Description

3D Systems Situation Overview:

Carbone959 originally wrote up 3D Systems on VIC back in 2013, which was a well-thought out and timely write-up. 

Since this write-up, as carbone959 presciently opined, 3D Systems has experienced lackluster organic growth, turning negative in 2015. The stock has had three reprises since this period, May 2017, September 2018, and currently (Jan 2021), where a transient period of growth invites new investors dazzled with the “theme” of 3D printing while shorts are squeezed. Just as in May 2017 and September 2018, we believe 3D System's is currently setting up to similarly be a timely short.

If one approached this Company with fresh eyes and observed the organic growth profile shown below, one ought to think the business was in secular or competition-driven decline and garnered a low multiple of revenue / profits:

Yet as of today, the stock is up 200% since the end of 2017 driven by 3D pre-announcing its 4Q20 results on Jan 7th, wherein they reported the expectation of “strong [4Q20] organic growth exceeding 20% in both Healthcare and Industrial business units on a consecutive quarter basis.” As one can see above, this would imply a resumption to y/y organic growth (albeit comping off a -8% quarter in 4Q19). 

Business Description:

3D Systems was originally founded in 1986 by the inventor of stereolithography (SLA) 3D printers. Since this time, the Company has acquired more than 50 tuck-in acquisitions. As it exists today, the Company’s two printing technologies are SLA and SLS. SLA is mostly used for dental printing (aligners) and prototype creations, while SLS is used in various industrial processes. We believe SLA makes up >80% of 3D’s revenue. 

Idea / Thesis: 

We believe the positive organic growth that 3D systems is currently seeing (+5% in 4Q20 after -15% y/y in 3Q20) is driven largely by the capacity build-out of a major customer, Align Technology, the maker of invaslign branded dental aligners. The Company remains competitively challenged in both SLA and SLS 3D printing technologies, which should hinder longer-term organic growth prospects. 

As such, we view the current resumption of growth as transient and therefore low quality; not fuel for a doubling of the stock to 5.4x 2019 (pre-pandemic) revenue (or 36x EBITDA if one assumes they earned a 15% EBITDA margin on these sales).

We believe the Company might be worth 3x sales to an acquirer, with little standalone value of the business. We estimate the normalized revenue of this business at around $600mm, placing the implied EV at $1.8bn (or a $1.85bn mkt cap including a small amount of current net cash). This equates to $14.92/share or 46% downside from the current price. 

Temporary demand boost from Align Technology’s capacity buildout.

While this is not stated explicitly by 3D Systems, we believe its largest customer is Align Technology.  

Align makes a dental aligner product which is a custom made piece of plastic that molds ones teeth (an “invisible” replacement for braces). Align produces these aligners using 3D printers -- specifically 3D System’s iPro 8000 (one can see a walk through of Align’s facility in their promotional video here, which shows an iPro 8000 machine at the 32 sec mark https://www.youtube.com/watch?v=bKsGNrEKx9M). Though we think Align has started to use 3D’s next gen Figure 4 printer, for the purposes of this analysis we show the economics as if they are still using iPro machines (we have not been able to confirm the cadence / use of Figure 4 yet and using the iPro 8000 as reference is still largely illustrative). They essentially take dental imaging in, 3D print a custom plastic aligner, and ship it back to the customer (a very unique application requiring the massive customization of 3D printing). 

Align has expanded capacity significantly over the past two years given the underlying growth of its business. This capacity expansion has not been steady, though, which has created distortions in 3D’s revenue growth over time. Specifically, in the 1H of 2018 they began the purchase of new 3D printers for a new manufacturing facility in China (which began operations in 4Q18): 

“We expect Q4 gross margin to be in the range of 72.3% to 73%, reflecting lower margins as we begin to produce clear aligners in our new manufacturing facility in Ziyang, China, where we will initially have higher fixed costs spread across very low volumes. “ -- 3Q18 Align Investor call

This timing directly ties up with a spike in 3D System’s healthcare revenue om 2Q18 ($61mm, or 27% y/y growth, contributing 5ppt to the overall y/y growth in the quarter, 11% y/y).

When taking a look at Align’s disclosed capacity (on conference calls they sporadically update how many aligners they are printing in a day), we can see the huge jump between 1H18 and 2H18, but another huge jump from 2019 to 2020:  

12/2/2020        750,000 to 1,000,000

12/4/2019        500,000

6/5/2019          450,000

6/14/2018        350,000

2/15/2018        300,000

2/16/2017        200,000

6/2/2016          150,000

5/29/2014        100,000

We give a range for the most recent data point because management was not explicit on their call:

“We know how to manufacture at scale. We're producing 750,000 plus aligners sometimes in a day, sometimes 1 million unique aligners in a day.” -- Align conference call on 12/2/20

To spell this out -- their capacity for printing aligners grew 500,000 (or 250,000 depending on how one reads mgmt’s commentary) from YE2019 to YE2020. This compares to the prior large growth experienced of ~250k from the start of 2018 to the start of 2019 (in-line with the China facility build-out). 

That is massive growth in 2020, and we do not think this came in the first half of 2020. Align’s business was hit by COVID, shipments of aligners went from growing 24% y/y in 4Q19 to just 3% in 1Q20 and declined 41% y/y in 2Q20. They caught up in 3Q20 and 4Q20 (+29% and +21% y/y respectively), which we think necessitated their investments in new capacity (there was pent up demand from the pandemic and they moved quickly to flex up capacity to serve it). 

Just like we saw back in 1H18, with this lumpy capacity build out by Align in 2H20 we are also seeing 3D’s healthcare revenue inflect to a peak. 3D’s disclosed 3Q20 healthcare revenue grew 7% y/y after 2Q20 declined by 11% y/y. I estimate 3D’s HC revenue grew to ~$74mm in 4Q20, or 35% y/y growth. 

Making some estimates for Align’s contribution to 3D’s revenue, we believe 3D’s revenue would have actually declined 9% in 4Q20 vs. the +5% growth implied by the mid-point of their 4Q20 pre-announcement if Align had not placed orders for these printers. This is using the 750k figure (and not the 1mm figure that ALGN mgmt also offered on their call).

We arrive at this by the following analysis: 

We assume Align’s capacity in 4Q20 hit 750k aligners per day (in-line with the low end of their commentary). The last stated number we have for capacity was 500k aligners per day back in 4Q19. Since ALGN only grew shipments 3% y/y in 1Q20 and the world entered into the COVID-19 pandemic, we assume they only added an incremental 25k worth of capacity in 1Q20 and no incremental capacity in 2Q20. This means that the Company added 225k worth of capacity in 2H20, or 112.5k per q on avg. 

The iPro 8000 can produce 75 molds per hour, or 1.25 molds per minute. If we assume the Company operates at 85% uptime, this would imply a total of 147 printers were required in 2H20. (1,440 minutes in a day, 1.25 molds per minute = 1800 molds per printer per day. 85% uptime = 1,530 effective molds per printer per day. 225k of incremental aligners printer capacity per day / 1,530 = 147 printers needed). 

We believe these printers carry ASP of $400k, or ~$30mm of revenue on 74 printers ordered in each of 3Q20 and 4Q20. 

This math is shown below:

Longer-term competitive factors

I do not want to belabor the competitive factors here as the focus of this writeup is the transient demand from Align adding capacity and others have done a good job over time detailing competitive dynamics in space.

At a high level, my takeaway has been that there is decent competition for 3D Systems. No competitor that is going to immediately crush their business - but a setup which makes extended periods of profitable growth unlikely for 3D. 

Within SLA offerings, 3D is getting squeezed at the low end by competitor FormFactor while the Chinese manufacturer UnionTech is making some in-roads at the high-end (we have seen UnionTech’s product go for >50% cheaper than a comparable 3D unit at times). 

UnionTech has a dominant share of the Chinese market (~70%+), but it still needs to improve its distribution in the U.S. The key issue with further growth by UnionTech for 3D systems will be that UnionTech is an open system - meaning it can use any material. 3D Systems attempts to lock customers into buying their highly priced (high margin) materials. If UnionTech gains traction by selling its printers at a discount to 3D and does not lock in customers to expensive materials, 3D’s business could be significantly impaired. 

Within SLS, HP and EOS compete. HP announced a line up of 3D printers called Jet Fusion which it claims is superior to DDD (they are not calling these SLS printers, but they are very similar). 

Valuation

We value 3D Systems by applying a 3x sales multiple to our estimate of normalized revenue of $600mm. With slight net cash PF for a recent small divestiture, this yields a $1.85bn mkt cap, or $14.92/share and 46% downside from the current price. 

$600mm of normalized sales is a decent amount above consensus for 2022 ($573mm), and 4.5% below FY19. While 3D has never shown material profitability since 2013 (LSD EBITDA margin since then; -1% in 2019), as it attempts to subsidize printers to garner a long tail of higher margin material revenue-stream, we give them the benefit of the doubt and assume normalized EBITDA margins of 15% (what they might earn if costs are cut / they are acquired by a strategic). This would be $90mm of EBITDA, or ~38x EBITDA at today’s EV (3.4bn). 

Risks

• There is a camp of people who believe most dentist practitioners eventually will have their own 3D printer so they can print dentures and surgical guides, among other commonly used items. There may be an opportunity for 3D Systems at dental labs. 

• There has been limited traction so far at the dentist office as the cost/benefit still favors centralized manufacturing / manufacturing at dental labs. 

• Stratasys and Formlabs are competitive here. 

• Align is going to open another manufacturing facility in Europe in 2021 that may create another lumpy quarter or two for 3D’s business. 

Disclaimer: This memorandum is for discussion purposes only and is not intended to be, nor should it be construed or used as, financial, legal, tax or investment advice or a general solicitation. This memorandum is as of the date posted, is not complete and is subject to change. The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates. Certain information has been provided by sources believed to be reliable, but has not been independently verified and its accuracy or completeness cannot be guaranteed and should not be relied upon as such.

Catalyst

End of Align's capacity build out resulting in a resumption of organic revenue decline for 3D.