Is This the Most Overvalued Stock On The Market?

By (dsterman),

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While working at aninvestment magazine back in the 1990s, I profiled a young technology company with a very intriguing product. This company had a smallsales base and struggled to make profits, but its device, which could create fully formed objects in a microwave oven-size device, was right out of Star Trek.

That company, Stratasys (Nasdaq: SSYS) was an early pioneer in the field of "rapid prototyping" -- or what's now known as 3-D printing. (Some also nowcall this the "additive manufacturing"market .) Stratasys, along with rivals 3D Systems ( DDD ) and ExOne (Nasdaq: XONE) are no longer a well-kept secret. The first twostocks have risen more than 350% over the past two years, and XONE has doubled in value since its early 2013IPO .

Clearly, the market for these companies' devices is starting to take off. Stratasys boosted sales more than 30% in 2011 and 2012, its best growth rates since 2004. 3D Systems has boosted growth at an even more impressive 45% clip over the past three years. And all three are expected to boost sales at least 40% thisyear .

The outlook ahead is also quite bright, as new applications are emerging in the automotive, health care, aerospace and consumer markets.Credit Suisse estimates the industry had roughly $2 billion in sales last year and sees that figure rising to $5 billion by 2016, or a 24%compound annual growth rate. The fact that these stocks trade for at least 35 times projected 2014 profits (and 88 times in the case of XONE) might almost seem justifiable. Investors are paying up now for expected highprofit levels down the road.

Yet even as investors bid these stocks ever higher, they may be missing some key speed bumps in the road ahead. It starts with competition.

Last November, GE ( GE ) acquired a pair ofprivately held 3-D printing firms, Morris Technologies and Rapid Quality Manufacturing. Although GE hasn't made a big industry push this year interms of contract wins, the company has been bolstering its presence at industry trade shows, leading some to expect a bigger competitive push in 2014.

Transforming powdered metal into finished metal parts is expected to be one of the biggest growth areas for the industry, and Sweden-based Arcam appears to have the industry's strongest capabilities in this niche. Arcam noted a big jump in orders andbacklog when six-month results were released in August, leading to expectations of 60% to 65%revenue growth. Competition is also emerging from a handful of other privately held firms that includes EnvisionTEC, Eos and Micor.

Flickr/Creative Tools
The outlook ahead is quite bright, as new applications are emerging in the automotive, health care, aerospace and consumer markets.

On the consumer side, known as desktop printers, Formlabs, Printrbot, Leapfrog (not the toy company), RoBo 3D and Solidoodle are all ramping up sales efforts.

The problem with competition is that it tends to lead to more aggressive pricing strategies across the industry. And thatwill make it harder for 3D Systems and Stratasys to maintain gross margins above 50%, as they did in 2012.

Also, a fast-growing industry means that many of these privately held rivals may soon look to go public (investment bankers likely see them as easy deals to get done in light of the strong investor interest). Once a flurry of new companies goes public in an industry, they use their IPOfunds to speed up new product development and expand marketing efforts. So Stratasys, 3D Systems and XONE may be in a golden moment -- but, from a competitive perspective, one that may not last.

Analysts at Credit Suisse arebearish on the prospects for XONE, as they believe that company has a weaker productoffering and too shallow an industry presence. These analysts are morebullish on the outlook for 3D Systems, with a $62price target that is 15% above current levels. (The neutralrating on Stratasys reflects a lush valuation for thatstock .)

Yet these analysts, in a recent comprehensive industry report, failed to takenote of some potentialred flags that investors should be aware of regarding industry darling 3D Systems.

For starters, the company's organic growth rate is alot less impressive than you'd imagine. Since September 2011, DDD has made 16 acquisitions, which is more than the rest of the industry combined. Fully one-third of the company's organic growth rate in the most recent quarter came from acquisitions, and analysts see organic growth slowing to 15% to 20% next year. (Deals completed thus far in 2013 explain the total projected growth rate of 24% in 2014.)

All of those acquisitions have pumped upgoodwill , and 3D Systems carries just $410 million in tangiblebook value . That's less than the company has raised in itsmultiple secondary offerings over the past half-decade, meaningbalance sheet value creation has been nil.

Also of concern: 3D Systems'accounts receivable spiked $18 million in the second quarter to nearly $120 million. That has raised concerns that the company is stuffing the sales channel in order to meet high quarterly sales targets thatWall Street is anticipating. Lastly, a drop in six-monthcash flow (from $21 million in 2012 to $12 million in 2013) is disconcerting, especially when statednet income for the first six months of 2013 was $34 million.

Risks to Consider: As anupside risk, both SSYS and DDD have the broadest product offerings in the industry, which makes them viableacquisition candidates to a large manufacturer that wants to enter this space.

Action to Take --> Although all three of these stocks sport very lofty valuations, 3D Systems appears to be the riskiest stock here, due to balance sheet and cash flow concerns. Fully 29% of this stock'sfloat is held by short sellers, reflecting the mounting concerns around this seemingly impressivegrowth company .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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This article appears in: Investing , Investing Ideas , Stocks
Referenced Stocks: DDD , GE

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