Description

We are recommending a short position in the shares of Stratasys LTD (NasdaqGS: SYSS).  Stratasys (or the “Company) is a leading global provider of 3D printing and additive manufacturing solutions.  The Company had previously been on a robust growth trajectory as revenue grew from $215M in 2012 to $750M in 2014. However; growth has recently stagnated as sales have declined to $672M in 2016 and the mid-point of 2017 guidance is $660M. While proponents of the stock view the recent revenue decline as a “momentary hick-up” in the Company’s growth trajectory, we believe the declines are structural in nature.  While we believe the industry will continue to grow at a robust rate; however, we expect share losses from increased competition will limit Stratasys growth and pressure margins.  While multiples have meaningfully come down over the last few years, the stock continues to trade as growth stock (~24x EV/non-GAAP EBITDA and a >100x PE multiple), despite the structural declines in growth rates and incremental margin risks from increased competition.  

We believe increased competitive intensity will drive margin pressure and increased share loss.  We note that Stratasys has seen its market share decline from ~40% in 2014 to ~17% in 2016 and analyst forecast share to continue to decline to 11% by 2018.  We expect increased competition will come from a number of sources:  

• 2D Printing Companies:  A number of 2D printer manufacturers such as HP and Ricoh (sole supplier of printer heads for PolyJet 3D printers) are looking to drive growth as the 2D printer market is in structural decline.   

• HP Inc.:  HP Inc. has disclosed having 400+ 3D printing patents. HP Inc. also introduced the HP Jet Fusion 3D printers (3200 and 4200 Series) in May 2016 that use its proprietary Multi Jet Fusion 3D printing technique. HP claims to provide end-to-end 3D printing solutions that are 10x faster and have 50% of the cost compared to existing FDM and SLS based 3D printing alternatives. Further, these solutions have a voxel level (i.e. volumetric pixel or 3D equivalent of pixel) control to provide high levels of precision and flexibility over control of properties such as color, texture, mechanical/electrical/optical characteristics among others. Unlike the SLS method that prints point-by-point, HP’s solutions print layer-by-layer at speeds of up to 340mn voxels per second, thereby providing significant speed advantage over competition. HP has partnered with several companies including:  BMW, Jabil, Johnson & Johnson, Nike, Arkema, Evonik, 3MF Consortium, Autodesk, and Siemens.  We note a recent William Blair report cited channel checks indicating a number of DDD distributors were switching to HP (we would expect similar pressure for SYSS). It is also worth noting that Jabil is slated to receive HP’s first MultiJet Fusion printer in North America.

• Japanese printing companies –Ricoh launched its AMS5500P in 2015 in collaboration with Aspect.  The product is focused on developing functional prototypes for the automotive sector. Epson plans to launch 3D printers by 2019 targeting industrial use-cases and Canon revealed its resin-based 3D printer concept in late 2015.

• Xerox:  While Xerox is yet to announce any material plans regarding the 3D printing market, we expect Xerox to be an eventual entrant.  

• Manufacturers Companies:  We expect that over time a number of 3D printing customers will become competitors as third party providers have not always been successful at matching their specific requirements and 3D printing will provide key differentiation vs. other manufacturing competitors.  

• GE:  – GE has invested nearly $1.5bn in its 3D printing business since 2010 and intends to grow the business to $1bn by 2020. GE has also made a number of acquisitions in the space:

• Morris Technologies in 2012 and leveraged it to 3D print fuel nozzles for its LEAP jet engine. GE intends to ramp nozzle production to 40,000 units by 2020.

• In late 2016, GE acquired Arcam and Concept Laser for $1.3bn.  These companies focus on metal printing and expand GEs patent portfolio related to powder metals. In contrast, Stratasys currently does not offer metal printing by itself, but leverages its printing bureaus to provide metal printing services.

GE’s internal development of 3D printing technologies will turn one of the largest industrial customers into a competitor for traditional 3D printing companies. GE expects to achieve $3-5bn in product related cost reductions as it utilizes its 3D printed components across businesses including aerospace, healthcare etc.

• Siemens:  Siemens has been investing in its product lifecycle management (PLM) software offering as part of its Digital Factory vision. Siemens has made a number of acquisitions such as LMS International (mechatronic simulation) and CD-adapco (computational fluid dynamics simulation) among others in the past to bolster its PLM software offering. The Company recently announced its intention to acquire Mentor Graphics.  Siemens aspirations in the space seem to go beyond software as it has recently been investing in metal based 3D printing as well.  Recent investments include a EUR 21 million investment in a printing facility in Sweden and a majority stake in Materials Solutions, a provider of high performance parts for the automotive, aerospace, and power generation markets.

• Startups:  3D printing is in early stages and has largely been limited to rapid prototyping and short-run manufacturing. However, a number of companies are developing technologies and materials focused on large-scale production.  Notable start-ups in the space include Carbon (Continuous Liquid Interface Production technology), Voxel8 (3DP for circuits), Local Motors (automotive manufacturing), XJet (NanoParticle Jetting) among others.

The pick-up in competitive intensity will manifest itself in both in continued share loss (recall share declined from 40% to 17%) and margin erosion.  We note that GE and HP are in lower growth and lower margin sectors (GE Gross margin ~40% and HP is ~20% vs. >50% for SSYS).  We believe both of these companies will price aggressively to capture share.  We also believe pricing will need to come down for the industry to drive adoption as well as transition from proto-typing to production (which tends to be much more cost focused).  In a recent Gartner study 60% of respondents cited price as the primary impediment toward adoption.  Additionally, 3D Systems recently cut the price of its ProX SLS 500 by 30% as well as lowering the reseller price on its consumable materials.  

We generously value the shares at 15x forward EBITDA (including SBC) for a target valuation of $16.51 or 30% downside from the 7-17-17 closing share price.

Catalyst

Increased competition will drive share loss and margin pressure.