IPO Preview: Proto Lab

| About: Proto Labs (PRLB)

Based in Maple Plain, MN, Proto Lab (proposed PRLB) scheduled a $60 million IPO with a market capitalization of $325 million at a price range mid-point of $14 for Friday, February 24, 2012.

PRLB is one of four IPOs scheduled for this week (see our IPO calendar). Notice that Yelp! is scheduled for next week.

PRLB is a service business that quickly develops prototypes for low production runs. PRLB's current competitive edge is a set of proprietary programs for computer numerical control (CNC) machines.

For the year ended December, 2011, PRLB's sales increased 52% to $99 million from $65 million and profit increased 64% to $18 million from $11 million.

Comparing sequential quarterly growth for the December, 2011, quarter with the previous (September) quarter, sales are down 5% and profit is down 42%.

Normally IPOs that are successful in the IPO after-market go into their IPO on an upswing. The relative decline in sales and profit for the December quarter gives us pause.

Also, PRLB's specialized service could become commoditized in the future as rapid prototyping becomes easier and cheaper for the end user or the end user's suppliers to do themselves.

Our initial thought was to avoid PRLB on the IPO, because the December quarter was down relative to the September quarter.

PRLB looks reasonably valued at 25 times earnings (at the price range mid-point) for the year ended December, 2011, except for the December quarter decline in sales and profits.

But because the Dow is flirting with 13,000 and because the current stock market is hungry for companies that have internal growth, we now believe PRLB is a buy on the IPO.

PRLB is in the 'rapid prototyping business.'

"Rapid prototyping" is the automatic construction of physical objects using additive manufacturing technology. The first techniques for rapid prototyping became available in the late 1980s and were used to produce models and prototype parts. Today, they are used for a much wider range of applications and are even used to manufacture production-quality parts in relatively small numbers. Read more

Early in the product development process, "additive rapid prototyping" processes such as stereolithography, selective laser sintering, fused deposition modeling or 3D printing can be used to quickly produce an approximate physical representation of a part, but these representations often do not meet product developers' requirements for dimensional accuracy, cosmetics and material properties.

As an alternative or supplement to additive rapid prototyping, CNC machining can be used to produce low volumes of high-quality custom parts in either metal or plastic, while for follow-on functional testing, market evaluation and production runs, plastic parts are typically manufactured using injection molding. Both CNC machining and injection molding yield a part with the look, feel and performance of the finished product.

2012 (January fiscal) vs 2011
BV's revenue increased $34.0 million, or 52.4%, for 2011, compared with 2010. Of this growth, $15.6 was attributable to sales to 3,430 existing customer companies, and $18.4 million was attributable to sales to 2,600 new customer companies acquired during 2011.

Overall revenue growth was driven by a 51.9% increase in U.S. revenue, a 53.8% increase in international revenue, a 46.2% increase in Protomold revenue and a 74.6% increase in Firstcut revenue, in each case for 2011 compared with 2010.

There are several important trends impacting product developers worldwide, including the increasing use of e-commerce to bring efficiency, collaboration and immediate access to information, the increasing pressure to accelerate the speed with which they can bring their new products to market, and the increasing adoption of 3D CAD software to facilitate the design of custom mechanical parts.

PRLB knows of no published third-party estimates of PRLB's specific addressable markets.

PRLB's Protomold injection molding service addresses a subset of the plastic injection molding market, which Plastics Custom Research, a market research firm, estimates was $50.3 billion in North America in 2010.

PRLB's Firstcut CNC machining service addresses a subset of the machine shop services segment, which IBISWorld, a market research firm, estimates was $34.9 billion in the United States in 2010.

In addition, according to Jon Peddie Research, a market research firm, in December 2009 there were approximately 13 million users of CAD software worldwide, of which approximately 41%, or 5.3 million, were users of 3D CAD software.

PRLB believes a substantial portion of these 3D CAD users were product developers working in industries PRLB serves, although PRLB does not serve every application within these industries.

From the inception of the company in 1999 through December 31, 2011, PRLB has filled orders for 20,000 product developers.

PRLB's customers conduct nearly all of their business with PRLB over the Internet.

PRLB targets its services to the millions of product developers who use three-dimensional computer-aided design, or 3D CAD, software to design products across a diverse range of end-markets.

PRLP believes its use of advanced technology enables the company to offer significant advantages at competitive prices to many product developers and is the primary reason PRLB believes it has become a leading supplier of low-volume custom parts.

PRLB customers typically order low volumes of custom parts because they need a prototype to confirm the form, fit and function of one or more components of a product under development, or because they need an initial supply of parts to support pilot production while their high-volume production mold is being prepared, or because their product will only be released in a limited quantity.

In each of these instances, PRLB believes its solution provides product developers with an exceptional combination of speed, competitive pricing, ease of use and reliability that they typically cannot find among conventional custom parts manufacturers.

PRLB's technology and manufacturing expertise enable the company to ship parts in as little as one business day after receipt of a customer's design submission and process a large number of submissions.

As a result, many of PRLB's customers tend to return to Proto Labs to meet their ongoing needs, with approximately 77%, 77% and 81% of revenue in 2009, 2010 and 2011, respectively, derived from existing customers who had placed orders with PRLB in prior years.

Right now PRLB has developed state-of-the-art systems for additive, rapid prototyping; computer numerical control applications.

We are concerned that advancing technology will make the rapid prototyping process faster and cheaper, and easier to use so that specialty services PRLB provides will, in time, become more of a commodity - although not quite to the point of self-service printing at FedX Kinkos (NYSE:FDX).

In other words, PRLB may lose its competitive edge as prices go down and alternative capabilities go up.

Take the case of 3D printing, for example. 3D printing is a phrase used to describe the process of creating three dimensional objects from digital file using a materials printer, in a manner similar to printing images on paper.

The term is most closely associated with additive manufacturing technology, where an object is created by laying down successive layers of material. Recently the term is increasingly being used to describe all types of additive manufacturing processes, or even other types of rapid prototyping technology.

Since 2003 there has been large growth in the sale of 3D printers. Additionally, the cost of 3D printers has gone down. The technology also finds use in the fields of jewelry, footwear, industrial design, architecture, engineering and construction, automotive, aerospace, dental and medical industries, education, geographic information systems, civil engineering, and many others. Read more

The market for low-volume custom parts manufacturing is fragmented, highly competitive and subject to rapid and significant technological change.

Current and potential competitors include captive in-house services, other custom manufacturers, and alternative manufacturing vendors such as those utilizing stereolithography, selective laser sintering, fused deposition modeling and 3D printing.

Moreover, some of PRLB's existing and potential competitors are researching, designing, developing and marketing other types of products and services.

PRLB also expects that future competition may arise from the development of allied or related techniques for custom parts manufacturing that are not encompassed by PRLB's patents, from the issuance of patents to other companies that may inhibit PRLB's ability to develop certain products and from improvements to existing technologies.

And PRLB's competitors may attempt to adopt and improve upon key aspects of PRLB's business model, such as development of technology that automates much of the manual labor conventionally required to quote and manufacture low-volume custom parts, implementation of interactive web-based and automated user interface and quoting systems and/or building scalable operating models specifically designed for efficient low-volume production.

Third-party CAD software companies may develop software that mold-makers, injection molders and CNC machine shops could use to compete with PRLB's business model. Additive manufacturers may develop stronger, higher temperature resins or introduce other improvements that could more effectively compete with PRLB on part quality. The PRLB IPO is scheduled to price Thursday evening.

$54 million for working capital and other general corporate purposes

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.