The "third industrial revolution" has come under some recent scrutiny, especially with the operations of one of its market leaders, 3D Systems (DDD). The company did not manage to continue its bullish trend of significantly beating analyst expectations as their latest quarterly results disappointed hopeful investors. Consequently, the share price of DDD has hit the low 30s (after the stock split) which were levels seen in late 2012, before the momentum run-up to all time highs. Rightfully so, investors have raised questions as to why such a revolutionary technology is posting underwhelming revenue growth figures. Such matters are coming in the midst of growing concerns over DDD's actual organic growth due to the history of the company's acquisitions. To add, the competition in the field has intensified with Stratasys (SSYS) and Proto Labs (PRLB) posting strong earnings results and ExOne (XONE) making noise as a new player in the 3D printing space with their recent IPO.
3D printing technology is utilized mostly by niche applications such as customized manufacturing, designing concept models and creating prototypes. However, in order for this technology to reach its hyped claim of being a "potential trillion dollar disruptive innovation," 3D printing must be employed in mass production and manufacturing. At present though, 3D printing isn't suited for bulk printing due to its high production costs and slow printing process. These roadblocks limit the technology from advancing beyond the realm of prototyping and small niche custom applications.
Economies of scale make traditional manufacturing faster and more economically friendly than the 3D printing method. A Deloitte study determined that printing a dinner plate would cost 30x more than buying one at Ikea. A printed wrench is 10x more than one at a hardware store, while being of inferior quality. The time 3D printers take to complete a job is also a constraint that limits the technology's use in mass production. The biggest 3D printers, mammoth stereolithograhy machines, can take up to a week to complete the biggest print jobs. DDD's very own ZPrinter 650 prints at approximately 1 vertical inch/hour. These restrictions of cost, time and size reveal just how far 3D printing is from making a revolutionary change in manufacturing. Obviously, to become more effective as a mass production process, 3D printing must cut down costs of material and its completion time.
Undoubtedly, as the technology develops, 3D printers will become cheaper, more reliable and capable of handling greater scales of production. However, the timing and extent of this development is speculative. Markets are currently pricing respective 3D companies ahead of their development curve, which is why recent scrutiny surrounding the unestablished market has surfaced.
Unfazed by the 3D printing limitations and scrutiny is the niche of bioprinting. Its exclusive market leader, Organovo (ONVO.PK), works with pharma industry and academia to develop biological 3D models that have the potential to accelerate the drug discovery process. Operating in an already established market of healthcare R&D, Organovo's ability to bridge the gap between traditional animal models and human trials adds value to unmet needs in the sector. This opportunity provides the company with a potential $500 million dollar market by 2018 in the form of 3D cell assays, as CEO Keith Murphy stated in a December 2012 company presentation. Organovo's NovoGen MMX bioprinter provides 3D living tissue models that imitate the human system better than the traditional 2D cell assays would. As a result, this would increase the return in pipeline development for pharmaceuticals. The company is revealing data for their 3D printed liver assay at the Experimental Biology Conference towards the end of April. This release will take the company a step closer to launching their first product by 2014.
Another potentially radical business model, however, can be through licensing the NovoGen MMX printer to help pharmas test the effectiveness of their drugs. If the printer is used to validate a drug into being commercialized, ONVO can receive back end rights such as royalties and milestone payments. By offering a platform that can be licensed, ONVO would be selling printers for additional future rewards while also developing their technology. As innovative academic institutions and industry researchers make use of the printer in their studies, recognition around the industry would broaden as Organovo contributes to the drug discovery process.
A comparable lucrative model is utilized by PDL BioPharma (PDLI), which pioneered the humanization of antibodies that enabled the discovery of a new generation of cancer treatments. PDL receives royalties (ranging from 1-3%) based on sales of launched antibody products by other companies such as Herceptin, Avastin and Lucentis. This licensing business model presents PDL with minimal costs of production and rewards that are high margined. In 2012, PDL had revenues of $374.5 Mill and operating expenses of $25.5 million, which accounts to 6.82% of revenue. Consequently, the company earned a net income of $211.7 million that equates to a whopping 56.5% profit margin. Such substantial profit margins provide tangible cash flows for management to raise shareholder value instead of using external funds to operate the business.
Another example of a biotech in drug discovery and development that capitalizes off its patented technology is Ligand Pharmaceuticals (LGND). The company's Captisol platform optimizes the solubility and stability of drugs and, in return, receives royalties from sales of developed drugs that utilized the technology. During 2012, LGND had a gross margin of 88.5% symbolizing a minimal expense towards the production of its product as majority of earnings came from royalties. As an alternative, expenses were distributed to R&D and employee salaries.
Conversely, a biotech like Dendreon (DNDN), which develops and commercializes its own drugs will be labeled with added risk as they incur large overhead costs of production. Provenge, their first commercialized product, offers a FDA approved treatment of prostate cancer at a cost of $93,000. This is a demanded product as 1 in 6 American men are diagnosed with prostate cancer during their lifetime. In 2012, the company posted impressive revenues of $325.4 million although only a gross margin of 30%. The steep cost to manufacture and advertise Provenge, however, was more than twice what the company earned in revenues, which resulted in a net loss of $393.6 million. This is a very inefficient business model that continues to lose income for shareholders of DNDN, who have yet to see tangible cash flows. Even though DNDN offers a sought after drug at a premium price, its overhead costs make the company economically inefficient.
With a similar high margin business model as PDL and LGND, Organovo bears minimal risk when licensing their NovoGen MMX platform to an industry lab or academic center conducting research on a potential drug. The revolutionary bioprinter offers the pharmaceutical industry an opportunity to potentially disrupt the standard by which new drugs are developed by providing better safety and efficacy solutions with its 3D functional human tissue. Preclinical models would be more accurately embodied by printed 3D human tissue rather than cells in a Petri dish or animal systems. The company has taken a step towards validating these 3D human tissues for the drug development process by partnering with ZenBio, a leading provider of advanced cell-based solutions and services. For its contributions to the discovery process, Organovo would receive future rewards, in royalty payments. This has already been established in the company's current partnership with United Therapeutics (UTHR).
If 3D human tissues can replace the traditional standards by which drugs are developed in preclinical trials, Organovo would be taking a cut out of every approved drug that the pharma industry or academia bring to the market. This lucrative model would provide ONVO with unbelievably high margin royalty stream and minimal costs of production. Instead of production costs, the company would be allocating its expenses towards R&D and employee salaries, both of which offer some sort of return to the business. Pharmaceutical Research and Manufacturers of America (PhRMA) estimates its members spent approximately $50 billion in 2011 in discovering and developing new medicines. It is evident that the largest pharmas are willing to spend billions to get a drug into the market. If ONVO can assist in increasing the success rate of approvals with its platform, royalties will be a trivial price that pharmas are prepared pay.
Organovo's long-term goal of being able to print full tissue organs on demand may be a farfetched goal, however the company is able to satisfy current unmet needs in the drug discovery process. This alone provides an opportunity for ONVO to set its mark in an already established market of pharmaceutical R&D. On the other hand, fellow 3D printing company DDD is being scrutinized for its inability to impact the mass manufacturing process due to the costs and time constraints faced. To add, common 3D printing technology is being limited to the unestablished market of prototyping and small niche applications. 3D printing's long-term ultimate goal of one day being a mass manufacturing force has been improperly promoted which has resulted in valuations that price respective companies ahead of their fundamentals. In a valuation sense, Organovo does not raise the same red flags, especially with their recent 6.6% price fall on March 13th due to the ending of exercisable warrant lock out period. Looking forward, the elimination of warrants decrease derivative liability from the balance sheet in exchange for capital. These moves act as part of a larger goal to pursue a senior listing into a more reputable exchange like the Nasdaq-CM. Although 3D printing companies have come under some fire recently, the bioprinting niche presents investors with a promising company that has the potential to alter a billion dollar drug testing market.
Disclosure: I am long ONVO.PK.