- Autodesk's 3-D printing hardware initiative confirms our view that entry barriers are coming down in the industry and that ASPs and gross margins are likely to keep trending south.
- More importantly, Autodesk's open-source software is a major threat to the profitability of 3D Systems and peers.
- If this software enjoys wide adoption, it could transform printer makers into plastic box makers, like Microsoft did with PC makers 30 years ago.
- The margin and earnings downside on 3D Systems remains significant, and we remain convinced that the stock is on its way to our $26 bear-case valuation.
At first sight, Autodesk's (NASDAQ:ADSK) announced launch of an open-source software platform called Spark is good news for the 3-D printing industry and its leader, 3D Systems (NYSE:DDD). Autodesk's long track record in the design software business is indeed likely to make Spark more reliable and more user-friendly than proprietary solutions. And the open-source nature of Spark will save printer makers R&D costs, and will enable them to offer less expensive printers. Consequently, this initiative is likely to favor the adoption of 3-D printers around the world. Great.
But a deeper analysis shows that this announcement also has key negative implications for 3D Systems and its peers.
First, Autodesk will ship an open-source 3-D printer to show off Spark's functionalities. We would not expect software maker Autodesk to turn into a hardware maker, but this initiative, which follows that of HP (NYSE:HPQ) just a few weeks ago, clearly demonstrates that the barriers to entry are coming down in the 3-D printing industry. As we said back in January in our article "Competition To Heat Up As Key Patents Expire", the gradual expiry of key patents between 2014 and 2017, notably the Laser Sintering patent (owned by 3D Systems), was likely to attract new competitors, and this is exactly what is happening. The outcome is quite simple: as many technologies are no more protected by patents, new competitors can develop 3-D printers at a low cost and sell them at low prices, putting pressure on ASPs in the industry and on gross margins. As a reminder, 3D Systems' gross margin on printers was down roughly 500bps in Q1, and the trend is unlikely to reverse soon, in our view.
Second, Autodesk seeks to become the 3-D printing software standard by offering free software to printer makers. In our January article "Autodesk: A Different And Safer Way To Play The 3-D Printing Revolution", we said that in the 80s and 90s, software makers were the real winners of the computer revolution, with Microsoft (NASDAQ:MSFT) grabbing most of the dollars generated by the PC industry at the expense of hardware makers. We believed that history could repeat itself in the current 3-D printing revolution… And apparently, Autodesk is trying to follow Microsoft's example, i.e. taking control of the software and transforming printer makers into plastic box makers. Therefore, Autodesk CEO's comments that the established players in the industry are unlikely to adopt Spark and that "it's going to be a fight" are all but surprising, as 3D Systems and peers will try to preserve their margins. Note that 3D Systems' operating margin was above 20% last year, while that of a PC and printer maker like HP is below 10%.
The margin and earnings downside remains significant, and we remain convinced that 3D Systems is on its way to our $26 bear-case valuation.