3D Systems (DDD) along with Stratasys (SSYS) are the two biggest players in an emerging industry called 3D printing. 3D printing is essentially a technology that allows the creation of a prototype or a copied object through a 3D printer. 3D printer are machines that work in a similar fashion to inkjet document printers.
(click to enlarge)(Image from www.3d-model.ch)
What you see above is 3D System's personal 3D printer which is called "Cube". In contrast to Stratasys, which is focusing on becoming the go-to shop for the high end, professional 3D printing and consumables, 3D Systems has taken a different approach.
Along with offering a wide variety of solutions for professionals, 3D Systems is trying to become also the dominant player in consumer 3D printing. Through internal research & development and numerous acquisitions, 3D Systems is trying to create a 3D printer affordable and simple enough for everyday home use.
And it has chosen two ways to earn additional & recurring revenue from the printers it sells. The first way is through proprietary cartridges that its printers use and which customers can get only from 3D Systems. The second way is through the creation of an online store where designers sell to consumers digital 3D designs for them to use. Furthermore consumers can have finished objects printed and delivered to them through "cloud printing". 3D Systems gets a fee for every transaction that happens in its store.
However, 3D Systems made a mistake that may prove to be fatal for its 3D printer sales if it is not corrected soon enough. It charges more for its consumables than its competitors which may result in less sales as budget-conscious consumers may choose some other OEM's printer due to lower consumables cost.
3D Systems' main competitor in the consumer market is a company called MakerBot. Makerbot offers a competitive consumer product that despite being more expensive than 3D Systems' Cube has some other advantages that make it quite popular.
MakerBot isn't using expensive proprietary cartridges but consumables that work with a very wide variety of printers. Furthermore, in contrast to 3D Systems's design store, MakerBot has developed a user community, the "Thingiverse", where people can upload or download 3D designs for free.
(Image from MarketBot.com)
As 3D printing technology evolves, I expect this industry to develop a similar structure and economics with the current paper printing industry. Prices for retail 3D printers will continue to fall and OEM profits will increasingly depend on consumables instead of printer sales.
3D Systems is well positioned to benefit from this trend through its proprietary cartridges although it will have to reduce its prices if it wants to stay competitive on the long run.
Trying to see ahead in the 3D printing consumer market is a high risk proposition because of too many moving parts. Having said that, I believe that if 3D Systems brings down the prices of its consumables has a good chance to lead this exploding market.
For us investors though, this just part of the story. There are some things about 3D Systems that should make investors cautious about buying its stock for the long-term.
3D Systems has seen erratic behaviour concerning its shares. It has done two stock splits, a two-for-one in 2011 and a three-for-two in 2013. Since stock splits don't offer any value to shareholders there is an issue about the company's true motives for doing them. Furthermore the company has diluted shareholders by approximately 28% since the end of 2010.
Moreover, the company is a serial acquirer with dozens of acquisitions over the past four years. This is a warning sign that the company may have trouble growing organically. Furthermore, it raises concerns about value destruction since serial acquirers tend to overpay for acquisition. This is especially true for hot, technology markets.
As investors willing to buy 3D Systems stock we should account for a huge margin of safety to compensate for the above red flags and the chance that something goes awry with the company's growth prospects.
Unfortunately, its current valuation of 36 times its 2012 free cash flow and 45 times its 2012 earnings per share is forbidding because it implies a 30% average EPS growth rate over the next decade. Even if 3D Systems achieves that kind of growth the risks involved (dilution, overpaid acquisitions) are too big to consider this a fair price.
I will keep this stock on my watchlist but I'm not touching it above 20 times its current earnings per share.