3D Systems: Where We Went Wrong, A Value Perspective Post Earnings

| About: 3D Systems (DDD)

Summary

Investors obviously got the long term trend of DDD wrong, but how so? And why?

Obvious prospects for physical growth in a business do not translate into obvious profits for investors.

I provide a counter to a recent Seeking Alpha post arguing that its price/book ratio is attractive.

After yet another expected whiff on Q2 earnings, despite a massive morning rise, DDD is still not a buy.

I never considered myself a "value investor." Value, ha, that's for the older crowd with their Microsofts (NASDAQ:MSFT) and IBMs (NYSE:IBM) isn't it? Maybe after my lesson learned from 3D Systems it's not as outrageous a concept as I thought it might be. Some time ago, this way of thinking led me to buy some shares in perhaps one of the most infamously shorted stocks of the past 18 months - 3D systems (NYSE:DDD). 3D Systems violates just about every principle of value investing.

In Part I of this article I analyze several things investors missed, and continued to miss quarter after quarter. In Part 2 I analyze a fellow Seeking Alpha writer's recent post prior to earnings arguing that 3D Systems is a Buy, and address his methodology error in valuing a company with such a high proportion of intangible assets with a price/book ratio. Despite a 25% rise as of this morning for reasons that might only become apparent on the conference call, 3D Systems continues to be an extremely underwhelming stock.

A Quick Peek at the Numbers

3D Systems reported a Q2 2015 loss of $13.7 million, despite reporting a profit in the same quarter in 2014. It also lost 12 cents a share, and made an adjusted 3 cents per share, under the expectations for 8 cents a share. 3D Systems also missed on revenue by about $8-10 million depending on what estimate you're using, coming in at $170 million. Revenue growth was 13% over the 2014 prior quarter. Organic revenue also declined by 5% (!!).

CEO Avi Reichental summed up earnings with the comment he has used almost every recent quarter, stating that they are "disappointed with the overall results" and that there are still, somehow, "operating inefficiencies" affecting growth. The stock has been up and down this morning, rising to almost $15 (a near 30% gain), before falling to the low $14 at the time of this writing. This can probably be explained by satisfaction that at least 3D Systems didn't completely blow the ball on revenue. So is this a time to jump back in? I think not.

Limit Your Selection to Stocks Selling Not Far Above Tangible-Asset Value

3D Systems failed miserably on this metric during its stratospheric rise, as well as on its downward descent, and it continues to fail in this respect. Value investors limit themselves to companies selling not too far above tangible asset value, excluding intangible assets like goodwill, copyrights, trademarks, patents, and brands.

3D Systems Form 10-Q filed for the recent quarterly period ending March 31, 2015 states that 3D systems goodwill and net intangible assets totaled just over $901 million of its $1.513 billion dollar assets. As of the end of that period, 3D Systems closed at $27.42, a massive drop from its near $100 price point just 15 months prior. Its market cap at the time was about $3 billion (down from about $10 billion at the top of its run), or about 4x tangible assets.

Has any of this changed for the current quarter? No. 3D Systems reported $627 million in goodwill and another $287 million in net intangible assets. It's total assets were $1.526 billion, resulting in total tangible assets of $612 million. Thus, it currently trades just under 3x tangible assets. The pricepoint is certainly more attractive than ever before, but another big issue remains.

Obvious Prospects for Physical Growth in a Business Do Not Translate Into Obvious Profits for Investors

At its peak the growth of 3D Systems was so obvious to the world. Canalyst predicted the global 3D printing market to grow to $16.2 billion by 2018, attaining a compound annual growth rate of 45.7% from 2013 to 2018. Even as the industry began its retrospectively obvious decline, Gartner predicted a compound annual growth rate of 106.6% in worldwide shipments of 3D printers from 2012 to 2018, and a revenue growth of 87.7% for this period. If an inflection point was coming, the market still seems to be waiting for it.

3D Systems is not even close to matching market expectations when it comes to this level of growth. Their Q1 2015 Q/Q growth was a paltry 8.7%, and their Q2 2015 Q/Q growth was, as stated, 12.5%. Their organic growth actually declined this quarter - growth not accounting for acquisitions less than one year old. The company has simply failed to demonstrate, quarter after quarter, that it can generate consistent double digit revenue growth.

When company growth consistently fails to meet expectations for industry growth, you have a problem on your hands. Those that spotted this earlier than others saved a lot of pain. With such large expected revenue growth, many expected at least some evidence of profits, yet 3D Systems continues to show losses, all while being unable to grow revenue even close to industry expectations.

Minimize the Odds of Suffering Irreversible Losses

The classic saying goes that "taking a foolish risk can put you so deep in the hole that it's virtually impossible to get out." 3D Systems is the epitome of that stock, despite it looking like it can't go too much lower than the mid-teens. But with continued operational efficiencies, a lack of evidence that it can sustain any semblance of large double digit growth sufficient to warrant its price, and a lack of any evidence that the business can be profitable at any point in the near future, more losses may yet to come, despite the nice bump this morning.

Is 3D Systems a Buy after Q2 Earnings?

Fellow Seeking Alpha contributor George Kesarios recently wrote that 3D systems was a buy at $15 a share (it now sits near $13 by the way). He stated that "[a]n added feature is that the stock is also trading close to book value, with the Price/Book ratio at about 1.3. So you are basically buying the stock at book, something very rare for a growth stock."

Mr. Kesarios's calculation is premised on including the nearly 60% worth of intangible assets that comprise 3D Systems. If we take out 3D System's intangible assets, and use 3D System's Price/Tangible Book Value (a more reasonable metric for this type of stock given its massive proportion of goodwill), its recently reported tangible assets are about $612 million, and its liabilities $230 million. Thus, it's tangible book value is $382 million. With a market cap of about $1.6 billion, we get a tangible price/book ratio of about 4.2. I leave the conclusion as to whether that makes it a buy or sell, but given 3D System's almost unnatural proportion of intangible assets on its books, I believe the tangible book value per share should be used when considering the stock, and that using the price/book ratio in such a straightforward manner may be somewhat misleading.

Disclosure: I/we 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.

Additional disclosure: I am not a professional investor and the opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.

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