At the end of March, I wrote an article about 3D systems (DDD) where I valued the stock based on future free cash flows. According to my assumptions and the model, the fair value of the stock came out to be $47 - at the time 3D Systems was trading at around $30. The stock closed over $43 on Wednesday May 8, 2013. Taking into account the sharp upward movement of the stock; I may have to soon adjust my price target upwards. The 3D printing industry overall has been branded as hype only, but I beg to differ. If we look at the two biggest players in the sector (3D systems and Stratasys (SSYS)); their rise has been backed by solid revenue growth and earnings.
The 3D technology has slowly started to become an integral part of the manufacturing industry. Although the technology still has a long way to go, it has already made substantial changes in the production processes. The industry is still in its infancy and the boom will likely happen over the next decade. That is the reason I believe the rise in 3D systems and Stratasys' stock price is not hype, but reflects the future potential. Despite showing double digit growth, I do not believe these companies have hit the peak yet.
Share Issue: What Does this Mean for Existing Shareholders?
The company has been expanding aggressively through acquisitions. There are two ways to grow: acquisitions and developing new facilities and products - the first option is quicker and offers the company a chance to grab the growth opportunity in time. For a growing company, it is extremely important to have ample funds to exploit the growth opportunity. Debt, stock issue and cash flows from operations are the three most feasible options.
The company is going to issue new shares in order to fund future acquisitions. In a normal transaction of this kind, the current shareholders will face dilution, and might not like the idea. However, 3D Systems' shareholders have shown a completely different attitude. The stock is going up despite the share issue. There is another interesting fact to keep in mind regarding 3D Systems' capital structure. The company has been able to sell convertible debt, which means even debt investors of the company have confidence in the future prospects of the company.
A large chunk of these investors availed the option of converting their debt into equity, indicating they believe 3D Systems' stock is a better investment than holding its debt. The company had to report about $5.7 million in losses from these conversions, which brought its net income down. However, these charges are non-cash and there was no impact on the cash flows. I believe the management has a strong belief that over the next two to three years, the 3D printing industry can enter the boom stage and the company wants to be ready and well positioned to exploit this growth opportunity.
Moving onto the details of the transaction - the stock issue will be worth $250 million and it will be priced on Thursday May 9. In addition, 1.3 million shares will be sold by directors, affiliates and certain officers. The company, however, will not receive any proceeds from the selling stockholders. Total Share count for 3D Systems have increased recently due to the new stock issues and debt conversion. However, as long as the revenue growth continues, the shareholders do not need to worry about considerable dilution. It also shows that the company is confident about the future growth in EPS and an increased number of shares will not bring down EPS.
Total number of shares at the end of the quarter was 91.8 million, up from 76.3 million a year ago. However, the dilution in earnings did not happen due to the increase in number of shares. If we take out the non-cash expense of $5.7 million for convertible debt, the EPS for the quarter would have been between $0.11 and $0.12, considerably higher than $0.08 reported a year ago. If the organic growth of over 20% continues over the next year, the shareholders have nothing to worry about and the share issue will not cause dilution. However, if the revenue growth takes a hit, then we might see the double impact of increase in outstanding shares and a fall in earnings.
Acquisition of RPDG
The newest addition the 3D Systems portfolio is Rapid Product Development Group (RPDG), a company mainly focused on industrial segment of the 3D printing industry. The company has operations in the U.S., China, Mexico and the U.K., and mainly offers rapid prototyping, tooling and production. The company uses Stereolithography and selective laser sintering techniques among others.
RPDG will undoubtedly strengthen the industrial equipment segment of the company. There is no doubt that Stratasys currently has an upper hand in the industrial and medical segments and its portfolio is stronger than all of its competitors. On the other hand, 3D Systems' grip is weaker on the industrial segment and some investments like RPDG will further strengthen the position of the company.
The new stock offering will be priced after the close of the market on Thursday. It will be interesting to see how investors react to the news. Till now, the response about the stock offering has been positive from shareholders, and I believe the company will be able to get a good price for its stocks. It is the ideal time for the company to raise cash through equity as the stock is consistently moving up.