The companies operating in the 3D printing industry have experienced phenomenal rise over the past year. One company that has caught the eye of speculators as well as long-term investors is 3D Systems (DDD). 3D systems stock price has been extremely volatile, and it has rewarded smart investors and traders. Long-term investors of the company have also benefited due to the immense growth shown by the company over the past year. Despite strong growth and obvious potential in the industry; some investors still doubt the future growth potential of the company.
While I believe 3D systems will experience price volatility in the short-term, I remain confident that the long-term prospects of the company are bright. Here, I have developed a free cash flow model for the company. I have valued 3D systems on the basis of future free cash flow generation ability of the company. In the following paragraphs, I will explain the model and assumptions used in the model. Along with the assumptions, I will also provide pro-forma earnings and valuation models.
Model and Assumptions
I have tried to keep my assumptions in line with the expectations of the company. For future growth in revenues, I have used organic growth number that lies somewhere between the forecasted growth numbers for 2013. For the first five years (hyper growth period), I have used a 30% growth rate in revenues (3D systems expects organic growth rate to be between 24% and 37% during 2013). 3D systems is currently operating in slow growth segments of the 3D printing industry. However, as the industry experiences growth over the next decade, organic growth for 3D systems will increase. In that case, my assumptions might become conservative. For the following four years, I believe growth will slow down due to increased competition and low expansion opportunities. As a result, I have assumed a growth rate of 6% for the four years after the hyper growth period. Finally, I expect the company to grow at a constant rate of 3% after the first two stages of high-growth period.
On the expenses side, I have followed the same approach and assumed a declining growth rate in manufacturing expenses due to economies of scale and operational efficiencies. At the moment, 3D systems has a gross margin of around 51%, which I believe will go up during the hyper growth period, and then finally, it will settle around 60%. Furthermore, the tax rate at the moment is around 10% -- I have used a gradually increasing tax rate that will finally settle at 25%.
Pro-Forma earnings shown above have been calculated using the above mentioned assumptions. According to my calculations, 3D Systems should be able to maintain solid operating and net profit margins even after the hyper growth period.
For valuation, I have used a 17% discount rate, which I believe is appropriate for a high growth volatile stock. Discount rate is a unique component, which can differ for each investor. However, I feel a discount rate around 17% is warranted taking into account the volatility in the stock. Below table shows the calculation of free cash flows and fair value of the company.
For the free cash flow calculation, I have taken net income as the starting point. All of these net income figures represent projected net income based on above mentioned assumptions. To reach the free cash flows, I have made adjustments regarding, depreciation, amortization, interest expense and other non-cash items such as restructuring expenses/gains, gains/losses on equipment sale and taxes. Furthermore, investment in fixed and working capital has also been taken into account.
Free cash flows beyond 2022 have been projected at a constant growth rate of 3% and discounted at the discount rate of 17% (adjusted for growth rate) to calculate terminal year free cash flows. After calculating free cash flows for each year, I have discounted those free cash flows at 17% to reach at the present value, and added them to achieve $2.78 billion in discounted free cash flows. After calculating free cash flows, I deducted the total debt of the company to find the value for common stockholders. According to my free cash flow model, 3D Systems' stock should be trading at around $47 per share. At the moment, the stock is trading at around $30 per share.
My valuation model is based on long-term free cash flows generation ability of the company. There might be deviations in stock price in the short-term. However, in the long-term, I believe 3D systems' stock will appreciate in value substantially. The company is already working on initiatives to grow its business worldwide. Recently, 3D systems announced a new reseller agreement with Al-mera, a jewelry leader in Turkey. The company is aggressively trying to exploit different segments of the market. I like how 3D systems is diversifying geographically as well as in its product offering, which can offer substantial value to the company in the long-term.