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The difference between a great company with a growth and a great growth stock must be understood to determine investing in 3D Systems (NYSE:DDD). Yesterday, we discussed DDD in our daily recap article after they received an upgrade. Right now, what we see is a very compelling business with a stock that has gotten ahead of itself. Moving forward, the key to 3D Systems to us is that the company is able to get into the consumer market as well as continue to expand their corporate partners. Right now, we believe that 3D Systems is overvalued for their potential growth over the next several years and that areas of growth offer lower margins as well are purely speculative in their success. Yet, we believe that two catalysts (consumer printing and industry consolidation), if they play out more quickly, could provide potential upside even from today's prices.

The first major place of growth for 3D Systems is with the everyday consumer. Currently, the company does the majority of their business with advanced manufacturing companies and healthcare solutions. The future of 3D printing, though, will also expand into the consumer. Currently, 3D Systems offers the Cube to consumers. Starting at $1299, the printer is quite expensive and available in a limited number of retailers. Right now, the company is working with Staples to sell the product, but as of Q2's earnings call, it was only in select stores. The price point, further, is a concern for us. What can one do with the Cube?

The company's slogan is "Creativity reimagined" for the Cube. Right now, the majority of what consumers can do is create simple objects like toys, small home goods (hangers, napkin rings, pencil holders), jewelry, and more. Additionally, products can be no larger than 5.5" x 5.5" x 5.5". For now, clients get 25 free 3D files to print. On top of the $1299 price tag, though, materials are expensive as well as files for printing are not free past 25. How much are materials? A single cartridge costs $49. How much can you print with a cartridge? The company markets that you can make 30+ simple, small models and/or 13-15 cell phone cases. At current prices, we cannot see the consumer being completely satisfied with the limitations of designs and uses along with the cost.

Moving forward, the company has to be able to bring this price level down as well as expand the amount of offerings that the printer can do. Advanced manufacturers are able to make more intricate parts, automotive solutions, prosthetics, dental models, prototypes, and even tools. The advanced technologies and materials of the higher end printers allows for a larger array of potential printing solutions. If people could quickly print screws, nails, office supplies, kitchen tools, and much more, these products would appeal to a wider audience. The problem is bringing down the cost and increasing the offerings.

From Fortune:

The emergence of sub-$1,000 printers -- and even sub-$500 printers -- aimed at the consumer market has placed 3-D printing within the grasp of just about anyone. The problem, Gasman says, is that the lower-end printers aren't very good. "There's beginning to be a low end to it, something like a $400 printer," Gasman says. "And one concern we have for this space, and it's shared across the industry, if you set the expectation high for what these things can do and someone buys one for $350 and finds that it's next to useless, that will put them off the whole concept." You can do amazing things with a printer that costs about two-and-a-half-grand, Gasman says -- a relatively inexpensive machine as far as 3-D printers go, but the kind of expense that warrants a discussion in most households. And will consumers want a $350 machine dedicated to making trinkets? Until quality comes downhill along with cost, widespread adoption by consumers could be muted.

What is 3D Systems doing to battle this issue?

They see the opportunity and are expanding their R&D, and we are confident that they will be able to get this problem solved. They have led the way for sub-$10,000 printers that can do very high-tech things, but consumers in high volumes cannot afford a $100 printer to print off trinkets and accessories.

Further, what does the lower-end printers do to margins. Paul Coster, analyst at JPMorgan, asked a great question of the company in the last earnings call, noting that the company was seeing a decline in growth on materials as well as lower-priced systems becoming more popular. He questioned the margin mix. In response, Damon Gregoire, Senior VP and CFO, commented:

What we do on the consumer side which you're absolutely correct, those are not heavily utilized machines, but given the mix of what has been placed over the last few quarters and how long it takes customers to install it, the lag in installing and fully deploying those into manufacturing projects that's what gives us the confidence.

So, the company does realize that they will see less materials bought on this end as well as the margins for them will likely be lower as the printers also have to be priced more cheaply. That issue is a big one we see for DDD that we do not believe is resolved at this time. For that reason, we believe a more cautious approach to growth should be used. The potential, though, is tremendous. A safe and inexpensive printer can be very popular, but the margin mix and ability to get to that level are still question marks.

Another major development over the next several years should be a consolidation of the industry. 3D Systems and main competitor, Stratasys (NASDAQ:SSYS), have been on the acquisition binge. DDD has bought over fifteen companies since 2011, and that trend does not seem likely to stop. The company can easily purchase small outfits to improve certain devices, and this route could answer the consumer issue. Overall, though, the shrinkage of the industry is a big benefit for DDD and SSYS. As fewer players are in the market and the company horizontally integrates, these companies can lock out third parties, raise prices, and increase margins. Further, as the company does this, they increase their barriers to entry. Creating 3D printing technology and having smart teams of some twenty companies acquired over the past three years can create a lot of advantages.

This macro-trend in 3D systems leads to some of the pricing that we are seeing for the companies, but at the same time, the trend is still going to take some years to play out. Additionally, we worry about other non-3D companies getting involved at some point. It would make sense for companies like Lexmark (NYSE:LXK) and Hewlett-Packard (NYSE:HPQ) to get involved. They won't be interested in DDD and SSYS at these levels, so they will likely attack at the private level. Moves like this would be tougher for DDD and SSYS due to the brand name recognition and channels that LXK and HPQ already operate.

At current pricing, we believe it's time to "wait and see." Using a 25-30% expectation for growth per year in current trends, we come up with a $36 level for the company. In order to see the current levels that DDD is priced at, the company would have to see operating income grow to over $400M by 2017, which is how much they currently make in revenue. The only way that level is achievable is that the company sees a growth in margins through consolidation of the market, increased material demand, and good consumer demand to increase volumes. To see even more upside than current prices, we are looking at some very lofty five-year goals. With a price/sales sitting at 12.5 and future P/E at 40+, this growth stock has fully priced in a lot of its growth and then some. Yet, if DDD can release a 3D printer that can attract a very strong consumer client base and can see more consolidation of the market, $55 could be cheap. For now, we are not willing to speculate about execution and would rather price again when more information is available.

Price Target Analysis

Step 1.

Project operating income, taxes, depreciation, capex, and working capital for five years. Calculate cash flow available by taking operating income - taxes + depreciation - capital expenditures - working capital.

2013 Projections

2014 Projections

2015 Projections

2016 Projections

2017 Projections

Operating Income

85

108

140

175

225

Taxes

0

27

35

44

56

Depreciation

42

44

45

47

50

Capital Expendit.

-7

-10

-15

-20

-25

Working Capital

21

21

21

21

21

Available Cash Flow

99

94

114

137

173

Step 2.

Calculate present value of available cash flow (PV factor of WACC * available cash flow). You can calculate WACC, but we have given this number to you. The PV factor of WACC is calculated by taking 1 / [(1 + WACC)^# of FY years away from current]. For example, 2016 would be 1 / [(1 + WACC)^4 (2016-2012). WACC for PCLN: 10.0%

2013

2014

2015

2016

2017

PV Factor of WACC

0.9091

0.8264

0.7513

0.6830

*

PV of Available Cash Flow

90

78

86

94

*

Step 3.

For the fifth year, we calculate a residual calculation. Taking the fifth year available cash flow and dividing by the cap rate, which is calculated by WACC subtracting out residual growth rate, calculate this number. Companies with high levels of growth have higher residual growth, while companies with lower growth levels have lower residual growth. Cap Rate for PCLN: 4.0%

2017

Available Cash Flow

173

Divided by Cap Rate

4.0%

Residual Value

4319

Multiply by 20167PV Factor

0.6830

PV of Residual Value

2950

Step 4.

Calculate Equity Value - add PV of residual value, available cash flow PVs, current cash, and subtract debt:

Sum of Available Cash Flows

347

PV of Residual Value

2950

Cash/Cash Equivalents

349

Interest Bearing Debt

25

Equity Value

3621

Step 5.

Divide equity value by shares outstanding:

Equity Value

3621

Shares Outstanding

101.61

Price Target

$36

Source: 3D Systems Has Promise But Valuations Are Too High For Current Issues/Catalysts