3D Systems: 4-D Printing A Threat To Long-Term Margins?

The 3-D printing technology is evolving so fast that 4-D printing, i.e. the combination of high resolution 3D printers with smart materials that change their shape in response to outside stimuli, is already there. The rising importance and complexity of materials suggests in our view that 3D Systems' (DDD) input costs will rise in the future, putting some pressure on the margins of its key consumables business.

We reiterate our view that consensus margin expectations are way too high on 3D Systems and that the stock is a Sell. For those willing to invest in the 3-D printing sector in these uncertain times, an interesting and lower risk strategy would be to go Long Stratasys (SSYS) and Short 3D Systems.

What is 4-D printing?

While 3-D printing is still in its infancy, a new technology is already making the buzz: 4-D printing . Actually, 4-D printing is an evolution of 3-D printing: instead of building static 3D items, the technology allows dynamic materials to self-assemble into different shapes after they have been printed or to evolve over time in response to their environment. The "fourth dimension" represents change and time.

Source: MIT's Self-Assembly Lab

4-D printing is likely to have a major impact on construction and manufacturing industries as it will make it easier to build in extreme environments thanks to dynamic and tunable structures. But 4-D printing is also likely to have an impact on everyday life: just think of self-assembling furniture, clothing changing in response to your body temperature, better tire grip as you go through turns …

Smart materials to play a key role in the printing industry

As 4-D printing is the combination of high resolution 3-D printers with smart materials, that change their shape in response to outside stimuli (water, air, heat or light), it is quite obvious that materials will play a growing role in this business in coming years.

Smart materials already exist, as explained by Skylar Tibbits, head of the MIT's Self-Assembly Lab which, in collaboration with Stratasys' Education and R&D departments, is at the forefront of 4-D printing. Notably shape-memory alloys (such as nickel titanium), used in stents and other biomedical technologies, and shape-memory polymers or smart plastics.

But for cost reasons, Skylar Tibbits has for the moment a preference for everyday materials like plastics, metals and woods. He then combines and prints these materials in different thicknesses and orientations. The MIT's Self-Assembly Lab notably developed a printing material that expands 150% when it meets water and a few prototypes, among which a tube that folds itself into a cube when submerged in water.

We believe that the MIT's Self-Assembly Lab approach is a just a first step and that smart plastics and alloys will be part of the game in a few years as their cost declines. Later, materials might change in a way most of us are unable to imagine today. Just think of an object that is composed of atoms (an atom is the smallest particle of an element that remains identical to all other particles) and compounds (atoms of different particles combined) which are "intelligent" and can take the desired shape ... You think this is science fiction? Have a look at this article … Actually, we just need more computing power.

Due to their rising importance and complexity, materials are likely to climb the value chain of the industry over the years (4-D printing commercial use is not expected before three to five years). This suggests in our view that the 4-D technology could change the economics of the 3-D printing industry, with rising input costs and hence lower margins for 3D Systems and peers.

Potential margin pressure ahead for 3D Systems?

In our view, odds are good that material providers such as Victrex (OTC:VTXPY) will ask for a higher share of the profits on consumables through higher prices in the future. This could put some pressure on the profitability of the consumables business at 3D Systems (and peers), suggesting that the long-term earnings growth driver of the company is at risk. Indeed, consumables are expected to generate most of the industry profits in the long-term.

In all, the advent of 4-D printing and smart materials strengthens our view (see our previous articles) that consensus margin expectations are way too high on 3D Systems and peers.

Conclusion

We reiterate our negative stance on the 3-D printing sector and specifically our Sell recommendation on 3D Systems. The stock is currently trading at 96x 2014 EPS, a level which is not justified in our view by the company's earnings power (+20-30% a year in a best-case scenario). It's also worth noting that 3D Systems does not seem to be at the forefront of 4-D printing as this is Stratasys which works with the MIT on the technology.

For those willing to invest in the 3-D printing sector in these uncertain times, an interesting and lower risk strategy would be to go Long Stratasys and Short 3D Systems. At 58x 2014 EPS, Stratasys' valuation appears much more decent. And importantly, the company is highly innovative (Stratasys is likely to be seen as a pioneer of 4-D printing) and is set to become a dominant force in the consumer business, that will drive the 3-D printing industry in coming years. As you all know, the reviews for its MakerBot product on Amazon have been much better than those for 3D Systems' Cubify.

Source: 3D Systems: 4-D Printing A Threat To Long-Term Margins?

Disclosure: I am short DDD. 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. (More...)

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