Desktop Metal: Investments In Technology And Recurring Revenue Streams May Imply More Than 41% Upside Potential
Summary
- Desktop Metal offers new additive manufacturing technologies based on the production of end-use parts. The company produces composite and metal systems for the automotive, heavy industry, and consumer goods sectors.
- Additional investments in reducing workflow complexity, software development, and hardware will most likely increase the adoption of additive manufacturing.
- Take into account that Desktop Metal is intending to replace industrial processes representing a target market of $12 trillion.
- If we use a free cash flow multiple of 40x, terminal FCF of $230 million, net debt close to $500 million, and a share count of 260 million, the implied share price is equal to $15.
- In my view, as more traders learn about DM's expectations, the demand for the stock will increase, which may push the share price up.
mgkaya/E+ via Getty Images
If Desktop Metal, Inc. (NYSE:DM) further invests in new innovative technologies to implement additive manufacturing technologies, sales will most likely trend north. Besides, if DM receives new potential recurring revenue streams from service contracts, the FCF margin would increase at a good rate. Under my best-case scenario, I obtained a fair price of $15 with moderate figures like a free cash flow multiple of 40x and a terminal FCF of $230 million.
Desktop Metal, Inc.
Founded in 2015, Desktop Metal offers new additive manufacturing technologies based on the production of end-use parts. The company produces composite and metal systems for the automotive, heavy industry, consumer goods, and other sectors:
Source: Desktop Metal, Inc.
Source: Desktop Metal, Inc.
Desktop Metal, Inc. appears to be doing almost everything in the product life cycle including product development and mass production. According to the management, additive manufacturing can change the way parts are designed and manufactured. In the last annual report, the company noted that the new technology is more competitive than old manufacturing processes in terms of both costs and volumes.
With Sufficient Investments In The Adoption Of Additive Manufacturing, I Assumed Sales Growth Of 21% And a CFO Margin Of 16%
In my view, if Desktop Metal, Inc. continues to invest in enhancing solutions to manufacture large quantities of parts at a lower cost, profitability will increase. In addition, clients will most likely choose the company’s additive manufacturing technologies, which may enhance revenue growth. It is also especially relevant to mention potential recurring revenue streams that may appear from sales of consumables and service contracts. Financial advisors will find the lines below like music for their ears:
Our solutions focused on volume production also enable us to capture recurring revenue streams through the sales of consumables and service contracts.
Source: 10-k
Finally, additional investments in reducing workflow complexity, software development, and hardware will most likely increase the adoption of additive manufacturing. Take into account that Desktop Metal is intending to replace industrial processes representing a target market of $12 trillion. If the company’s technologies are sophisticated enough, revenue growth will probably increase:
Historically, processes such as casting, stamping, molding, and machining have dominated global manufacturing, which is a $12 trillion industry, according to estimates by A.T. Kearney.
Source: 10-k
Under previous assumptions, I used sales growth of 21% y/y, which is close to the figure produced by the Wohlers Report 2020. It is also not far from the sales estimates produced by other investment analysts:
According to the Wohlers Report 2020 and management estimates, the global additive manufacturing market is expected to grow from $12 billion in 2019 to $146 billion in 2030 at a compound annual growth rate of approximately 25%.
Source: 10-k
As shown in the image below, I assumed that sales would grow from close to $101 million in 2021 to more than $4 billion in 2035. Sales growth would stand at 70%-50% from 2022 to 2025, and 21% from 2026 to 2035:
Source: Author’s Compilations
Competitors in the 3D printing industry report CFO/Sales of 9%-16%, so I will be using a long-term CFO margin of 16%. I expect a negative CFO for approximately three years, then an 8% margin, and finally a CFO margin of 16% until 2035:
Source: Ycharts
Under this particular case scenario, which I consider moderate, the FCF would grow from $7 million to $218 million in 2035. The FCF margin would stand at 4.9% in 2035:
Source: Author’s Compilations
If we use a WACC of 7.8%, which is the result of most CAPM models out there, the sum of the free cash flow stands at close to $293 million:
Source: Author’s Compilations
Competitors are currently trading at 43x-79x FCF. In my view, in 2035, the valuations would be a bit lower than now. With this in mind, I used two scenarios with 22x and 40x FCF:
Source: Ycharts
The results with a multiple of 22x include an implied market capitalization of $2.543 billion, and a fair price of $9.8:
Source: Author’s Compilations
Notice that Desktop Metal, Inc. has a significant amount of cash, and almost no debt. The asset/liability ratio stands at more than 17x. I believe that the management counts with a significant amount of liquidity to develop new technologies, and to enhance revenue and FCF generation:
Source: 10-Q
Source: 10-Q
If we use a free cash flow multiple of 40x, terminal FCF of $230 million, net debt close to $500 million, and a share count of 260 million, the implied share price is equal to $15. Under this particular case scenario, the shares appear cheap at the current valuation of $7.5-$10:
Source: Author’s Compilations
Sales Estimates Are Less Significant Than Expected Because Certain Industries Are Not Willing To Use Desktop Metal’s Technology
Desktop Metal, Inc. acquired competitors in the past, and the management intends to pursue acquisitions in the future too. It is among the objectives of the company. More M&A will most likely mean revenue growth, but it could also go wrong. Take into account that Desktop Metal, Inc. reported a significant amount of goodwill. If the management did not calculate the synergies correctly, accountants may have to execute an asset impairment. As a result, revenue growth may be less significant than expected, and FCF margins may not grow that fast.
I will also be expecting an increase in the distribution network. Currently, the company has over 265 resellers. If the company cannot increase its network, sales growth may not be as large as expected. The management is also assuming that new industries may be willing to enter the market. In this case scenario, I assume that certain industries will not be willing to adapt to the company’s new technologies:
We intend to extend this distribution network by adding further geographic coverage and sales capacity as well as developing industry-specific expertise to drive penetration in vertical markets such as automotive, aerospace, medical and dental, and consumer products.
Source: 10-k
Under this traumatic case scenario, I assumed sales growth of 15% from 2025 to 2035, and 70%-64% from 2022 to 2023. The company would be reporting sales close to $2.5 billion in 2035.
Source: Author’s Compilations
I also used a CFO/Sales margin of 14% with a capital expenditures margin of 11%. The result includes a free cash flow of $11-$79 million:
Source: Author’s Compilations
If we use a WACC of 8.2%, which is a bit higher than that in the previous case scenario, the sum of the free cash flow stands at $15.5 million. Notice that results would be very detrimental for the cost of equity, and would increase the WACC. When traders sell equity, companies usually find less attractive financing terms in the market:
Source: Author’s Compilations
With the previous figures, I also used a free cash flow margin of 20x, net debt close to $500 million, and 260 million shares outstanding. The implied result is equal to $4.1:
Source: Author’s Compilations
If we can sell equity at 37x FCF, the implied result would be closer to $5.87. Given the previous case scenarios, I believe that the downside risk is less significant than the upside potential. With this in mind, I will most likely buy shares of Desktop Metal, Inc. at the current valuation:
Source: Author’s Compilations
Conclusion
If Desktop Metal, Inc. continues to develop solutions to implement additive manufacturing technologies in new industries, sales growth will most likely increase. Potential recurring revenue streams from sales of consumables and service contracts could also be very beneficial for the revenue line. Under moderate assumptions, I obtained a fair price of $15, which makes the current valuation of Desktop Metal, Inc. quite cheap. In my opinion, as more traders learn about the expectations of the 3D printing industry, the demand for the stock will increase, which may push the share price up.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of DM either through stock ownership, options, or other derivatives. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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