Clayton Christenson, Professor of Business Administration at Harvard Business School, is the father of the phrase "disruptive innovation." Disruptive innovation is "a process by which a product or service takes root initially in simple applications at the bottom of a market and then relentlessly moves up market, eventually displacing established competitors." In 2011, Christenson was dubbed the "most influential business thinker in the world" according to a poll of business executives, consultants and professors.
By Christenson's definition, innovation develops products or applications to meet the needs outside the "norm." This innovation is typically too expensive or too sophisticated or too complicated for the majority of consumers in the market. When a company takes the innovation and begins offering it to the masses, the innovation has the potential to become disruptive. An easily understood example is cellular phones. The technology was originally developed for situations where access to a person was needed on a 24X7 basis regardless of locale. What was once indication of a status of criticality or importance has primarily displaced land-line topography for personal telecommunications.
IPG Photonics (IPGP) considers itself a disruptive innovator. IPG develops and manufactures fiber lasers. Gas and crystal lasers are traditional offerings. Fiber lasers offer greater power, higher beam quality, better efficiency, and a smaller footprint at lower costs.
Lasers are used for marking, engraving, cutting, drilling and welding. Lasers are used to cut all shapes, from simple and complex, all sizes, from micro to macro, and all thicknesses, from thin to thick. Fiber lasers were initially used for precise, fine welding and fast cutting. Adoption has extended to numerous materials processing applications in the automotive, manufacturing, industrial, aerospace, and electronics industries. Opportunities continue to emerge in the telecom, medical, energy and advanced materials fields.
Laser sales peaked in 2008 but succumbed to the global economic downturn in 2009. In late 2010, the industry began experiencing some recovery. Of the $3.79 billion laser market in 2011, fiber lasers comprised 15.5% or $588 million of it. In 2015, the laser market is projected to grow to $4.78 billion while the fiber laser segment is projected to almost double to 28.6%.
IPG already claims first mover advantage is making fiber lasers commercially available. Through its proprietary process and high volume production, IPG has driven down the component cost. Fiber lasers consumes 70% less energy which further drives down the cost of operation. IPG even offers plug and play solutions. Such factors have contributed to a compounded annual growth rate (CAGR) in revenue from 2009 to 2012 of almost 45% for IPG.
By fiscal year-end 2012, IPG had revenues of $563 million and earnings per share (EPS) of $2.81. Its profit margin was a history high of 25.8%. IPG has only $18 million in debt and has a healthy cash position of $384 million. Even considering the rapid pace of and constant demand for innovation, IPG's research and development expenses capture less than 10% of its operating income.
Industry projections for the fiber laser market in 2015 are $1.37 billion. IPG is well positioned to capture a large share of that market. Specifically, high power fiber lasers only constitute 20% of the existing laser market. IPG believes adoption could grow to 50% to 75% of the market in just three to five years. In the fourth quarter of 2012, 48% of IPG revenue resulted from the sale of high power fiber lasers. During its fourth quarter earnings conference call, IPG noted an increase in quote activity for its fiber laser systems. New products such as UV fiber lasers, green lasers, ultra short pulse lasers and megawatt scale fiber lasers are also attracting new customers, new applications and new markets.
Competition does exist for IPG. Coherent (COHR), a traditional photonics supplier, introduced its first fiber laser in the fall of 2011. Jenoptik, a German optoelectronics producer, sells both thin-disk and fiber lasers. Thin-disk lasers offer scalable power and beam quality. Many in the industry argue there is a reasonable place for both. Trumpf, a fabricating equipment and industrial laser manufacturer, even produces hybrid lasers meshing both fiber and thin-disk. But IPG believes its ten-year head start with fiber lasers has created a fairly significant moat for its competitors.
IPG is recently trading within 10% of its 52-week high. The long-term growth estimate for EPS is 22%, resulting in a YPEG calculation of $81.50. That number offers at least 25% upside compared to recent share price. Even using a more conservative estimate of 17% growth for both revenue and EPS, IPG share price should easily surpass its historical high of $78.59 before 2015.
Considering market penetration of fiber lasers in the total laser market is estimated to be less than 30% at that point, there's still room for innovation and disruption. If there's still room for innovation and disruption, there's still room for IPG Photonics' to grow.
Additional disclosure: I belong to an investment club that owns shares in IPGP.