As I type this article the rebate rate for The ExOne Company (XONE) stands at a staggering 100%. It would be difficult to overstate the importance of that single fact. What it means is that, at current rates, those who have short positions in XONE will pay the entire value of their position in a single year, regardless of what happens to the stock price. That's right, at today's prices and rate 1000 shares held short would have a maximum theoretical gain of $60,000 (if the company went bankrupt, for instance) and holding that position means paying interest at the rate $60,000 per year. Who would take such a proposition? The answer is "not many", and those who find themselves in it are doubtless looking for circumstances to change dramatically and quickly or else to exit their positions.
As detailed in Part 1, the 37.69% short interest figure does not necessarily represent the real percentage of outright short bets against the company. Nonetheless, even high double digit rebate rates cannot persist for long. This means that risk/reward ratio for XONE is heavily skewed towards the rewards side for the near future. Even more crucially, the shares are also exhibiting all the other fundamental criteria of the Momentum Mechanism and thus represent a multi-bagger opportunity. This article will explain why, how we got here, and what to look for (and perhaps more importantly, ignore) going forward in order to successfully manage a long position in what is admittedly a risky company.
How We Got Here
The ExOne Company sells additive manufacturing machines (aka "3D printers"), along with associated supplies and services, to industrial customers. The company also produces specialty-designed items at its Production Service Centers, "PSCs", which are located in the United States, Germany and Japan. XONE shares began trading publicly in February of this year, and rose to a high just over $75 in August, before falling sharply to end September at around $45.
The rise in share price from the start of trading is easily explained by the excitement surrounding additive manufacturing (a better term for 3D printing). Reporting from prestigious sources such as The Economist have repeatedly predicted how transformative the technology will be. September's drop, on the other hand, is the result of a perfect storm created by 4 nearly simultaneous events:
- ExOne's shelf offering at $62/share: while natural for a new company in growth mode, this is still dilutive to existing shareholders. Furthermore, management sold some of their own shares in the offering, although they maintain substantial ownership.
- Filing of the Voxeljet (VJET) IPO: Voxeljet is the nearest competitor to ExOne's business model. It has been around longer, despite the recent American IPO, and thus has established earnings.
- Negative press from thestreetsweeper.org: this website is backed by Manuel Asensio, a noted short seller who has been sanctioned by FINRA. Their strongly-worded stories on another stock I cover have multiple examples of creating a slingshot effect via incorrect predictions.
- The introduction of options trading in XONE: as noted in part 1 of this article, options can drive the price of a stock, just as much as the stock can affect its options. For most of the year, XONE traded without any options available. The introduction of options can temporarily divert funds from the underlying and magnify price movements happening at that time, due to the inherent leverage of options.
All of these factors conspired to drive shares down 40% from their highs. The rebound in recent weeks, speaks to their oversold condition and continued investor demand. This was NOT a low-float IPO of the sort mentioned in part 1; investor demand appears quite genuine and sustainable, rather than market-manufactured. At prices below even what qualified investors paid in the offering, we are still at a good entry point, since there has been no material change in the ExOne's outlook, and the long term thesis remains very much intact. If you don't believe me, you can take a look at FBR Capital's reasons for their $75 price target. I don't put much value in most analyst ratings, and even less in technical analysis. In fact, I view the latter as the generalized essence of "chasing news". Nonetheless, a perceived range is a necessary precursor to the Momentum Mechanism, and I think we've just seen the bottom of it.
What to Expect
It almost goes without saying that there will be continued volatility in XONE, but let me emphasize that a bit further. There is significant execution risk with any new company. At this stage, this is a swing-for-the-fences investment that is best suited for investors who can either monitor it continually, or else be comfortable with losing the entirety of a small stake. The former sort should, of course, practice disciplined position management with the expectation of large and rapid swings in share price.
The next potential pivot point is just days away, when the company is expected to announce its first ever profit of 1 cent per share after market close on Wednesday, November 13. Given all the effort towards opening new sales channels and capital expenditure associated with research on new materials and expansion of PSCs, I would not be particularly surprised or concerned if the company misses this milestone for the current quarter. If it does, the short interest will cushion any downturn in the stock. On the other hand, given the short data referenced at the beginning of this article, it is possible that good news could set of short squeeze of epic proportions and serve as the trigger for the Momentum Mechanism. I certainly don't advise counting on this, and my guess is that reduction R&D spending might be a better leading indicator of an eventual inflection point.
The introduction of new materials is key, and justifies the capital expenditure. ExOne's main advantage over other additive manufactures is in the broad range of materials it can use to fabricate items. So far they can produce in silica sand, ceramics, stainless steel, bronze, glass, iron (infused with bronze), and bonded tungsten are available. The last two are recent additions and iron, in particular, holds great promise because of its combination of strength and low cost. The company is still working on introducing other materials including graphite, aluminum, magnesium and titanium. Additive manufacturing competitor Arcam AB (OTCPK:AMAVF) already has a good business using titanium for aerospace and medical applications. The potential applications for graphite are myriad, but still in their infancy.
I believe aluminum/magnesium and other such alloys would be the biggest near term win because of their usefulness in aerospace applications. One of the primary advantages that additive manufacturing has over traditional techniques is time to product. Additive manufacturing measures production times in hours, whereas traditional manufacturing typically has minimum turnaround times of 6-8 weeks. This becomes critical for industries that need rapid iterations of production and testing, such as aerospace. Computer modeling of air and fluid dynamics can only take designers so far, and industries concerned with these attributes often need to go through many repetitive cycles of designing, producing and testing a part. ExOne would have absolutely zero competition for parts of these types.
Similarly, multi-material production capability is an important milestone to watch for since conventional CNC and other "subtractive" manufacturing processes are not well-suited to such items. I don't think we'll see it until after the company has leveled off on the introduction of new materials, but it is an achievable goal for which ExOne is ideally positioned. Parts with shifting grades of metallic composition could enable whole new classes of technology and help ExOne outstrip even the already impressive growth projections for the additive manufacturing industry.
What to Ignore
Stocks subject to the Momentum Mechanism will necessarily engender controversy. Here's a quick list of likely arguments that I believe investors in XONE should ignore, or at least discount.
Claims that AM won't (or will) replace CnC manufacturing: The reality is that additive manufacturing will not replace or even endanger traditional processes for many years to come, and quite possibly will never do so. While there are situations where AM is cheaper, the up-front production cost for a customized item can currently be under $1000, making traditional manufacturing cost-competitive for runs numbered as low as dozens of items. This point is irrelevant to our investment thesis. Additive manufacturing shines in the areas of quick turn-around times (as discussed above) and in the types of shapes that can be produced. Thus it will continue to grow its own niche rather than competing directly with traditional manufacturing processes.
Comparisons to Consumer 3D Printing Companies: I personally don't believe predictions of widespread direct consumer use of 3D printers, but it doesn't matter. ExOne is focused solely on industrial customers and has little in common with companies like 3D Systems (DDD). Hopefully the terms "3D printing", and "additive manufacturing" will eventually bifurcate. The closest comparisons to ExOne in additive manufacture are Voxeljet, which has a larger maximum build size, and Arcam, which uses slower, more expensive Electron Beam Melting technology. Both companies are far more limited in terms of material selection.
Acquisition rumors: Hewlett Packard (HPQ) has said they will get into 3D printing. Even if they were to pursue acquisition for such a strategy, it's unlikely that ExOne's market is one they'd want to go after. Worse yet are rumors of an IBM (IBM) buyout. I'd heavily discount any acquisition news unless it contains compelling evidence of imminent action.
Trailing valuation metrics: Whenever ExOne does cross into profitability, it will almost certainly result in very high trailing PE multiples and this will only serve to further fuel valuation criticisms. As discussed in Part 1, such controversy is essential maintaining the Momentum Mechanism. This is a new, high-growth market and it will take quite some time to even quantify the total sales opportunity, though some of the links above provide starting points. Doing that and using properly discounted forward valuation metrics is likely to be the only way to properly assess when the stock price might be getting ahead of itself from a practical trading perspective. No such analysis is likely to relevant, or even possible, until well after a trigger has occurred.
ExOne is a company with both tremendous growth potential and execution risk. Recent events have created an attractive entry point. While it is possible that a very disappointing earnings report on Wednesday could make bring better pricing, risk/reward is favorable based on the current short data. Either way, the market dynamics surrounding XONE shares seem to be setting up for its eventual participation in the Momentum Mechanism, which was detailed in my prior article. Purchasing XONE ahead of the trigger represents a longer-term opportunity for investors to multiply their initial investment.