Description

Shorting the 3D printing industry for the past year has been a great trade, especially 3D Systems (DDD), a company that offers dubious technology, is run by a promotional CEO fond of selling stock, has an aggressive channel selling strategy, and is covered by a cheerleading group of sell side analysts who vastly overestimated the size of the consumer 3D printing market.  But a lot has changed in the past year, mostly investor expectations and company valuations and through our diligence on the 3D printing industry, we discovered that rival Stratasys (SSYS) is a vastly different company than DDD.  While both companies produce 3D printers, the similarities end there.  SSYS is the leader in FDM (fused deposition modeling) 3D printing technology which is protected by several key patents that were recently upheld by the US patent office.  DDD largely sells printers into the competitively crowded SLS (selective laser sintering) and SLA (stereolithography) markets.  SSYS drop ships printers directly from their factories to customers whereas DDD requires their distributors to hold large amounts of inventory.  The risk of channel stuffing at SSYS is nil.  SSYS has largely grown into the world’s largest 3D printing company organically whereas DDD is a serial acquirer, using that purchased growth in order to mask underlying core sales weakness.  Both stocks are down huge from their peaks reached in early 2014 due to fears over rapidly increasing competition, product obsolescence, and bubble-like product cycles.  While it is true that the entire 3D printing industry is currently undergoing a hiccup in its long-term growth rate, there are numerous reasons to be excited about the future of SSYS. 

Without trying to sound too bombastic, 3D printing has the potential to drastically change the way the world manufactures products across numerous industries including aerospace, automotive, medical, consumer products, and electronics.  3D printing enables product designers of all types to take their virtual computer-created 3D models and produce them in the real world using an ever expanding palette of materials.  The first major application for 3D printing was rapid prototyping, a technique which enables the fabrication of physical parts in less than a day that previously took weeks to manufacture via custom molding.  Rapid prototyping is also cheaper than traditional service bureau-manufactured prototypes because custom molds are not needed and human labor is eliminated.  The second big application for the industry is in manufacturing production where 3D printers are being used today to produce both custom-made tools, jigs, and fixtures used on production lines as well as end-use parts that are being placed into airplanes, autos, and people’s bodies.  Additive manufacturing saves time and money, enables previously ‘impossible objects’ to now be manufactured, and reduces waste, all at the touch of a button.

SSYS is decidedly the world’s largest 3D printing company with approximately 50% market share.  The company primarily sells two lines of 3D printers: FDM and PolyJet.  FDM technology builds parts layer-by-layer from the bottom up by heating and extruding tiny droplets of thermoplastic filament.  FDM technology is the world’s leading 3D printing technology for a variety of reasons: 1) it supports hundreds of types of production-grade thermoplastics that designers are already familiar working with, 2) those same thermoplastics exhibit a plethora of desirable properties including toughness, environmental stability, flammability, translucence and biocompatibility, 3) and it enables the production of complex geometries that are impractical using traditional subtractive manufacturing technologies like CNC (computerized numerical control) machining.  PolyJet technology produces smooth, accurate prototypes with liquid photopolymers that have fine detail and can be manufactured using a large gamut of colors, transparencies, and flexibilities.  Via an acquisition in 2013, the company also produces consumer-oriented 3D printers under the MakerBot brand.

Fundamentally, SSYS operates a tried and true business model: razor/razor blade.   The company sells 3D printers to customers at a low gross margin and then enjoys an annuity stream of consumable materials for the life of the printer.  These spools of filament are proprietary to SSYS machines and carry 80%+ gross margins.  Materials revenues are about 30% of SSYS’ total and are growing at a 20% clip as the installed base continues to expand.  SSYS is also the world’s largest additive manufacturing service bureau whereby it enables customers who are not quite ready to purchase a 3D printer to have access to their capabilities via an outsourcing model.  Services are 25% of SSYS’ revenue and continue to grow 20%+ as the company continues to roll out its services globally.

SSYS is poised for growth and has been investing heavily in order to drive that growth.  Despite all of the wonders SSYS 3D printing technology brings to the manufacturing space, growth has recently slowed due to a tough global capex environment and difficult comps.  Given recent channel checks, we are confident that growth is likely to resume at its historical rate of 20%+ within the next year due to very strong sales pipelines at SSYS resellers, continued strong growth in both materials and services, and the lapping of a product quality issue at MakerBot.  

3D printers represent capital sales and the business is inherently lumpy.  FX headwinds from a strong dollar have also impacted sales overseas, particularly in Asia-Pac, where currencies such as the yen have fallen dramatically in their purchasing power over the past year.  Furthermore, the company’s MakerBot subsidiary has had product quality issues that have led to steep sales declines Y/Y as the company is attempting to rehabilitate the brand.  SSYS has missed revenue estimates the past four quarters but we believe expectations have been sufficiently set low enough that when the true organic growth rate of the business starts to shine through over the next few quarters, the stock will begin to re-rate appropriately.  As such, when the market slowed down in 1H15, operating margins depressed, and the company had to reset expectations for the full year.  Despite this, we believe the company can return to mid-teens operating margins in 2016 as top line growth reaccelerates and opex is expected to be flat to down Y/Y.  Our 2016 EPS estimate is much higher than the Street consensus and at a 35x multiple we think the stock is worth $75 (+150%).  Additional upside may come in the form of two new printing platforms, SLA and SLS, that SSYS is currently developing.  These two technologies represent a competitive, but growing field within the 3D printing industry and with SSYS’ global distribution we believe the company can take meaningful market share over time.  Our downside is protected by the 20% of the market cap that is in cash, the high gross profit annuity stream generated by the materials and services businesses, and the large amount of intellectual property the company has developed over the past 20 years. 

In our estimation, the market is currently ascribing a low value to SSYS because they equate the company with both a fad (3D printing) and a hyped stock (3D Systems).  SSYS is neither.  It is the world leader in a rapidly growing industry that is poised to change the way the world manufactures everything.

DISCLAIMER: The author is long SSYS.  This is not a recommendation to buy or sell any investment.  Additionally, this document should not be relied upon to make an investment decision as the numbers and figures presented are solely the author’s estimates.  Investors should contact the company directly and read SSYS public filings to form their own opinions and make their own investment decisions.  The author may transact in the securities of SSYS without notice.  

Catalyst

- After lapping tough 2014, double digit organic growth of the 3D printing industry shines through in 2016 and beyond.