Stocks like 3D systems Corporation (NYSE:DDD), The ExOne Company (NASDAQ:XONE) and Stratasys Limited (NASDAQ:SSYS) have been flying high until recently. However, concerns around 3D printing sector makes one wonder, if bullish investors are trying to build a new ship with an old wood? The issues are much deeper than a quarterly disappointment. Issues like disappearing barriers to entry, equity dilution via acquisitions, depleting cash reserves and questionable market opportunity for the sector can seriously arrest investor enthusiasm over coming quarters. Excitement over 3D printing sector is built around the potential to revolutionize manufacturing and growing adoption outside of niche markets, besides strong equity markets.
This excitement fueled by Hollywood inspired technology, backed by research papers, small but high in percentage sales growth figures and bull market in equities, is nothing new to the market. Displays, PC component, solar panels, flash memory and digital Integrated chips among others have seen similar trends. High sales volume projections bring in volumes of new low cost manufacturers with massive price pressure and low margins. The cycle finishes with the industry being taken over by low cost manufacturers in Asia. It might happen to 3D printing industry as well.
Snapshot of the technology
3D (Three Dimensional) printing is what some call "Additive" manufacturing process i.e. adding layers of raw material like plastic or metal to create 3 dimensional products. Extra raw material is removed, to give shape to the product, in traditional ('subtractive") manufacturing process.
3D printers are not much different from prototyping machines in use by many labs or highly specialized small batch manufacturers for decades, where a unit can be manufactured instead of multiple units at the same time. Yes, there are no economies of scale in this "Additive" manufacturing process.
Recent technological developments have opened gates for low-cost 3D printers with small footprint, resulting in strong initial interest from hobbyists and designers alike. The interest shown by global consumer electronics manufacturers to cater to this increased demand is equally strong. A significant number of such manufacturers globally are already making 3D printers, and more manufacturers (including out of China) are expected to join in. Some big corporations like GE (NYSE:GE) and Hewlett Packard (NYSE:HPQ) also have a strong patent portfolio in this field.
Historically, high cost of "Fabs" in industries like display manufacturing and PC component manufacturing made it difficult for new players to enter the market. That is not the case with 3D printing, making it easier for new players to enter the market and opening it up for low cost manufacturing out of Asia. There are some companies involved in "Bio Printing", applied in the healthcare industry. I'm not including those for discussion in this article.
Sector hitting a wall of Concerns
Following issues can be very detrimental to the profitable growth of 3D printing industry and the hype built around these stocks;
1. Patents are expiring: "laser sintering" patent expires in 2014 and 3D System Inc is supposed to be most exposed to "laser sintering" patent expiration effects. Expiration of this patent will allow competing manufacturers to use "laser sintering" technology to build high-resolution printers at lower cost enabling better-finished output of their printers. It seems that every time a major patent expires in the 3D printing industry, it gives rise to a new leader. Last major patent that expired was "Fused Deposition" which led to the rise of open source low cost 3D printers; "Makerbot" owned by SSYS became leader in the market for such printers. Some smart folks believe that it might happen to "laser deposition" technology as well.
2. Limits to Mass Adoption: Limitations in terms of usage of raw material are clearly evident from the current limit of single raw material "prints" at one time. Look around and you will be hard pressed to find anything made of a single type of plastic or metal. Even printing different colors on one "print" is a challenge. Size is another challenge, currently most popular consumer scale 3D printers can print only up to 6"cube size products.
3. Speed Limitations: Current generations of consumer focused 3D Printers are extremely slow. One Hollywood style 3D application, I can think of is "Mission Impossible" style masks being printed but these available 3D printers are no way near that fast. As per some reports, it takes almost 3 days (65-70 hours) to print/ build a single brick size object.
4. High Material Cost: Much has been said about cost of 3D printers declining fast but cost of raw material used for printing is still high, ranging from $50 to $500 per kilogram. Some rough estimates work out that with 1 kilogram of raw material, you might not be able to make more than 6 tennis balls. It'll be a while, before 3D printed products can even think of replacing products made in large batches. Even for hobby it comes with a hefty price tag.
5. Copyright Infringements: Since the 3D printer market is currently very small so little attention is being paid to the issue of royalty but once adoption increases there are bound to be issues around copyright over Computer Aided Design (CAD) models. An analogy can be used on a music system and music industry during the emerging phase. When music is just noise and free, it's the music system that is important but eventually the song owners (in this case the design owners) would want royalty thereby further taking out the cheap production argument.
6. Material strength and finish: Low cost 3D printers use layering technology so they have what some people call "laminate weakness", which means due to the bonding of layers, they are not as strong as traditional injection molding technology. Finishing is another issue, these low cost printers "print" very rough surfaces, especially compared to products manufactured using other technologies.
7. Health hazard: New Research paper from Illinois Institute of Technology talks about potential hazardous fumes emanating from printing indoors, which can seriously dent the home-hobby market. This market holds more potential from unit sale standpoint for lower price models.
Most concerns raised here are addressed as 'short-term" in nature by ardent fans of technology. In "Long-term" we might effectively be able to print a 3D printer, why would anyone buy it?
It is more important than ever to scrutinize each new technology development in the 3D printing industry since some investors have already lost money by investing in stocks like MSSD in the past, claiming to be significant players in 3D printing and there might be more coming.
I highly recommend taking a look at a 3D printer unit in operation before committing new investment in this sector, if haven't seen one yet.
Where is the Cash going?
Looking at Cash flow statements, some important metrics stand out.
Cash paid for acquisition in last 6 Qtrs.
Operating cash flow last year.
Cash on balance sheet Q2 2013.
- Out of these 3 stocks, 3D systems Corporation seem to have a special fancy for acquisitions. Acquisitions are not just dilutive but also highlight the weakness of patent portfolio in my view. Even after all these dilutive acquisitions, I doubt if there's any player in the industry, who can claim to have a complete patent solution to offer full suite of 3D printers covering different metals, plastic, colors and healthcare related printers.
- Weak cash position is a serious issue for XONE. After recently raising close to $90 million from public markets, The ExOne Company has just $65m left. It is losing close to $8m in operations yearly, But more importantly XONE is expected to spend another $50 million by the end of 2014 to improve/ expand its manufacturing facilities in Germany, further depleting its cash balance. XONE share sale lock up period has expired recently and pressure on stock is pretty visible after that.
- Equity dilutions: Even if investors are shying away from monetizing some of the stock gains, companies are certainly making good with their fund raising efforts. In last year and a half, DDD has raised more than $375 million and XONE has raised $90m from the public sale of its equity. SSYS has also received $ 30 million from exercise of stock options.
- DDD and SSYS are spending 5-10 times their operating cash flow on acquisitions, but it isn't affecting their organic revenue growth numbers by much.
Valuation is expensive but growth is not impressive
The current set of numbers for some 3D printing stocks characterizes them with miniscule revenues like startups, acquisitions like a mature industry and valuations like a proven high growth momentum sector. Valuations are stretched, to say the least, as per the figures in the chart below.
PE Exp. 2013 Nos.
PE Exp. 2014 Nos.
*ttm is trailing twelve months & source is yahoo finance.
Pricing and resultant margins are expected to come under pressure with expected high double-digit declines in prices for some lower end, high volume printers, in a year. Another reason to take a closer look at the margins is because the noise about services and raw material supplies being higher margins is hardly being reflected in numbers currently; they are no better than typical manufacturer producer margins of mid 30% level.
Usually, these high valuations are reserved for very high growth businesses in a ramp up mode but looking at organic growth rates (Q2 2013) below, these are hardly high growth rate revenue numbers.
Organic Yearly Rev growth %
XONE revenue growth rate is definitely high but it's important to note that it's coming off from low base of $4.7 million to $9.2m.
It's not just the quarterly numbers; issues with the sector are reaching a crescendo of worries. It would make perfect sense to en-cash some of the strong performance recently before these stocks have to prove themselves via 'trial by fire" of their own. Which they might be able to do only by producing high revenue growth, improvement of margins and generation of enough cash flows to ward off competition from big players. Out of which not all players might come unscathed.
These stocks could lose 30-40% of their value over the coming weeks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.