3D Systems: $83 Or $26? Well, $26 Becomes More And More Likely

Mar.21.14 | About: 3D Systems (DDD)


HP’s 3-D printing initiative is a serious blow to the bull thesis on 3D Systems.

Competition is just starting to heat up. The situation is likely to get worse when Asian low-cost companies expand their distribution reach.

3D Systems' ASPs and gross margins are at risk and we expect additional EPS disappointments. Our bear-case valuation stands at $26.

An HP bid for 3D Systems is highly unlikely in our view.

HP (NYSE:HPQ) announced yesterday that it would outline plans to enter the 3-D printing market in June, with CEO Meg Whitman adding that HP researchers had developed a breakthrough technology. That technology is expected to improve the quality of substrates used in the process (a positive for the quality of finished products) and to speed up the printing process.

This announcement is clearly a blow to the bull thesis on 3D Systems (NYSE:DDD) and peers and confirms what we said back in January in an article titled "Competition to heat up as key patents expire, earnings risk on the downside". The stock has lost 30% since then and we now believe that the $26 bear-case valuation we set in our "$83 Or $26? Pick Your Scenario" article is becoming more and more likely.

Increased competition now a reality

We said in January that the expiry of key patents between 2014 and 2017, notably the laser Sintering patent (owned by 3D Systems) which expired in February 2014, would spark increased competition and pricing pressures across the industry as open-source hardware printers would be able to integrate laser sintering.

The HP announcement perfectly illustrates this: HP is a new competitor in the 3-D printing industry and plans to price aggressively. Bulls say that HP's first attempt to enter the 3-D business failed in 2012 when the company ended its distribution agreement with Stratasys (NASDAQ:SSYS) in 2012, and that it could fail again in 2014. But in our view, there's a big difference this time around: HP apparently spent a lot in R&D and claims it has developed a breakthrough technology. We will not have the opportunity to check HP's claims before a couple of months, but it looks like the company will be a serious competitor in the very short-term (in the business segment first) and that should be a major source of concern for 3D Systems and its shareholders.

Competition is also heating up in the consumer market. A recent article in the Nikkei Asian Review highlighted that Japanese hobbyists would soon have the opportunity to buy 3-D printers coming from Taiwan (New Kimpo) or Singapore (Pirate3D) for much less than $1000. This suggests that 3D Systems could find it difficult to grab share in the all-important consumer space over coming years (note that was already the case in Q4). And the arrival of low-cost Chinese printers could only make things worse.

In all, we reiterate our view that the ASP of printers is likely to fall sharply in coming quarters, suggesting significant pressure on gross margins going ahead: prices go down, but costs remain high due to continued marketing and R&D efforts. We would expect additional profit-warnings from 3D Systems and peers.

M&A: not a likely exit opportunity for shareholders

Our fellow SA author Almario Alexej Alcazar suggested yesterday that 3D Systems could end up being acquired by HP. In our view, this scenario is highly unlikely, at least in the short-term.

First, we struggle to see how HP could justify such an acquisition to its shareholders, notably after the Autonomy disaster: a 3D Systems acquisition would significantly dilute HP's EPS in view of 3D Systems' stratospheric valuation multiples.

Second, HP has a large printing patents portfolio and claims it has developed a breakthrough 3-D printing technology while 3D Systems patents are gradually expiring.

Last, HP has a huge distribution reach (businesses and consumers). So, where's the need to acquire 3D Systems?


3D Systems' business and earnings are obviously at risk. Against this backdrop, we believe that our bear-case $26 valuation is becoming more and more likely. As a reminder, we used the following assumptions to get to this valuation (for full details, see our article):

- 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.

- Discount rate of 10.4% (beta of 1.3x).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.