I should preface this by saying that though I tend to be gadget-happy and lust for the latest toys from tech-world … I still tend to think that many fabulou breathroughs are dumb ideas that will never catch on. After all, not everyone can be as silly as me, right?
I was convinced that putting cameras in cell phones was idiocy. And having a little machine that you carry with you so your boss can email you at any time, day or night, and the little box will ping you and force you to be available at all hours? That could obviously never catch on. Or after that, after we’d all gotten addicted to our little Blackberries, what on earth was the chance that a little touch screen device that didn’t even have a keyboard, which makes you misspell every other word, what were the odds that would beat out those handy little keyboards?
Except that everyone has a camera in their phone now. And Blackberries were even more ubiquitous five years ago than iPhones and their ilk are now. So I shouldn’t be trusted to pick the next hot technology that will take off, because even when I want one I think they’re foolish and destined to appeal only to nuts like me.
Thus it is today that we look at three-dee printing for our “Idea of the Month” fun. Why? Well, partly it’s because I think it would be really cool to have one but I think it’s patently absurd that any normal person would want one — that’s my contrarian side. And partly it’s because every newsletter and his brother is touting one or another of these picks, so I thought, now that we’ve seen a pullback in most of the companies, that now might be the time to see if we could get on board with one or another of them.
I should let you know, though, that it was a close call this month. I had several other ideas percolating, and came very, very close to profiling Mako Surgical (MAKO) this time around — but I’ve gotten a bit greedy. Since MAKO is so expensive relative to any conventional metrics, and priced for blue-sky growth as the “next Intuitive Surgical” (as it has been dubbed by several pundits), I want some more bad news first. I really want them to report another quarter with good procedure growth and bad device sales, with a few more academic analyses that buttress their argument that the robotic arm really does help to improve outcomes for knee arthroplasty and hip replacement. Then they’d be taking a real page from the Intuitive Surgical handbook, back when I owned IRSG in its early growth days (yes, I sold it far too early in the low $100s) it often made huge jumps up and down on earnings and gave opportunities for long-term holders to get in slowly on the way up if they believed in the story.
I am close to believing in the Mako story and buying the argument — or at least, buying the argument that baby boomers will respond to the marketing campaigns and demand MAKOPlasty over conventional treatments, so we’ll see. That patient demand is the key factor — it was men who saw the marketing that said (with some evidence to back it up) that robotic prostatectomy improved sexual function and bladder control who demanded robotic surgery, and it was those same patients who forced hospitals to compete with one another to see who could attract surgeons and patients by having enough robots available. And as more robots were bought for a million bucks a pop, hospitals felt the need to use them more often, creating a cycle of profitability. So I think we’re close to starting that cycle with MAKO, which will always have a smaller niche than the ISRG da Vinci, but I’m not quite convinced yet … this might be a reasonable time to start nibbling, but I’m going to keep reading.
Today, though, it’s about 3D. Not 3D movies, but three dimensional “printing” — the machines and software that take three dimensional computer designs and turn them into physical objects. It is unbelievably cool, which is why most of the newsletter ads teasing these picks include a video of how they work … and the machines are now reaching somewhat of a tipping point even if they will probably remain marginal toys on the high-end consumer side for quite a while.
And as the Motley Fool folks, Michael Robinson, and now the Casey Research folks in their ad that launched this week have all said, there are a limited number of companies that are poised to dominate the business, much as the few firms like Epson, HP and Lexmark dominated regular desktop printing in the early home computer days before printers became almost completely commoditized (though some of them still do just fine on the rapacious pricing for replacement inks, even though that market, too, has opened up to more competition).
The Casey ad just started running, and it’s one I haven’t written about yet — so let’s build our look at these stocks by first checking out how they tout ‘em.
That ad starts out with the big picture tease:
“Former Microsoft Employee Builds Machine in His Basement… Expected to Make Its Way into Millions of US Homes and Generate $3.7 Billion by 2015″
That former Microsoft employee is Alex Daley, who edits Casey’s Extraordinary Technology letter, and it sounds like he probably built one of these 3D printers in his basement, which is what a lot of tech hobbyists do (you can buy a kit a lot cheaper than you can buy the completed machine).
And after he goes on to describe his upbringing as a brilliant geek and his tech savviness and experience, he tells us that he thinks the 3D printing/rapid prototyping movement could become huge … here’s how he puts it:
“I tell you these things not to brag, but to show you that through my experience in the trenches of high tech… as an advisor to wealthy angel investors… as a collaborator with inventors… and as a trusted member of Bill Gates’ R&D team… I have a unique advantage when it comes to finding the next big disruptive idea – the next opportunity to generate an obscene amount of money from a single investment.
“And I believe I’ve found such an opportunity…
“‘Bigger than the Internet’ ….
“Earlier last year, I began studying a new type of technology that will not only radically alter the way we share ideas and purchase everyday goods, but will likely solve one of the biggest public health crises in the US.
“In fact, it’s a pretty safe bet that this technology’s significance will fall somewhere between the invention of Twitter and the dawn of the Industrial Revolution.
“And I’m not the only one saying this…
“Fellow technologists like MIT Professor Neil Gershenfeld say this technology is ‘every bit as important as the invention of the personal computer.’ Digital strategist Steve Sammartino goes so far as to say that it will bring about a revolution that falls into the ‘bigger than the Internet’ category. And Business Insider reports that this technology will be ‘the next trillion-dollar industry.’
“The technology I’m referring to is the science of replication.”
OK, so yes, “replication” is one thing these machines are good at — if you have a decent 3D scanning capability (and this is even an iPhone app now, so it’s certainly getting democratized just as the machines themselves are) you can actually make pretty good 3D copies of lots of basic objects. Higher-end 3D printers and laser scanners can approach perfection at this.
Here’s how he describes it:
“… let’s just say it works at the sub-millimeter level to convert and synthesize the human imagination into a living reality… giving 300+ million Americans the ability to turn an idea into a tangible object in a matter of minutes.”
I think the home machines are basically at the millimeter level in terms of their level of fine detail, not sub-millimeter, but yes, I’m sure they’ll continue to advance quickly — and the bigger professional machines are, of course, better. Here’s the quick history from the ad, which, like other ads for 3D printers, starts with the premise that we’re following the same basic trend of technology adoption that brought computers into homes and phones into shirt pockets:
“… the science of replication dates back to 1986.
“At the time, an engineer named Chuck Hull was working at a manufacturing plant called Ultra Violet Products or UVP in Valencia, California.
“After hours, when all the other employees went home, Hull spent his time in the back offices of UVP, experimenting and developing this replication technology.
“Initially Hull called the process “stereolithography” and defined it as a method for making solid objects by successively “printing” thin layers of ultraviolet-curable material one on top of the other until a fully formed object emerges.
“To turn his idea into a reality, Hull invented a machine that could literally scan any object and then make a clone or near-perfect replica of that object, molded in plastic. He even wrote computer software to orchestrate the process, so that anyone could utilize this technology without needing experience in computer programming, design, or architecture….
“Hull patented the process and began developing it from there into a commercial business. However, like any technology, it took time to perfect. It took over three decades for the computer to shrink down to the size of a suitcase and spawn the PC revolution. The plasma TV took nearly 100 years to become a commercial reality. And the same was true for replication – at first it was not precise enough, fast enough, nor workable for materials other than plastics. And the printers took up half a room and cost hundreds of thousands of dollars.
“If that sounds familiar, it should. Just like with the PC, out of the sight of the average American, on the weekend in unsuspecting garages, at nights in company back rooms, geeks have been toiling away.
“The result has been a remarkable increase in speed, precision, and choice of materials. These replicators now weld metal, print plastic, even biological materials… and are being adopted at a stunning rate.
“The US government is backing it, specifically the US Air Force, NASA, and the US Defense Department… as well as academia. Cornell, Wake Forest, Stanford, and MIT have all dedicated resources to its advancement.
“It’s also seeing rapid transference to the private sector. Citroën, Renault, Airbus, Boeing, Hewlett Packard, Lockheed Martin, Mercedes, Honda, Philips, Apple, GE, Nokia, Motorola, and even Google are some of the companies now using it.
“And now, for the first time in history, this technology is cheap enough to be bought and used by pretty much anyone in a developed economy.”
So that’s the big picture history — and it lays the groundwork for the theory that we’re not just seeing a developing industry with a technology that’s been adopted by designers and manufacturers around the world, but we’re seeing perhaps the beginning of a consumer revolution in this space as well.
Is he teasing the same two picks, Stratasys (SSYS) and 3D Systems (DDD) that have been pitched in the past by the Motley Fool and others? Let’s see how he hints them up:
“What I’ve found is that two of these companies stand head and shoulders above the rest and are poised to benefit most from the growth of 3D printing over the next few years.
“I can’t go into too many details here… but I’ll tell you what I can…
“Replication Technology Play #1: This company has more than 300 US and foreign patents, customers in 80 countries, and has managed to increase its revenue by more than 40% each year since 2009 – despite the economic downturn. Last year alone, it increased its net income by 69%. It has also had record revenue and units shipped in 2011, with an annual growth of 242%. It is poised to emulate the Microsoft of a quarter-century ago and position itself at the forefront of this digital revolution.
“Replication Technology Play #2: The second company I’m particularly excited about specializes in developing and improving 3D-printing technology. Its customers include the likes of Google, Northrop Grumman, P&G, Black and Decker, Cisco Systems, Electrolux, Pioneer, Sony, Nike, NASA, and virtually all car and motorcycle companies. Over the last year, the company has increased its revenue by 25% and its net income by 180%. It has just signed an exclusive deal to manufacture replication machines for one of the largest computer companies in the US. This deal should prove extremely profitable for this firm.”
This might be mixing things up a bit, because 3D Systems did report unit growth of 242% in 2011, but they claim way more than 300 patents (well over 1,000 — not that the number of patents is necessarily a key differentiator, most patents are worthless and it’s generally a small percentage of key ones that make the real difference to a patent portfolio). 3D Systems has indeed put together several years of 40% revenue growth since 2009 … though, as you might guess, 2009 was a down year for them as for most others. And actually, their revenues trended down for several years, from 2007 through 2009, and they were generally on a long-term slower growth trajectory for many years before that. So “#1″ must be 3D Systems (DDD).
And yes, it looks like #2 must be Stratasys (SSYS) — though the income and revenue growth numbers are a little bit stale, as is the “just signed” news. Stratasys has a deal to manufacture 3D printers for Hewlett Packard, which was signed back in 2010, and they are selling them, at least in Europe, but it doesn’t seem to have created quite as much dramatic revenue growth as the folks who shouted “breakthrough” when the HP deal was first announced were hoping. This is really more of a distribution deal, to a specific mid-market target audience, though the printers are HP-branded.
And if you consider these two leading companies to “be” the business (which is an exaggeration), then a #3.7 billion industry would be a lot of growth by 2015 — the two have combined revenues of about $500 million annually right now, including SSYS’s pending merger.
There seem to be a couple differentiators in the mix here — Stratasys and 3D Systems have been the large and longtime innovators in this space, with first-stage versions of their “deposition” machines developed in their preliminary, super-expensive versions in the mid-1980s, and available really only to very large companies in big-ticket industries like aerospace. In the early days, these were referred to as “fused deposition modeling” systems for prototyping, or more generically as “additive” machines — as opposed to the more common “subtractive” machines that basically act like the sculptors of old, starting with a block of whatever and chiseling away the unneeded bits (there are some good quotes about this from famous sculptors who were asked how they did their work, though all are probably at least partly apocryphal — Auguste Rodin said “I choose a block of marble and chop off whatever I don’t need, and Michelangelo reportedly said “I saw the angel in the marble and carved until I set him free.” There’s also another one, an old story of a sculptor who did a beautiful work of a horse and who was asked how he did it — he answered, “I just chiseled away everything that didn’t look like a horse.” Don’t quote me in English class, none of those attributions are very solid.)
And both companies have used slightly different techniques. Chuck Hull is the founder of 3D systems and his original idea, which he termed “stereolithography,” was using ultraviolet light to solidify a liquid in a vat to form a computer-derived shape, while the “fused deposition” of layers of bonded material apparently started with Stratasys — though both offer a variety of machines with different capabilities now, in part because both have steadily acquired smaller companies with innovative techniques or products.
Stratasys has generally been growing more slowly recently and is a little smaller, with arguably less of a consumer focus, while 3D Systems is larger and has grown more quickly, and is pinning a fair amount of hope on (or at least getting a lot of hype for) its breakthrough home tabletop printer that they are hoping to turn into a nascent craze among folks who are dying to build little 5″ square plastic creations of their own design (that’s the Cube, with Apple-inspired design and the design-exchanging “Cubify” site that they’re hoping will develop into a vibrant “app store” for files that are used to create physical objects).
And even on the stock front, there are significant differences — 3D just did a big secondary offering that hurt the stock and made them a bit cheaper, and they’ve gobbled up a couple more of their smaller competitors in recent years; and Stratasys did an acquisition last year but has just launched a potentially game-changing merger with near-equal Objet, an Israeli firm that probably would have gone public sometime soon if they hadn’t joined forces with SSYS in an all-stock deal that will bring the company’s market cap up to about $1.4 billion, more or less the same size as DDD. So the way I look at it, number two and three are merging to compete with number one.
Now we’re going to have two similarly-sized titans (relative to the size of their industry so far), and both can claim some sort of “first mover” advantage in different parts of the market — though there are other 3D printer makers out there, too, including the one that is by far the dominant name among hipster hobbyists and “early adopters”, Makerbot (they sell a few printers, including the newest one called the Replicator, but are far from being public and are very focused on the individual market and “open source” design sharing). Makerbot costs only a little bit more than the Cube printer that 3D systems just started selling, and it looks a bit more steam-punk (the Cube is more glossy and smooth, like how you might imagine an Apple sewing machine would look). But early adopters have several options, there are other kits and several less-well-known companies that haven’t yet been acquired by the big guys, and there’s also even a cheaper Chinese maker called Personal Portable 3D Printer selling a sub-$1,000 model now. There will probably be stiff competition to get these machines a bit cheaper and into homes, if only because, as with 2D printing, they can make a lot of money on the refillable cartridges if this really takes off.
I appreciate the mass adoption argument, but I still do think it’s a ways off, and I like the companies that sell to professionals more. There’s still a lot of room for “mass adoption” in small workplaces that can now arguably afford the “entry level professional” $10,000-20,000 machines (they’re also available for lease) in place of having to outsource their “printing” to other companies (most of these firms, including both DDD and SSYS, also provide printing services through separate divisions for those who don’t want to buy their own machines).
I want the companies who sell to toy designers and architects and furniture designers and what have you, and who are competing to make more advanced and technically challenging machines, and who are selling the higher-end machines that can do the small-scale production work in machine shops and factories. There are plenty of places where, if you’re making only a few hundred or few thousand products, it can be cheaper to produce them with a “replicator” than with conventional machines. This customer base is the same folks who have CAD software now, and the presentation from SSYS cites the fact that there are five million installed 3-D CAD software seats right now, but only a bit over 40,000 rapid prototyping machines — which seems to present a strong long-term tailwind, particularly as prices go down and capabilities improve. Arguably both DDD and SSYS are selling into this trend, of course, but I think that Stratasys, with the product line from Objet that includes printing in multiple materials and with their new professional sub-$10,000 printer that may cut into outsourcing among small design shops (as well as their casting-ready Solidscape product line that they acquired last year), may have a bit of an edge.
Unfortunately, that edge comes at a price — SSYS is more expensive, and I also think that Stratasys is likely to see a little bit of earnings per share dilution for the next couple quarters, even with any economies of scale that they might get from Objet (which might not be much, at least not immediately, since they’re not going to instantly close the Israeli facilities and move everyone). That’s because Objet, while it is profitable and growing, has been a little bit less profitable than Stratasys, and therefore the earnings per share for the new combined company, which will have a helluva lot more shares, could be lower. I don’t know what Objet’s growth rate was before their planned IPO, but the ability to integrate the two companies, cross-sell, and develop next generation products together will certainly be key. Right now, Objet is known more for their multi-head jet technology that allows them to create more refined but less durable products using multiple materials — so they offer more of a high-end prototyper than a high-end production manufacturing capability (though the fact that they’re also using a variation of ink jet technology might also mean they can get prices down more quickly).
Let’s take a quick look at the basic earnings numbers — Objet isn’t public so doesn’t have filings, but their results for the last year were made available in the filings regarding the proposed merger.
“The Stratasys and Objet combined pro forma revenue and earnings per share for the 3-month period ended March 31, 2012 on a non-GAAP basis are $83.0 million and $0.32 per share, respectively, compared to Stratasys standalone reported non-GAAP revenue and earnings of $45.0 million and $0.28 per share.
“The combined pro forma revenue and earnings per share for the 12-month period ended December 31, 2011 on a non-GAAP basis are $277.0 million and $0.94 per share, respectively, compared to Stratasys standalone reported non-GAAP revenue and earnings of $155.9 million and $1.04 per share.”
So you can see that this past quarter, the earnings would have been accretive on a per-share basis — but over the whole of 2011, Objet’s profitability per share was substantially lower. You can look at that as a growth indicator, that Objet has been growing earnings per share a bit more quickly than Stratasys, but there’s no guarantee that this growth outperformance will continue, particularly since we’re basing the accretive assumption off of the first quarter, which tends to be seasonally slow. They did say that they expect the merger to be accretive to EPS for SSYS shareholders within a year, but it wouldn’t surprise me if that gets pushed back, particularly if there’s economic weakness among their clients. You can see the presentation of their announced merger here.
So that means the shares are trading for about 50X last year’s earnings, and, going off of analyst projections, about 30X 2013 earnings. The analysts think they’ll grow earnings at about 15% a year, which I think would be a failure — I think that’s a reasonable number for 2013, but that they will need to ramp up sales a bit more than that to justify their current valuation. Analysts have bumped up their earnings expectations for 2013 already since the merger announcement, but I think that although the company is setting up well for the future they may well have a bad quarter or two along the way and easing in over a longer period of time would probably be the wisest plan. We have a small pullback here, but I don’t think it will be the last one this year.
And how does that compare with DDD? Well, 3D Systems is also expensive … but it’s growing faster, and it’s not quite as expensive. They also have the potential catalyst of the sales of their new Cube printer, which just started this quarter (though as I always try to point out when folks start talking “catalysts” for their stocks, catalysts can also be bad — like disappointing sales).
DDD is selling for about 42 times last year’s earnings, and for about 22 times 2013 projected earnings — and they’re also expected by analysts to grow more quickly than SSYS (analysts are pegging them for better than 20% a year). So by the numbers, it’s clearly still DDD in the lead, and I think the best choice is picking up an initial position in DDD first, on the pullback generated by yet another relatively small acquisition and their secondary offering is probably the better first step.
Frankly, they’ll both probably do pretty well over the next five years if the rosy predictions for the sector as a whole are accurate — as will the software companies, led by Autodesk (ADSK) and Dassault Systems (DASTY), both also reasonably priced for their current growth but not as much “pure plays” on 3D printing. It’s a fast-growing business and they’re going to get some investor interest because the products are super cool, and some because they’re posting what is likely to continue to be solid earnings growth. But there is a big “but” here — it’s not that there’s competition, because I worry less about that when there are only a handful of leading companies with any scale, it’s that the “craze” part of this might not take off. These companies are almost 30 years old, and they have grown slowly for many of those years — if we are hitting an inflection point here, with more and more small machine shops and design firms getting these machines, and household early adopters starting to get them, then we’re still on the cutting edge of a big trend … but if it’s going to continue to be a slow adoption that trickles down to smaller companies, the growth could well disappoint. I don’t see a bit likelihood that we’ll have a clear breakout winner between these two companies and their products, they’ll fight with each other for market share, so betting on one stock makes less sense than betting on the societal trend.
I think, as the Fool and Casey folks have both stated, that you’re probably better off betting on both DDD and SSYS if you want exposure to these machines unless you’re really an industry expert. My inclination is to prefer the SSYS story, but I can’t get away from the fact that the DDD numbers are significantly better. I’d want to wait for a better price on SSYS shares and would start off exposure to this sector with DDD shares first at the current price. I do not have the technical expertise or experience actually using the machines to have a strong opinion about which one might be better than the other, this is just my sense from looking at their product lineups and the stories about Objet and it’s addition to Stratasys’ offerings. I do think that with two billion-dollar-plus companies leading the way in this sector that we have less to worry about in terms of other breakthrough innovators taking market share — there will always be other competitors, but as we’ve seen from Objet, which many folks feared as an up-and-coming competitor, it’s hard to break through when there are two strong companies with good market positioning, and it’s often the case that the big just absorb the small. Both firms are serial acquirers.
I expect the SSYS/Objet combined per-share numbers to be weaker for the next couple quarters, so I think this is one of those companies that, if you like the prospects, you can perhaps nibble now but wait and pick up more if investors are disappointed (with the risk being, of course, that they might do better than I expect). DDD is likely to get many more headlines, since they’re more actively marketing to consumers, and I would expect those shares to continue to be more volatile than SSYS but I don’t know of any particular catalyst that would weaken their per-share earnings so I’d try to pick up an initial position now and just add to it if there is any weakness. Both companies are expensive and priced for growth, and DDD is likely to see earnings per share growth that’s stronger than their competitor over the next few quarters if only because of the expected large Objet dilution, but over the long run I still think the Stratasys/Objet merger might create a better business a bit down the line with their combined lineup of products and sales forces. The two companies have extremely similar profiles when it comes to profit margins, and both have substantial insider ownership and high short positions (meaning because they’re expensive and have run up this year, that many investors are betting against them — both have nearly a third of the float sold short, which is very high and is a warning sign that there are plenty of people who believe this story has gotten out of hand when it comes to stock valuations).
These are not “value” ideas, to be sure, but I like the potential of the industry and think we can start to buy the two leaders on what has been a bit of a pullback over the last month or so — I do not yet own shares of either, and I’d also caution you to steer clear of these if you expect them to move straight up as momentum growth plays … I think they will grow into these valuations and that the number of mid-level installations will grow considerably over time, but it’s going to take several years of what will probably be volatile share prices. Buy if you want to get in on a large industrial trend that seems to be ramping up, but these stocks may well require some patience or, if you’re a stop-loss investor, some fairly long reins. There’s also a real pot of gold at the end of the rainbow if you see the installed base of printers continuing to grow fairly quickly or even accelerate: both of these companies make a lot of their profits from sales of consumables, the actual cartrides of polymers or plastics or whatever the “print” material is — it’s the old favorite “razor and blade” model that worked so well for the printer makers and should, given the tricky specs of these individual machines and the larger overall cost, work for a long time for these 3D printer makers as well.
So to sum it up: Almost every newsletter family is getting behind the 3D printing story in some way, the stocks have come back in a bit this year and, though they have gotten popular magazine covers, they’re still far from being the household names that they can become if the tools continue to get better and cheaper and start to get more real attention. Almost everyone who’s recommending these stocks is, like me, having trouble picking favorites based on the merits of the products, so we’ll stick with that basic bet to place, not win, and add both stocks to our list. I think the story and long-term trend are real, and I think DDD is the best buy now if you have to choose but that SSYS may easily catch up with them once the merger settles in over the coming year, so keep an eye out for pullbacks to add shares of that one (or to fill out a position, if you’re able to nibble away at both). This is speculative long-term growth, so be ready for a wild ride and keep re-checking whether you think the adoption of these machines is happening at an increasing rate, something that both of these companies depend on given their current valuations.