Seeking Alpha
Profile| Send Message|
( followers)

There are a number of reasons to suspect that the amazing rally in Arcam, (OTCPK:AMAVF), the 3D printing company from Sweden, is getting close to the end and might reverse going into 2014. There is significant downside in the stock.

Arcam: A Brief Description

Arcam is a additive manufacturing printing company (3D printing). It is focused on the metals space and uses electro-beam melting (EBM) technology to print its products. It focuses on two market segments: aerospace and orthopedic implants. EBM technology differs from laser printing technology, which other competitors use as it can only be built in small components and the materials a very expensive. As it currently stands, EBM printing technology is faster than laser printing, but it faces much harder competition as laser printing technologies become faster.

General Statistics

SEKm

2011

2012

2013E

Sales

107.7

138.9

198.1

Operating Income

4.6

14.6

21.0

EPS

1.47

3.6

5.04

P/E

224.2

EV/EBIT

218.7

P/B

21.1

Growth Slowing in the Short Term

Consensus shows Arcam growing by 50% annually the coming years. The short- and medium-term outlooks might not be that good. In Q3 "orders" were actually down 20% (see table below). Sales in Q4 are expected to see a substantial deceleration in year-over-year growth compared to previous quarters: In Q1 sales grew by >100%, in Q2 by >60%, and in Q3 by >50%, but Q4 looks to be only around 5% (based on Bloomberg analyst estimates of Q4 sales estimates of SEK65.60m). A sharp slowdown in year-over-year sales momentum in high valuation growth stocks normally makes the market nervous.

Orders intake YTD is -8%. This should change as more orders are announced in Q4, but with less than six weeks left, we look a little off from the 50% growth in orders the market is expecting. They need to produce seven more orders this quarter just to meet expectations.

SEKm

Q1

Q2

Q3

Q4

2012A

Q1

Q2

Q3

Q4E

2013E

2014E

Sales

18.9

32.4

25

63

138.9

38.1

54.0

40.4

65.6

198.1

263.3

Growth%

101.6%

66.7%

61.0%

5.0%

42.6%

32.9%

Order Intake

2

7

5

6

13

4

Growth Y/Y %

200.0%

85.7%

-20.0%

Note: Q4 estimates are from Bloomberg and 2014 from Introduce.se.

Growth Concerns in the Medium Term

Consultancy firm ID Tech is talking about slowing growth or even negative growth in certain 3D printing subsectors in 2014-16. This is not because the sector would have gone "ex-growth," but because there will be a saturation phase in the market. For example, within aerospace, Pratt & Whitney's VP Tom Prete says in the publication Institution of Mechanical Engineers that not only is the technology a couple of years out, but also faces severe competition from casting technology:

All are non-critical parts, like air ducts. When you have a lot of parts that are being produced with a casting, its always going to be difficult for additive manufacturers to compete on a cost basis. Once you have the tooling and your product on the dye, it's very cheap.

There was also a Financial Times article this week where the head of technology at Rolls Royce said that their use of 3D printing in aerospace (Arcam's most important sector) was "a few years away."

Production Capacity

Currently, the production capacity stands around 35 units a year. Substantial investments would most likely be needed to be expand this. For the company to be able to produce more than 35 a year, which is needed to reach the massive growth of 40%-50% growth assumed by the market, the company needs to spend a great deal to make it happen.

Valuation: From a Substantial Discount to a Substantial Premium

There was a great opportunity to buy Arcam in the spring when the stock was trading at a significant valuation multiple discount to its U.S. peer group. It was trading at a 30%-40% discount to U.S. peers as recently as April. The stock was undiscovered, had underperformed, and was much cheaper than its peers. This has changed remarkably over the past few months. The stock has outperformed XONE, SSYS, and DDD by multitudes since April, as can be seen below. For example, it is up more than 4x than its closest peer XONE.

Share Price Movement

4/1/2013

11/13/2013

% Change

AMAVF

31.93

167.25

423.8%

XONE

33.50

59.00

76.1%

DDD

33.14

78.12

135.7%

SSYS

74.15

125.35

69.0%

The stock is now trading at a substantial multiple premium. See chart below (Bloomberg analyst estimates):

Valuation Estimates

Multiples

EV/Sales 2013

EV/Sales 2014

AMAVF

19.0x

15.7x

XONE

15.3x

10.0x

DDD

15.0x

11.7x

SSYS

11.3x

8.3x

Analysis of Who's Buying the Shares

Analyzing public data on who has been buying the shares in the past few months leads to one important conclusion. The absolute majority of buying has been from U.S. retail investors. At end of Q2 (company data) there was no U.S. retail brokerage account among the top 20 shareholders, meaning that they owned less than 20,000 shares. At the end of Q3 (company data), the third-largest shareholder is Merrill Lynch retail client accounts, the fourth-largest is Charles Schwab retail client accounts, and the fifth-largest is Fidelity retail client accounts.

U.S. retail investors have bought almost 10% of the company in a period of three months. That is a very high number, and after having spent significant time analyzing flows over the past couple of years, this is (in my personal view, not backed up back quantitative research) unprecedented when it comes to U.S. investors buying an overseas stock. Who has been selling? The local Swedish long-only funds that have been following the company for many years. (See this link to company data.)

Patent Issues

There might very well be patent issues and problems in the 3D printing sector going forward. This is, of course, not only related to Arcam, but relevant for the entire sector. Patent expert Bryan Vogel at RKMC says that "significant IP litigation in the 3D printing sector is inevitable." The Patent and Trademark Office has received more than 6,800 applications related to 3D printing. The landscape here is still very unclear. There is a risk for costly lawsuits, something that would hurt a smaller company like Arcam more with their limited financial resources.

Also, the situation regarding Arcam's key patent is unclear. Their first patent was filed in 1993 and was approved in 1995. The company has most likely improved their patent portfolio ahead of the upcoming 20-year expiry for U.S. patents. But the market is not at all pricing in any patent or litigation risk, which might change.

China Regulation for 3D Printed Orthopedic Implants

The Chinese FDA recently introduced a regulatory approval process for orthopedic implants that are produced by 3D printing. The Chinese watchdog CFDA initiated "pre-approval" requirement for "high-risk Class 3 medical devices." This is one data point that the regulatory landscape for medical devices made by 3D printing is changing, and not for the better.

Product Recall

Arcam's client in the U.S. Exatech has recalled their product produced with EBM. Arcam is using Exatech as an example client for their orthopedic business in marketing material vs. investors. This recall is interesting as we this week got news of the J&J settlement, where J&J has to pay $4 billion for using metal in hip implants. The FDA commented: "All-metal implants can shed metallic debris, potentially damaging bone and soft tissue."

It is too early to tell what kind of implications this will have for Arcam in the orthopedic space, but it is discomforting that FDA is negative to using metal hip implants given that this is exactly what Arcam uses. It is clearly not supportive to the story that a key client in the U.S. has recalled their product without the company commenting on it. The J&J settlement for $4 billion was for 7,500 hip implants. More than 30,000 hip implants have so far been produced by Arcam clients using their technique. It would be disastrous for Arcam if it turned out that one of their clients gets sued due to using Arcam EBM.

Conclusion

3D printing might be the future, and the super-lofty valuations of all the stocks in the sector reflect that. One should be very careful with Arcam, as it has outperformed its peers by 4x over the last couple of months and trades at significant premium to its peers, despite declines in order intake in Q3 and Q4 that are expected to be the slowest growth quarters in a long time. What is especially worrisome is that during the last couple of months, almost all the net buyers are U.S.-based retail while local Swedish investors have been selling.

Considering all the risks ahead, with product recalls of its clients products in the orthopedic segment and patent concerns, I find Arcam to be overpriced not only on a absolute level, but also on relative level to its peers.

Disclosure: I am short OTCPK:AMAVF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Source: Arcam - Time To Sell