favor and have to crank up the innovation to please shareholders and keep customers coming. I will keep my eye on this market closely, and will do a follow-up when I am going to initiate some long-term long positions within the 3D printing industry.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in DDD over the next 72 hours.
Additional disclosure: Upon either a weekly island reversal gap, or an outside daily reversal bar, I will initiate a short position - this may be further than 72 hours out, but it is not far.