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The Direct Digital Manufacturing and 3D printing sector remains hot with the strong results reported by Stratasys, Inc. (NASDAQ:SSYS) Friday morning. The stock, though, was smashed 12% as investors fretted over inline Q4 guidance.

Stratasys engages in the development, manufacture, marketing, and servicing of three-dimensional (3D) printers, rapid prototyping (RP) systems, and related consumable materials for office-based RP and direct digital manufacturing (DDM) markets.

As written back in September, with the stock trading on Objet highs, Stone Fox Capital warned that investors were placing too much emphasis on a complex merger. At that point, the stock was valued as if the merger would complete without any hitches.

Q3 Earnings Highlights

The company reported the following highlights for Q3 2012:

  • The company reported record revenue of $49.7 million for the third quarter ended September 30, 2012, a 24% increase from the $40.0 million reported for the same period last year.
  • System shipments totaled 911 units for the third quarter of 2012, a 52% increase when compared to 600 units shipped for the same period last year.
  • Non-GAAP net income was $8.7 million for the third quarter, or $0.40 per share, representing a 42% increase over the non-GAAP net income of $6.2 million, or $0.29 per share, for the same period last year.

The company reported $0.40 EPS versus analysts' estimates of $0.37. After a couple of basically in-line reports, Stratasys reported a solid beat and a substantial gain over the Q2 numbers.

Q4 Guidance

The company provided the following guidance for Q4 2012:

  • Revenue guidance of $194 million to $199 million, versus previous guidance of $193 million to $198 million.
  • Non-GAAP earnings guidance of $1.37 to $1.40 per share, versus previous guidance of $1.31 to $1.38 per share.

The selloff is very surprising considering the company upped guidance for 2012. Investors, though, always become overly suspicious when a company beats for the past quarter and doesn't up the guidance in the current quarter. For some reason, investors never account for that fact companies tend to provide conservative guidance.

Objet Merger

The Objet merger continues to languish with the Committee on Foreign Investment in the United States (CFIUS) still needing to complete a review. The earning call had significant information about the deal. It was expected to be completed in Q3 has now been pushed until the end of Q4.

The merger is expected to allow Stratasys to rival 3D Systems (NYSE:DDD) as the leader in the rapid prototyping and 3D printing market as far as revenue. The company originally provided solidly accretive numbers for the pro-forma Q1, but the details have been sparse for the quarters since then.

As feared, the merger that originally spiked the stock due to the ability to turn Stratasys into a market leading, profit maker has run into problems. Mergers of this size tend to be complex especially when dealing with multiple countries. Bumps in the road should be expected.

Considering investors originally imagined significant accretion to earnings by now, the lack of updated guidance for the merged entity should concern investors and not surprisingly limit upside gains.

New Products

The company has been successful in developing new products such as the Mojo 3D printer that provides access to 3D commercial printing at under $10,000. It also is seeing success with the RedEye service that provides real time production of commercial DDM parts. Instead of manufacturers having to purchase the expensive printers, Stratasys produces the parts for the customers. The company now employs 14 machines in this service.

Another growth option has been the transition away from the distribution agreement with Hewlett-Packard Co. (NYSE:HPQ) to a focus on an independent channel.

Valuation

Valuing the stock remains difficult pending the earnings of a combined Stratasys and Objet. Analysts previously forecast earnings of $1.62 in 2013. Based on the original accretive numbers from Objet, the combined company could earn $1.80 to $2. Unfortunately the company hasn't provided any updates to verify the accretive nature of the deal still exists.

6 Month Chart - Stratasys

The stock is now selling below the 20 & 50 day moving averages suggesting the stock could see some more weakness in the short term.

(click to enlarge)

Conclusion

The huge selloff on Friday provides an interesting entry point for this stock, though it still trades at 30x very rough earnings estimates for the combined entity. Naturally any rejection of the merger would have significant impacts to the stock.

Anybody interested in the 3D printing sector should probably look into investing in 3D Systems instead. The company provides a cheaper entry into the sector without risking a market-moving event that could impact the stock price.

Source: Was The Stratasys Sell-Off Overdone?

Additional disclosure: Please consult your financial advisor before making any investment decisions.