I believe that 3D printing may be one of the most lucrative investment opportunities in the technology sector. You might not believe this - but prior to writing this article, I began my research on 3D Systems (DDD) with the expectation of wanting to short the stock. In other words, I really wanted to ride this pony downhill. The problem, however, is that my short-term biases were over-turned by the market potential of 3D printing technologies.
Initially, I thought that 3D printing couldn't possibly replace typical supply chains. That perhaps 3D printing is a gimmick. In other words, I was dead-set on the market being wrong. After all, like others on this website, even I get skeptical by overly generous price action. To put this in perspective, 3D Systems is 145.66% off of its 52-week low. Plus it trades at a frothy 122 price-to-earnings multiple. At first glance, anyone looking at the stock would assume that the stock is grossly overvalued - including me.
Finally, after reading through the investor presentations, the financial reports, various forecasts, and the conference calls - I have to admit, there could be more to this picture. In fact, I believe there's something extra that I could add to the discussion when it comes to 3D printing.
Also, because I am talking about the 3D printing and robotics industry as a whole, I have also included a brief discussion on Stratasys (SSYS), ExOne (XONE), iRobot (IRBT), and Adept Technology (ADEP). The focus ticker analysis will be somewhat limited as the purpose of this article is to get a basic understanding of how much of an impact a combination of both robotics and 3D printing will have on our global economy.
Setting the stage
Currently, 3D Systems has been acquiring other players in the 3D printing space. Whether or not it generates a phenomenal return is fairly irrelevant. What matters is securing intellectual property. 3D Systems is hoping to increase the range of materials and colors that an individual printer can print. This of course requires technical expertise that would have to come from people from varying engineering and software backgrounds. In summary, 3D Systems is hoping to create a single printer that can print anything, and at extremely high rates.
Source: 3D Systems
Stratasys recently acquired Makerbot for $403 million. Makerbot is a pretty major player in the 3D printing space as the company primarily engages in the lower-end of the market. Stratasys hopes to break as many price barriers with printing technology as possible. However, I find this business strategy to be the least attractive out of the peer group. This is because low-end printers haven't been shown to have much traction with consumers as there's a limited number of things a person spending $2,000 on a printer will be able to do. On the other hand, Stratasys does have higher-end printers, but it's not the company's primary focus. At the high-end, 3D Systems has the broadest range of products that can print the broadest range of materials.
Of the three, ExOne is still in its infancy, which makes the business a little less predictable when compared to the other two major 3D printer companies. ExOne currently focuses on selling printers for industrial applications. ExOne will be able to sustain higher growth rates due to being smaller and selling to a specific product niche that has the most market potential. On the downside, ExOne has only been able to produce machines that are capable of using glass, metals, and sand. Which is okay, but in any consumer product there can be a combination of plastics, and other basic materials. On the upside, ExOne offers 3D printers that can produce products at larger form factors.
Of the three companies, however, it seems that 3D Systems has a printing solution that can cover most basic and advanced materials between its print engines. 3D System can print from a combination of a million colors. So when it comes to versatility, 3D Systems has been able to lead the way, with Stratasys following close behind, while ExOne focuses on the industrial segment of the market.
Technologies that closely complement 3D printing are robotics, which of course is another industry barely in its infancy. Companies that are closely related to it would include iRobot and Adept Technology Manufacturing. Currently. iRobot is primarily focused on consumer markets and government contracts. But given enough time, iRobot should be able to advance its technology enough to build mobile robotics technology that has greater capability in any setting. Of course, the limiting factor is a combination of software, hardware, and economics.
Adept Technology, on the other hand, is more specialized in creating systems that will work in industrial settings. On the other hand, it's still only a $100 million market cap stock. Making it the smallest company amongst the equities in our infant industry analysis, giving it perhaps the most growth potential, but at the same time making it the most difficult to predict.
Currently Adept Technology's limiting factor of growth is the difficulty in implementing robots on current assembly lines. Currently, low cost labor seems to be the way to go in many parts of the emerging world, making it difficult for Adept Technology to find a market for its products. After all, the only assembly lines in the world that can afford a robot would be the specialized manufacturers. Plus, being the fact that it's a 3rd party supplier, it is difficult to compete with robots that are specifically created for certain parts of the supply chain.
Generalized robotics that can be flexible in many industrial applications is non-existent because current technology is limited to producing robots that are proficient at a very specific task. However, given enough time, I believe that robotics will become much more flexible in design and usability giving manufacturers added incentive to purchase a robot.
When robots are capable of assembling components created by 3D printing technologies, it becomes possible to have zero human labor on an assembly line.
A quick illustration
Imagine for a second you're a car parts vendor (I'm putting out random numbers and products that only exist in our hypothetical reality). You produce exhaust pipes that sell for $250 per unit. However, over in Kentucky, a different company who also has a 3D printer, that manufactures clothing, has a ton of idle capacity. The 3D printer is doing absolutely nothing for 12 hours straight. So instead of letting that happen, the company opts to use the 3D printer for its highest implied economic use. The manufacturer downloads software to manufacture car parts and lists the product on eBay or Amazon. Pretty soon, because sellers are crowding the market place with cheaper and cheaper exhaust pipes, you the original car parts vendor opt to sell something else. Perhaps, instead of selling car parts, you instead print out artificial legs and sell it to a hospital.
3D printing has vast potential at the high-end, and mid-end. Mid-end 3D printers are great for companies that need to create experimental prototypes, but because there are only so many research labs in the world, the market size is limited. Also, I'm not convinced that 3D printing will win the living room because any goods produced by an individual can be produced at a lower opportunity cost by a company with a higher-end 3D printing device.
In the future when manufacturing firms become cost competitive in the United States through the use of 3D printing technology, the economics of being a manufacturer will largely depend on supply/demand mechanisms.
The economic reality
I simply couldn't come across a compound annual growth rate assumption that seemed reasonable enough to use. Usually the compound growth rate assumptions that are provided by investor presentations are created using extrapolation techniques. Extrapolation is almost always based on historical growth, without any context for developments that may have not been factored in. Using math to extrapolate is similar to saying that the past is going to be similar to the future, but that is not always the case.
However, given a long enough of a time-frame, I am willing to estimate that standard manufacturing will die. Meaning that manufacturing will not be based on specialization, but rather it will become a perfectly competitive marketplace. The point at which this will happen is when industrial scale 3D printers are able to produce any product at lower cost than any labor-based (including China) manufacturing line. Meaning, that a 3D printer would have to be more cost competitive than any type of specialized manufacturer, like HonHai Precision, or Taiwan Semiconductor.
3D Printers aren't the only thing that would be necessary to replicate the production of a product. You would also need a robot that can assemble products automatically. If you look at a car manufacturing line, robots attach doors to a car and install engines into a car. So not only would a company need to print the individual components and send it down conveyor belts, you would need robots in a factory assemble specific components into a final product.
I believe that 3D Printing, therefore, lowers the barrier of entry for smaller manufacturers to co-exist with bigger ones. However, on the downside, up-front CAPEX, would mean that it's still a business exclusive to companies who have a lot of up-front investment capital. So while, I have been able to imagine a reality, where in theory manufacturing can become more cost competitive due to 3D printing, in practical application, it's still a bit of a far-fetch to expect a perfectly competitive marketplace in the next five to ten years.
So while the technology of universal manufacturing sounds appealing. It's still a very long ways from materializing. Specialization still seems to be the way to go in the manufacturing space.
Estimating the potential market value of 3D printing will be tough. But, I'm willing to assume that 3D printing, paired with assembling robotics technologies can in effect replace a very large percentage of labor costs, and machinery. I'm going to base these assumptions using some macro-data, and some company specific data, as well.
According to the CIA World Fact Book the worldwide gross domestic product is currently $84.97 trillion (2012 estimates). Currently, on a worldwide basis, manufacturing represents around 30.7% of total economic output. In other words, the total economic output relating to manufacturing is approximately $26.08 trillion. This means that the final value of all manufactured goods in a given year is $26.08 trillion.
So now, that we have determined the final value of all physical goods, we need to determine how much money will be spent specifically on 3D printers, plus other capital expenditure/technology related to 3D printing. This is going to be extremely difficult because we're going to be using really rough numbers. So, please do not treat my research with as much respect as a report written by Ben Bernanke or Warren Buffett.
In order to find the total addressable market for any given year, we need to find out the average spending of labor on manufacturing, and the average spending on machinery for manufacturing. To do this, I'm going to find a company in the industrial sector that gets extremely close to the industry average gross margin.
I am currently using FINVIZ to screen my results, and the two screens are: market cap $ 10 billion (and above) and I set sector at industrial. After finding all equities that match the criteria, the average gross margin percentage amongst the equities is 31.26%. A company with similar gross margins to the industry average gross margins is Deere & Co at 31.40%. Therefore, we will look specifically into Deer & Co's (DE) annual report and find the line items for spending that should relate to 3D printing technologies.
Deere & Co, in fiscal year 2012, has cost of sales of $25 billion. Looking specifically at those operating costs, we will make the assumption of value based on the annual depreciation on machinery. Deere & Co's reported $390 million in machinery depreciation for fiscal year 2012. Since the cost of manufacturing equipment is $390 million per year. I assume that Deer & Co's cost structure can be used as a sample for the broader economy.
Since 3D printers can replace both machinery and labor, a 3D printer will most likely be sold at a premium over typical machinery. Because of this, 3D Systems can technically mark the product up, and justify the mark-up on the basis of manufacturers being able to save costs on labor. Therefore, I am willing to include both the machinery and the manufacturing labor force as the total addressable market for 3D printers. To specify the cost of manufacturing labor, I had to use a bit of algebra, and make some assumptions.
Since the cost of goods sold is 80% of total revenues; I am willing to assume that 80% of Deere & Co's labor force is related to manufacturing overhead. Therefore, 53,487 of Deere & Co's employees are related to manufacturing. The average annual earnings of production employees in transportation and equipment manufacturing is $29.33 per hour in the month of August, according to the Bureau of Labor Statistics.
Assuming the average employee works 2,600 hours a year, at $29.33 per hour, Deere & Co compensates the average manufacturing employee at $76,258 per year. This totals to $4.08 billion in labor expenses per year, for manufacturing. When equipment and manufacturing labor costs are combined, Deere & Co spends $4.5 billion. Dividing the manufacturing cost $4.5 billion, into $33.5 billion revenue (FY 2012), and we find that 13.4% of a final product is related to manufacturing labor and equipment.
Since Deere& Co's margins were the closest to the average gross margin of the whole industrial sector, we will use it as our sample for identifying the global market potential for 3D printing/robotics. To do this, I multiply .134 (.134 x 26.08 trillion = 3.59 trillion), into worldwide aggregate manufacturing GDP, which is basically $3.59 trillion.
I believe that the total addressable market for 3D printing/robotics is equivalent to what companies are currently willing to pay for their goods to be manufactured. In other words, market equilibrium for all forms of manufacturing is at around 13.4% of a goods final cost.
We have been able to identify the total addressable market of 3D printing/robots, assuming manufacturers are able to replace manufacturing equipment and the workforce with a mix of 3D printing and robotic technologies.
Robotics and 3D printing are in its infant stages, therefore, I assume that the industry may be able to grow at a 35-45% compound annual growth rate over the next ten years, which is the growth projection offered by 3D Systems management team (look below this paragraph). Of course, the management team recently offered guidance above 25%, but I'm going to keep my assumptions at the higher rate as there's plenty of room for the industry to grow.
Source: 3D Systems
Once we reach beyond the ten-year mark, I believe that 3D Systems and its cohorts will grow at slower rates as 3D printing and robotics technology starts to mature.
According to Gartner's cycle of emerging technologies, it will take five-years for enterprise 3D printing to reach the point of productivity. Also, mobile robot technologies are expected to reach the point of productivity after ten years. So, in summary, I expect cannibalization of the standard manufacturing workforce/equipment after ten years, which is where I will start an exponential growth function that will model a long-run growth rate that will be limited by the point at which total addressable market is equivalent to total revenues produced by 3D printing/robotic companies.
I assume two-stage growth, and an eventual cool-down. The industrial revolution took place over the course of 80 years, which occurred between 1760 and 1840 (Wikipedia). I believe that 3D printing and robotics will take a similar amount of time to become globally saturated. I also believe that over that 80-year time frame, wealth will become even more concentrated and that the global economy will be driven by services and intellectual capital, furthering the emphasis on education and skills.
I assume that the potential market for 3D printing/robotics will grow by 3% per year as it is modeled by the long-run global GDP growth rate. I also want to mention that the potential market will be different from the actual market. Meaning, that I expect that at some point, the actual market will equal the potential market for 3D printing/robotics. This point will not be reached for many years as it will take a while for supply and demand mechanism to reach a point of 100% market saturation.
Assuming 3D printing/robotics can displace 13.4% of all costs associated to all manufactured goods, the total addressable market should reach $38.3 trillion by 2093. The total addressable market is growing at 3% per year, which models the long-run growth rate of the global economy. More goods have to be produced every year, you know?
The first graph is a graph of the total addressable market. The second graph is the first stage growth of the actual industry. I set the first stage of the growth model at an annual growth rate of 35%. I assume that the total revenue of the 3D printing industry will be $3.5 billion in 2013, based on a report by Credit Suisse, which will be the beginning point of our model.
The second stage growth rate will be modeled by using the growth factor of 3D Printing and Robotics total addressable market from 2023 to 2093. The second stage compound annual growth rate is 8.94%.
I believe that in the early stages, 3D printing will be exclusive to firms who want to manufacture using the technology and can afford the cost effectiveness. But by 2080, this will transition to half the world using a purely robotic/3D printed manufacturing line.
Finally, by 2093, I believe that robotics/3D printing will fully saturate the addressable market, implying a 0% labor force in manufacturing. 3D Printing and Robotics revenue may be lower than the represented figure as capital expenditure on robots and 3D printers will eventually decline. The manufacturing sector will rapidly shrink due to falling costs that will no longer be represented in physical goods. Therefore, given enough time, it is highly likely that advanced/basic material costs, and intellectual property will be the main factors to the cost of any physical product. Assuming recycling technologies and chemistry improve even further, and it is likely that at some point, the cost of any good or service will become dependent on the market value of the intellectual property.
Therefore, intellectual capital is the main force of capital in the 21st and 22nd century, and I expect this to fully materialize by 2040 in developed economies, 2070 in emerging economies, and 2093 for all under-developed economies.
Summary of methodology
From start to finish, the forecast took a long time to arrive at, and it involved a lot of calculation. So, I want to make a quick run-down on how I arrived at my conclusion, and what to interpret from it.
We arrived at our conclusion because we estimated the market potential by sampling Deer & Co's manufacturing costs. We then used that as a representation for the aggregate worldwide economy, which led to an assumption that 13% of all final goods is composed of labor and machinery costs. Because of this, we estimated that the total market potential is $3.9 trillion in 2013. The market potential is projected to grow at a 3% compound annual rate for the next 80 years, and I make my assumption over the next 80 years based on the borrowed time frame from the industrial revolution in the 1700s to 1800s. We established 2 growth stages; the initial growth rate was higher than the second one.
In the first phase of the growth model, I expect 3D printing to sustain the high growth rates it is already generating. This is because we're no-where near market saturation, and each year over the next ten years, the technology is expected to improve by leaps and bounds, which will unlock vast amounts of market potential over a short period of time.
In the second phase (after 2023), any firm selling 3D printers will attempt to maximize profit on any goods sold. This will inhibit the rate at which the global economy will reach full market saturation. Currently, there are some people in the world who do not even have access to a cell phone, much less running water. Therefore, my assumption of having a 0% manufacturing labor force will not happen for quite a while. This was the basis for using the industrial revolution for a starting and end-point for our long-term forecast of 80 years. I also assume that 3D printing technologies will not become very successful with consumers as I assume that higher-end 3D printers will remain vastly more cost competitive, reducing the incentive for consumers to pay up front for a smaller 3D printer.
I also want to mention that the future may be drastically different than the one that I have predicted. I can acknowledge that no one has the ability to predict the future with 100% certainty. Even so, I believe that I have presented research that will be a great starting point for doing your own research when determining, which 3D printing/robotics company you want to be a shareholder of.
I believe that the economics of manufacturing will become similar to our current agrarian society and that the labor force for manufacturing will become near non-existent. Productivity gains from robotics and 3D printing technologies will become more pronounced over the next ten years. I believe that 3D printing and robotics will retain a durable advantage for many years to come.
3D printing technology will remain as one of the most disruptive technologies that will hit our economy in the coming years ahead. Also, it pains me to say this, but those that do not have specialized skills and knowledge will struggle financially. So, for some, this may be an investment opportunity, but for others this should be a wake-up call to take higher-education seriously, and earn a degree in something that will have value in our intellectual market place.
In conclusion, these companies trade at extremely high price-to-earnings multiples, which can be justified given the potential these companies possess. However, they will also be susceptible to added market volatility, which will make it difficult for buy and hold investors to stomach volatility. Therefore, anyone who invests should have a timeframe similar to Warren Buffett.
Thanks for sticking through with me as I have written an article that is extremely long, and perhaps challenging. I have been hoping to write something new, and offer analysis that doesn't exist anywhere, but here on Seeking Alpha. I know that many of you will have questions so I will be sticking around to answer questions once the article is published.