I wrote an article about 3D Systems (DDD) at the start of December. In that article, I tried to calculate the fair value for 3D Systems based on the discounted cash flows model. Naturally, the calculated value showed that the stock was overvalued based on future cash flows. I say naturally because the industries with hyper-growth tend to have stocks that are usually overvalued due to the excitement about the future growth prospects. My valuation article was about finding out how much "over excitement" (overvaluation) was present in the stock at the time, and the results showed that it was substantial.
Most of the readers were not happy with my valuation and accused me of being too negative. However, my regular readers will know that I have a bullish stance on the 3D printing industry in the long-term, and I have been giving unbiased commentary on the stocks in this sector. My valuation was based purely on the free cash flows model and the future expectations about the company. I have always valued stocks based on the long-term growth prospects rather than short-term developments.
This Citron report has brought 3D Systems close to its fair value over the past few days, while I agree in part with the report, I believe it is too harsh. My valuation model showed that the stock should be trading close to $54 (I developed the model before the company announced new range of printers and partnership with Hershey's). These two steps will add considerably to the future revenue growth and free cash flows. After the adjustments to the model for these two events (upward adjustments in revenue growth), fair value comes close to $62-64 per share. However, nothing has changed for 3D Systems in terms of growth prospects and the industry dynamics. In fact, the position of the company has been enhanced due to these recent deals. I will try to further assess the situation of the industry.
As I have mentioned above, the stocks in this sector are trading at a premium due to the excitement around the 3D printing technology. I believe valuing these stocks based only on fundamentals will a wrong approach. In this article, I will be mainly focusing on the future growth potential of the industry and how it will help 3D Systems continue its impressive growth.
Industry Dynamics Have not Changed
The industry dynamics for the 3D printing industry have not changed drastically - we are still seeing massive growth and the industry is still at the hyper-growth stage, and 3D Systems and Stratasys (SSYS) are the two biggest players in the industry. Due to the better established network and global reach, both of these companies are ahead of their rivals. It is natural for an industry with hyper-growth to attract more players; however, it will not be easy for the new entrants to take on these two players. Moreover, we have to take into account the segments of the industry. For example, the consumer 3D printer segment can be further divided into hobbyist segment and the small scale businesses - businesses that cannot afford the large-scale printers or do not have the operational need for the large-scale printers.
Similarly, the industrial as well as the medical devices segments can be further divided into segments. In the industrial segment, we are seeing companies adopt 3D printing technology, not just in the metal 3D printing but also in the food industry. As I talked about 3D systems partnering with Hershey's in my previous article, there are a lot of outlets where these companies will continue to drive future growth. Stratasys has been investing heavily in increasing its sales network and R&D - ExOne (XONE) is coming closer to its customers in order to educate them through PSCs (product service centers), and 3D Systems is partnering with a number of companies. All of these steps show that the big players are making their moves to gobble up more market share.
Acquisitions are Necessary
Companies can grow through two means: Acquisitions, or developing the technology internally. Acquisitions are a faster way to grow and the company took this path when it decided to expand. Ideally, a company will try to make an acquisition which gives the highest level of synergies. However, when we are talking about a segmented market, some acquisition might not bring the desired level of synergies. As I mentioned above, the market for 3D printing is highly segmented and the 3D printing companies cater to a wide range of customers. 3D Systems has focused on the consumer segment and most of the acquisitions have been in this segment.
Now, acquisitions of small action figure manufacturing companies might not be a big deal or the best acquisition in terms of synergies; however, it cannot be denied that there is a feasible revenue growth opportunity available. In fact, the market is growing at a rapid pace. Similarly, 3D printed confections section also has a lot of growth potential, and the recent partnership with Hershey's shows that the major players in the industry are willing to use 3D printing on a large scale. Moving forward to the acquisition prices, there are a lot of factors that companies take into account while acquiring a business - the future growth opportunity, the fear of business growing and becoming a competitor, the ability to complement an existing product etc. We have seen technology companies pay massive amounts of cash (Facebook (FB) for Instagram and Google (GOOG) for Waze - sometimes acquisitions are made to capture more market share or to capture one specific segment. Most of the 3D Systems acquisitions have been focused on growing its market share. In some cases, the company has paid over the top; however, the long-term growth potential has been the main determinant of these deals.
Why 3D Systems will not Fail
There are a number of reasons the company will not fail, in my opinion. I have listed some of these reasons here.
3D Technology is Becoming Mainstream: The technology has been around for over two decades now; however, it has just started to take the center stage. The technology is becoming extremely popular and the acceptance is increasing. As a result, 3D printing companies have been able to record massive growth in revenues. According to IDC, the 3D printing industry will grow at a compound annual growth rate of 59% over the next four years. In the same time period, the revenue of these companies is expected to grow at about 30% annually.
One of the Biggest Players: 3D Systems is one of the biggest players in the industry - it will be naive to think that the company will not focus on developing better technology and enhancing its current portfolio of products. R&D is a major expense in the sector and the company will continue to work on new and improved products. The most recent addition to the company was the acquisition of The Sugar Lab -- this acquisition has opened a completely new market for 3D Systems. 3D printed edible confections can become a substantial growth driver for the company.
Strong Sales Network: 3D Systems has global presence and the company has one of the strongest sales networks in the sector. The company has been focusing on partnerships with regional players in order to increase its global footprint. These partnerships and strong ties with customers will allow the company to grow in both consumer as well as industrial segment.
The threat of increased competition in the industry is present due to the massive growth potential. However, the assumption that any company can enter and trump 3D Systems or Stratasys is wrong, in my opinion. Both of these companies have built a strong presence in the industry and any new entrant will have a big fight on its hands. The stocks are still slightly overvalued - however, it is normal for the industry. The most important thing to remember is that the future growth opportunity is real. Furthermore, the investors in this sector should always be ready for the wild swings in the price due to the volatility. However, I maintain my bullish stance for 3D Systems and believe that it will continue to grow in the long-term.