Bulls vs. Bears. Huge market opportunity vs. overly optimistic consensus expectations and bubbly valuation. The debate has been intense in the last days as investors had to digest 3 warnings in a row from ExOne (NASDAQ:XONE), Stratasys (NASDAQ:SSYS) and 3D Systems (NYSE:DDD).
Valuing companies in a booming industry is always a difficult task. But in our view, a DCF (discounted cash flow) valuation is well suited to this kind of mission as it enables to capture the long-term potential (revenues and margins) of any company.
Therefore, we have decided to perform a DCF valuation of 3D Systems, well actually 2 valuations (blue-sky scenario and bear case), to better assess how the current stock price compares to the bull and bear theses. Please note that we have used 3D Systems' non-GAAP figures which exclude non-cash items (even if the exclusion of some items, such as stock-based compensation expenses, could give rise to discussion) and that 2013 & 2014 figures are consensus forecasts.
We use a discount rate of 9.8% (with a beta of 1.2x, reflecting 3D System's higher risk compared to the stock market) and make the following assumptions:
- Organic revenue growth accelerates to 35% in 2015-2017 (vs. around +30% organic in 2013-14) and then very gradually softens.
- In 2023, 3D Systems generates more $7bn revenues (vs. $514m in 2013) and still delivers an impressive 25% revenue growth (i.e. close to the current level).
- EBIT margin recovers sharply in 2015 and 2016 following the 2014 dip and then gradually improves.
- In 2023, 3D Systems displays a 26% margin, and is therefore much more profitable than hardware makers (HP for instance has a margin slightly below 10%) and close to software makers' margin levels.
- Growth rate in perpetuity is 3.5%, consistent with world GDP growth across different economic cycles.
We get to a $83 valuation, or c.20% upside.
Source: AtonRâ Partners
We use a discount rate of 10.4% (with a slightly higher beta of 1.3x) and make the following assumptions:
- Organic revenue growth accelerates to 30% over 2015-2016 and then gradually moderates as competition increases and as the technology matures (pricing pressures).
- In 2023, 3D Systems generates more $4bn revenues (vs. $514m in 2013) and still delivers a comfortable 15% revenue growth.
- EBIT margin slightly recovers to 19% in 2015-2016 and then gradually declines as pricing pressures hit gross margins.
- In 2023, 3D Systems displays a 16% margin (roughly in line with the 2014 level), and is still more profitable than hardware makers …
- Growth rate in perpetuity is 3%, slightly more conservative than in our blue-sky scenario.
We get to a $26 valuation, or c.60% downside.
Source: AtonRâ Partners
We believe that the risk/reward is clearly not attractive for investors: a 20% upside in a blue-sky scenario is not sufficient in our view to offset the huge downside risk potential.
Importantly, we believe that 3D Systems' momentum has turned negative for the first time in a while recently following several warnings in the sector and that the earnings downside risk is still high as competition is likely to heat up following patent expiries (see our recent article on this issue).
We remain sellers of the stock. Anyway, if you want to test your own assumptions on 3D Systems (more bullish / bearish ones), leave a comment and we will run our DCF model for you.