Will The New Stratasys Create The Same Returns For Shareholders?

| About: Stratasys, Inc. (SSYS)
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After finalizing the Objet merger and surging to new all-time highs, what is the prognosis for Stratasys, Ltd. (NASDAQ:SSYS)? After a major sell off to $57.77 back in early November, our analysis suggested the sector was ripe for investing. At the time, 3D Systems (NYSE:DDD) remained the preferred stock in the sector. So what should investors do now?

Even with valuations sky high, the sector remained relatively obscure until recently. The December announcement by Staples (NASDAQ:SPLS) of in-store 3D printing plans and the recent segment focus by Jim Cramer on his Mad Money show is pushing the sector into the overheated area.

Objet Merger

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.

The Objet merger was finalized on December 3rd with the stock languishing in the upper $60s. The merger immediately makes the company a leader in 3D printing and DDM. Having faced some regulatory delays and lack of updated guidance surrounding the Objet financials, a major concern had surfaced on whether the merger would remain very accretive considering the delay.

The new entity has a wide range of capabilities and materials. It will offer three leading technologies: FDM for functional prototypes and production parts, inkjet-based PolyJet for prototyping parts with high feature detail and fine surface finish; and Solidscape Drop-on-Demand thermoplastic ink-jetting technology for complex wax patterns. The company will clearly become a powerhouse in the sector, but is the stock a value now?

The company expects to eliminate some duplicate costs over the next 18 months, but the real benefit is expected from the synergies on the revenue generation side.

Earnings Forecast

A major benefit of the Objet merger was the ability of Stratasys to acquire the private company on the apparent cheap. The deal will be immediately accretive- and potentially significantly so- considering the ability for synergistic revenue gains.

Nearly 30 days after the merger, analysts have already increased the earnings estimates for 2013 from $1.71 to $1.93. Part of this gain is related to the strong Q3 earnings report, but the majority is due to the highly accretive deal.

Table - EPS Trends

The original pro-forma Q1 numbers had the earnings growing from $0.28 to $0.32. This nearly 15% increase in earnings, if applied to the original 2013 estimates, would probably lift expectations to $2. Or conversely investors can add 15% to the $1.40 the company guided to for the final 2012 earnings. Assuming the same accretive percentage as Q1, on a pro-forma basis the company would earn around $1.61 for 2012. Investors can model the earnings potential for 2013 based on the appropriate growth rate. The 30% earnings growth would yield an amount of $2.09.

Stock Valuation

When the deal was announced on April 16th, the stock traded around $35 and quickly soared to over $40 that first day. Investors were wise to jump on board then as the stock continued to nearly double by the time the merger was completed.

If the company earns $2 in 2013, the stock currently trades at a remarkable 40x those estimates. Unless Objet is even more accretive than the original numbers suggest, the stock is at the high end of any reasonable valuation.

As the below chart highlights, the 1-year returns in Stratasys are morphed by the incredible 250% gain by 3D Systems. Don't expect these returns to be repeated any time soon.

SSYS Total Return Price Chart

SSYS Total Return Price data by YCharts


As mentioned in most of the articles on Stratasys, the huge potential is only equaled by the huge valuation. Not to mention, the plans of Staples to utilize Mcor Technologies' printers highlights the risks in the sector. Although the public markets focus on only Stratasys and 3D Systems, several compelling options exist that could unseat the market darlings. Ultimately, the concern still exists that a huge multi-national company will become a major entrant in the market.

As in November, investors need to realize that the growth won't be unabated without risks. Buying this sector and especially the stock on dips is suggested. Some issue will come along to scare investors again and that's the time to buy the stock.

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.

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