As one of the companies sparking a revolution in manufacturing, 3D Systems (NYSE:DDD) has found itself in the stock market spotlight. You can easily find stories about how 3-D printing will help us make fast, customized parts for everything from airplanes to human beings. But after posting a nearly 700% gain from its May 2011 IPO through the end of 2013, 3D Systems' share price has since fallen about 50%. It's not alone; its rival Stratasys (NASDAQ:SSYS) rose 300%, and then dropped about 30%, in the same period.
That's a pretty big drop. Should investors be worried that the long-term investment thesis is broken?
I've been following the company as the senior analyst for our Motley Fool Stock Advisor service, where 3D Systems is a recommendation. Over the course of this series, which attempts to answer that question, we'll use several different metrics that help evaluate 3D Systems and compare it with Stratasys, among others. We'll also look at what William Adams (aka will.i.am) brings to the company as its chief creative officer. And finally, we'll look at three bearish pieces written by Whitney Tilson and Citron Research, what they have to say, and whether you should pay attention to them. By the time we reach the end, you'll have a clearer understanding of where the company stands today, how it compares with its peers, and what I think is a good way to invest in this space.
Where I began
I'm a scientist by training, which means I like numbers and how they trend over time. Looking over the financial statements at 3D Systems, I noticed two potential yellow flags that prompted the deeper dive we'll go through together.
Yellow flag No. 1: As an analyst, I prefer to see more hard, cold cash from operations flowing into the business than is reported on the bottom line as net income. I also prefer to see that the company spends more cash to build up its asset base and keep itself modern than it's writing off on older equipment. Basically, this means that its capital expenditures, also referred to as capex, are outpacing the depreciation and amortization expense, or D&A.
Unfortunately, over the past few years, just the opposite has been occurring, with capex trailing D&A significantly. Why should we should be concerned by this? If the company puts off needed upgrades and spending for too long, the cost of finally replacing old assets could take a significant bite out of the cash flow it might otherwise be able to give back to shareholders or use to acquire other companies.
Yellow flag No. 2: This one's a bit more subtle. For the past several years, it looks like 3D Systems has been paying way more for the companies it's been buying than what might be prudent. Possibly a lot more.
For instance, in 2012, out of the $191.3 million it spent buying eight companies, only $60 million was assigned to identifiable net assets. In 2013, the numbers were $179.6 million and $51.2 million, respectively. Is this disparity justified? Note that companies routinely pay more than just the value of identifiable net assets -- the difference is called goodwill. In 3D Systems's case, this possibly excessive goodwill, which has grown rapidly on the company's balance sheet, raises a potentially serious issue: the possibility that the company might be manipulating earnings.
Goodwill is not amortized, or reduced via a charge against revenue every year. Identifiable assets, on the other hand, are, through D&A. Thus, one possible reason for the relatively large amount of goodwill being paid would be to lower expenses (and thus increase net income) in the future by under-reporting acquired assets and over-reporting goodwill. Note that I'm not saying this is the case, just that the possibility exists and we need to look into it further.
Where this series will go
We need to figure out whether the case for investing in 3D Systems is holding steady, improving, or deteriorating. To determine that, we'll try to answer the following questions:
- When 3D Systems and similar companies buy a competitor, how do they typically split the purchase price between goodwill and net identifiable assets?
- What is the financial situation at 3D Systems, and how does it compare with similar companies? In addition to the capex/D&A issue I raised earlier, we'll study various ratios calculated from the balance sheet and income statement, looking at the financial health of the company.
- What is 3D Systems's quality of earnings? That is, how closely do the earnings it reports as net income track with actual cash coming into the business? And how does that compare with similar companies?
- What are will.i.am's qualifications as a member of the executive team?
- Do 3D Systems critics Citron and Whitney Tilson make good points? Does the data back up their arguments to short the stock?
I hope you'll join me on this journey, learn something along the way, and come to a greater understanding of 3D Systems. In the next article of this series, we'll look more closely at that goodwill issue and see where 3D Systems sits compared with a group of comparable companies, including Stratasys.
As each article is published, you'll be able to find them by clicking here.