Simbionix does not 3-D print anything… That's good news
Let's start with a positive. 3D Systems' (NYSE:DDD) announced acquisition for $120m of Simbionix, a maker of simulators for surgical planning/training, is great. Simbionix hardware isn't used to 3-D print anything, and that's why it's great, in our view.
We have been saying since the beginning of the year that margins on 3-D printers were likely to go sharply down in coming years due to intense competition and declining ASPs. Coincidentally, 3D Systems buys, in recent weeks, the services business Robtec in Brazil and now a specialized hardware manufacturer not active in the 3-D printing business. Huuummm... This sounds like 3D Systems is seeking to diversify away from the traditional 3-D printer business, as it's well aware of the risks this business is facing. That would be a smart strategy, but obviously one that would take time.
FY14 guidance: The risk is on the downside
Despite poor Q2 revenue growth (25%, o/w 10% organic vs. +30% organic in previous quarters), 3D Systems left roughly unchanged its FY14 revenue target ($700-$740m). Actually, it probably lowered it by $10-$20m for the core business, i.e. excluding Simbionix. Anyway, this guidance implies second-half growth will accelerate to 40%-50%... despite tough comps (+50% growth in Q3 and +52% in Q4).
The company claims a record backlog, new product introductions and the contribution of Robtec and Simbionix. Fine, but the bar is nevertheless set extremely high at a time when industry conditions have become much tougher (profit warnings across the board). There is clearly no room for error, and any delay in a product shipment would lead 3D Systems to cut its guidance. The risk is clearly on the downside.
The only way to achieve this guidance is to have a stronger-than-expected contribution from acquisitions and new M&A, but investors' focus is likely to be on organic growth, not on absolute numbers.
Long-term projections need to be revisited
Q2 underlying trends suggest that long-term assumptions about 3D Systems' revenue growth potential need to be revisited. First, the 24% revenue drop in the consumer business confirms that 3D Systems is unlikely to be a strong player in this segment, seen by many analysts and investors as a key driver of the 3-D industry.
The company pointed to delayed new product availability in Q2, but the segment was already weak in previous quarters. 3D Systems trails Stratasys (NASDAQ:SSYS), which has much better reviews on Amazon (NASDAQ:AMZN) and which is now on Home Depot's (NYSE:HD) shelves. And the major 3-D players are now starting to face competition from low-cost Asian players, as we explained in previous articles.
Second, the strong backlog increase in Q2 (vs. a sharp slowdown in revenue growth) could suggest that final purchase decisions take much more time than in recent quarters, even if we acknowledge that delayed shipments of consumer products played a role.
In all, we believe that expectations of sustained 30% organic growth over coming years are not realistic.
In the same time, gross margin trends are worrying and call for lower profitability expectations going forward. 3D Systems explained the -400 bps gross margin performance in Q2 by "product transitions, obsolescence of older lines, and increased COGS". Even taking this into account, the underlying gross margin was down, as it was already down in Q1 (-130 bps). Something is going on, but 3D Systems does not talk about it... Has anyone noticed that printer unit growth of 126% compared badly to printer revenue growth in the teens? Printers are selling, yes, but at bargain prices.
We stick to our view that the expiry of key patents between 2014 and 2017 is sparking increased competition and pricing pressures across the industry, as open-source hardware printers are now able to integrate technologies such as laser sintering, as illustrated by the recent Autodesk (NASDAQ:ADSK) or HP (NYSE:HPQ) initiatives.
This is just a question of time before 3D Systems and analysts reset their expectations. We reiterate our $26 bear case (for more details please read our February article "3D Systems: $83 or $26? Pick Your Scenario").
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