3d print

See Appendix A-1 for Analyst Certification, Important Disclosures and non-US research analyst disclosures. Citi Research is a division of Citigroup Global Markets Inc. (the "Firm"), which does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Rating Target Price Current Year Earnings Estimates Company Ticker Old New Old New Old New 3D Systems DDD NA 1 NA US$60.00 NA US$0.98 Stratasys SSYS NA 1 NA US$125.00 NA US$1.89 25 August 2013 │ 45 pages PC & Enterprise Hardware (Citi) North America As Seen On TV: 3D Printing Ready For Primetime Positive View of the 3D Printing Sector; Recommending Leaders DDD and SSYS  3D printing ready to push beyond prototyping; Initiating on 3D Systems and Stratasys with a Buy — We feel the 3D printing / additive manufacturing market is on the cusp of seeing much broader adoption across more upstream production applications and the consumer end market. We believe the addition of those two opportunities could more than triple the current $2B+ market within 5 years (2017). As awareness of the technology’s capabilities evolves, we believe demand for print systems, materials and custom parts will accelerate. We also expect to see increased utilization of existing systems as customers start to extend use case beyond small batch digital manufacturing.  Familiar script: Growing materials mix will drive margin expansion — Similar to the 2D printer market, built on the razor/razor blade model, 3D print materials generate significantly higher gross margins (70%) than the printers (~40%). Consumables as a percent of revenue (mid-20s) is still low compared to the traditional print market (~80%) and we believe consumption will trend higher in the coming years. Additionally, adoption of higher-margin specialty materials which carry gross margins closer to 80% and a growing software component (~90%) will bolster overall profitability.  Prefer DDD for larger long-term TAM, clearer path to margin expansion — We believe DDD’s product line is best positioned to capitalize on all three potential market opportunities (Prototyping, Manufacturing, Consumer). We expect meaningful margin expansion from growing recurring revenue mix to drive earnings growth in excess of 30%. DDD’s numbers already reflect years of investing in low- priced consumer market giving margins a clearer upward trajectory.  SSYS will drive better utilization/cross-sell into large user base — We expect SSYS to benefit from increase materials usage and cross-sell (Objet / Makerbot) into its huge install base. The Makerbot acquisition also positions SSYS for an outsized share of the growing consumer market. We see sustainable margin expansion and earnings growth with materials consumption driving recurring revenue mix. The recent Objet merger coupled with Makerbot adds some integration risks.  Valuations justified by growth — At first glance DDD and SSYS, trading at 19x and 17x our CY14 EBITDA appear inflated, however, we believe current multiples are justified due to sustainable EBITDA growth north of 30% over the medium term. Kenneth Wong, CFA +1-415-951-1776 kenneth.wong@citi.com Citi Research Equities As Seen On TV: 3D Printing Ready For Primetime 25 August 2013 Citi Research 2 As Seen On TV: 3D Printing Ready For Primetime 4 Investment summary 4 Unwilling to be typecast for just prototyping; Eyeing bigger roles in advance manufacturing & consumer 7 Next industrial revolution likely premature, but broader adoption of Direct Digital Manufacturing (DDM) seems inevitable 8 Establishing a framework to understand the advance manufacturing opportunity 8 3D Printers: More likely to be the next VCR than a Segway 10 Trajectory of past consumer devices offer perspective on possible adoption timeframes 10 Sizing the consumer market 11 Roadblocks to broader consumer adoption slowly being removed 11 We’ve seen this plot before: Growing mix of high margin materials will drive profitability 13 Seeding of systems in 2012 and 2013 will bear fruit in the future 13 Competitive landscape: Enough growth to go around 14 Regional share shifting outside of North America 14 M&A activity warming up 15 Talking tech: Processes and materials 17 3D Systems (DDD) 19 Best Positioned For Long-term Growth; Clear Path To Margin Expansion 20 Estimates biased higher in FY14 and beyond 20 Margins set to expand as revenue mix trends towards materials and software 21 Channel expansion will have long-term benefits 22 Company 22 Management 22 Key risks 22 Q2 results: Uptick in demand offset by higher spending 23 Valuation 23 Stratasys Ltd (SSYS) 25 Market Leader Layering In Impressive Earnings Growth With Strong Sales Outlook 26 Estimates have headroom 26 Makerbotting a big splash in the consumer market 26 Growing usage print material consumption will boost margin profile 27 Company 28 Management 28 Key risks 29 Q2 results: Momentum building with top line acceleration and uptick in deal activity 29 Valuation 30 Appendix A-1 40 Contents As Seen On TV: 3D Printing Ready For Primetime 25 August 2013 Citi Research 3 Table of Figures Figure 1. Market still early and accelerating 4 Figure 2. Unit market share by 3D print process 5 Figure 3. Stock performance 5 Figure 4. Comparable company valuations: 3D printing 6 Figure 5. Market share of install base (Cumulative systems sold) 7 Figure 6. Market size projections: Citi vs. Industry expectations (in MM) 7 Figure 7. Market is expanding beyond prototyping (Base case) 7 Figure 8. Server virtualization penetration 9 Figure 9. Conservative 5-year trajectory of additive manufacturing as a share of growth capital spending budgets of customer verticals 9 Figure 10. Household penetration of consumer devices (Japan) 10 Figure 11. Potential consumer market adoption / opportunity 11 Figure 12. Contribution from price to DDD’s systems revenue growth 12 Figure 13. Impact of pricing on adoption of recent consumer devices 12 Figure 14. Impact of traditional inkjet supplies mix on gross margins 13 Figure 15. Growth of install base establishes foundation for higher materials sales 13 Figure 16. Contribution from volumes to DDD’s materials revenue growth 14 Figure 17. 2012 unit market share 14 Figure 18. Asian and European vendors seeing accelerated growth 15 Figure 19. Recent mergers & acquisition activity 15 Figure 20. 3D printing technologies 16 Figure 21. DDD: Citi vs. Consensus 20 Figure 22. Materials revenue growth: Impact of price, volume and FX 21 Figure 23. Higher revenue mix from materials will drive margins 21 Figure 24. Mix of higher priced specialty materials continues to grow 21 Figure 25. Backlog 45% above historical high 23 Figure 26. SSYS: Citi vs. Consensus 26 Figure 27. Markerbot printer sales 27 Figure 28. Revenue mix (FY11 to FY15E) 28 Figure 29. 3D Systems Income Statement (in 000s) 31 Figure 30. 3D Systems Balance Sheet (in 000s) 32 Figure 31. 3D Systems Cash Flow (in 000s) 33 Figure 32. Stratasys Income Statement (in 000s) 34 Figure 33. Stratasys Balance Sheet (in 000s) 35 Figure 34. Stratasys Cash Flow (in 000s) 36 As Seen On TV: 3D Printing Ready For Primetime 25 August 2013 Citi Research 4 Investment summary We are initiating coverage of the 3D printing / additive manufacturing sector with the two market leaders; 3D Systems (DDD) with a Buy rating and $60 price target and Stratasys (SSYS) with a Buy rating and $125 price target. While we expect both stocks to benefit from the growing demand for 3D print systems, materials and services, we prefer 3D Systems over Stratasys for its ability to capture a greater share of the total addressable market and clearer short- and medium-term margin trajectory. Additive manufacturing is the process of repeatedly applying thin layers of materials to build objects generated from 3D computer animated design (CAD) files. The technique is most commonly used by engineers during the prototyping stage of the design process. The main print materials are thermoplastic filaments, photopolymer resins, and powdered sand and metals, all of which are associated with specific print technologies and processes which we discuss in greater detail later on. Market opportunity expanding: We believe the ~$2B+ additive manufacturing market is beginning to attract customers beyond the traditional concept modeling and prototype engineers crowd. Larger manufacturing companies are looking to add elements of additive manufacturing into the production process and specialty end- markets such as medical, dental and jewelry are already printing end-use parts and goods for commercial use. General Electric is incorporating 3D printed components for its next generation LEAP engine due to the ability to create more complex and intricate geometries. Companies within the health vertical such as hearing aid maker Phonac and Invisalign braces manufacturer Align have already based their entire manufacturing process on the technology. While advance manufacturing applications currently account for 10-15% of total sales, over the long term we believe direct digital manufacturing (DDM) could represent the biggest share of the 3D printing market. Additionally, the recent “Maker” movement has created a flood of consumer curiosity and interest which we believe will materialize into a significant new market segment. We see the addition of those two opportunities as more than tripling the addressable market. We believe as customer awareness of the technology’s capabilities evolves, demand for print systems, materials and custom parts will accelerate. Margin expansion coming from improving revenue mix: We expect growing print materials mix to drive sustainable long-term margin expansion. As is the case with the traditional 2D printer market, 3D printer manufacturers generate significantly higher gross margins (~70%) on the print materials than the actual systems (~40%). Materials, also known as consumables, currently accounts for <30% of total sales, much lower than the traditional print market (~80%) and we believe consumption will trend higher in the coming years. Additionally, adoption of higher-margin specialty materials which carry gross margins closer to 80% and a growing mix of software (~90%) will bolster the company’s current margin profile. 3D printing is still a green field: We see plenty of open field for market participants to roam, but the competitive environment is getting warmer. While DDD and SSYS are the clear leaders in the sector accounting for a disproportionate share of the current market (Fig. 2), the industry is still early enough such that it is not yet a zero sum game. At the present, each system manufacturers offer relatively unique print capabilities and materials. Our discussion with those in the industry suggest it is not unusual for customers to have machines from multiple vendors As Seen On TV: 3D Printing Ready For Primetime Figure 1. Market still early and accelerating Source: Citi Research, Wohlers Report 2012 -20% -10% 0% 10% 20% 30% 40% $0 $500 $1,000 $1,500 $2,000 $2,500 $3,000 2008 2009 2010 2011 2012 Total revenue Y/Y growth As Seen On TV: 3D Printing Ready For Primetime 25 August 2013 Citi Research 5 running side by side in order to address different needs and applications. M&A activity has been picking in the space creating overlap across technologies. Over time, we anticipate that as consolidation gets more pronounced the product overlap could eventually create a more intense competitive environment. For now, we believe a rising tide lifts all ships. Figure 2. Unit market share by 3D print process Source: Citi Research, Wohlers Report 2012, Company Websites Valuations justified by growth: On the surface, current valuations (CY14E EPS - DDD: 36x / SSYS: 40x) appear inflated. However, we believe current multiples are justified due to sustainable earnings growth north of 30% over the medium term. Additionally, we believe investors will start to place greater emphasis on sector valuations from the perspective of EV/EBITDA instead of P/E as the growing capital investments needed to expand the services component of the business is a drag to pro-forma earnings. Through the lens of EV/EBITDA, Stratasys and 3D Systems are trading at 17x and 19x CY14 estimates respectively, with short- and medium-term EBITDA growth expected to be north of 30% by our forecast. Current multiples are also 20-25% below recent highs of 25x. Figure 3. Stock performance Source: Citi Research 99% FDM 5% 95% 17% 11% Photopolymerization 3% 7% 7% 48% 34% Material Jetting 21% 1% 2%1% Powder binding 45% 13% 10% 7% 6% 12% 97% 7% SLS / DMLS Sheet lamination 45% 2%5% Other Shaanxi Hengtong CMET Mcor ExOne SLM Solutions Wuhan Binuh Mech. Concept Laser DWS Carima EOS Envisiontec 3D Systems Stratasys $0 $20 $40 $60 $80 $100 $120 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 DDD SSYS As Seen On TV: 3D Printing Ready For Primetime 25 August 2013 Citi Research 6 Both companies are starting to generate a much greater share of sales from more profitable recurring revenue (materials and software). This dynamic has the dual effect of evening out lumpy printer sales and increasing revenue visibility and driving profitability. As we have seen with subscription-based valuation in the software sector, investors are willing to pay a premium for higher quality revenue. Lastly, there are limited assets to choose from in the 3D printing sector and so we recommend investors interested in adding exposure to this market buy both shares of DDD and SSYS. Figure 4. Comparable company valuations: 3D printing Source: Citi Research, Factset We want exposure to this secular story: We believe both companies will benefit from new customer growth as the technology extends to new markets and increased utilization of existing systems as customers extend use case to small batch digital manufacturing. However, we prefer DDD because the company is better positioned to capture a greater share of the long-term addressable market. We believe DDD’s product line is best positioned to capitalize on all 3 potential market opportunities (Prototyping, Manufacturing and Consumer). Additionally, the company has already invested heavily in seeding the consumer market and we believe the headwind to earnings from the initiatives is already reflected in numbers giving the company a much cleaner path to higher profitability. 3D Systems is our preferred pick: We believe 3D Systems is one of the best positioned companies to take advantage of the rapidly growing additive manufacturing / 3D printing sector. We expect adoption of 3D printing to extend beyond the existing rapid prototyping market and slowly over time replace many processes currently employed by advance manufacturing. Additionally, contrary to current expectations, we believe the consumer market will develop rapidly with 3D printers fulfilling consumers’ appetites for the next “it” gadget. We feel the company’s product portfolio and strong market position uniquely qualify 3D Systems to address all three market opportunities. Finally we believe 3D Systems could deliver upside to out-year earnings estimates as high-margin recurring consumables revenue becomes a much bigger mix of total revenue. 8/23/13 CY13E CY14E '12-'13E CY13E CY14E '12-'13E CY13E CY14E 3D Printing / Tools SSYS 1 $125.00 $105.82 $4,092 4% $3,936 21.3x 16.7x 166% 8.5x 6.3x 114% 55.9x 40.0x DDD 1 $60.00 $48.44 $4,922 6% $4,605 26.6x 18.9x 67% 9.0x 7.2x 44% 49.7x 35.9x XONE NR -- $67.80 $900 7% $839 NM 47.8x NM 17.3x 11.2x 69% NM NM PRLB NR -- $71.11 $1,802 7% $1,682 28.5x 23.7x 89% 10.4x 8.5x 28% 49.6x 41.3x 26.6x 21.3x 9.0x 7.2x 49.7x 40.0x 25.4x 26.8x 9.8x 7.3x 51.7x 39.1x CAD / Digital Design Software Vendors ADBE 1 $52.00 $45.77 $22,989 10% $20,958 15.9x 14.2x -27% 5.2x 5.0x -7% 31.5x 28.9x ADSK 2 $36.00 $38.91 $8,821 23% $7,201 12.4x 11.9x 2% 3.1x 3.0x -1% 22.1x 20.1x PMTC NR -- $27.39 $3,261 NA $3,272 10.6x 9.4x 27% 2.5x 2.4x 3% 14.9x 13.3x DSY-FR 1 $108.00 $99.39 $12,536 9% $11,461 15.6x 13.7x 27% 5.4x 4.9x 5% 26.7x 24.2x AVV-GB 1 $24.60 $23.84 $1,522 NA $1,522 16.0x 14.0x 31% 6.3x 5.7x 12% 0.3x 0.2x 16.0x 14.2x 5.9x 5.3x 29.1x 26.6x 18.4x 18.9x 7.1x 5.8x 31.3x 25.5xMean Median Enterprise Value Net Cash as % of Mkt Cap Median Mean EBITDA GrowthCompany Rating Target Price Price Market Cap P/EEV as Multiple of Revenue Revenue Growth EV as Multiple of EBITDA As Seen On TV: 3D Printing Ready For Primetime 25 August 2013 Citi Research 7 Stratasys will leverage large installed base: We think Stratasys is well positioned in the near term to drive incremental value from its large customer install base. While their business is more closely aligned with the “mature” prototyping market, we think the uptick in activity in the space will allow Stratsys to see increased materials sales. Additionally, the company recently finished training the combined Stratsys/Objet channel to sell the complete product line. Over the next 2-3 years, we believe SSYS can continue to capture a significant share of the prototyping market. The company’s recent Makerbot acquisition now positions Stratasys to leap into pole position in the Consumer segment, a market where it was previously absent. We do see integration risks with the Makerbot acquisition closing only 9 months after the company’s merger with Objet. Unwilling to be typecast for just prototyping; Eyeing bigger roles in advance manufacturing & consumer The market for print systems, materials and services in 2012 was estimated to be roughly $2B and growing north of 20% by market research firm Wohlers Associates. We believe the 3D printing / additive manufacturing market is about to experience much broader adoption across more upstream production applications and the consumer end market and as such our baseline assumptions project a slightly steeper trajectory than industry estimates (Fig. 6). In the past 3D printers were seen as too slow to manufacture true production parts or end-use products and the machines / materials too expensive and technical expertise threshold too high for the average consumer. We believe digital manufacturing applications will become a much larger share of the overall pie and expect the segment to represent a third of the total revenue contribution by 2021. Figure 6. Market size projections: Citi vs. Industry expectations (in MM) Figure 7. Market is expanding beyond prototyping (Base case) Source: Citi Research, Wohlers Report 2012 Source: Citi Research $0 $5,000 $10,000 $15,000 $20,000 2013 2015 2017 2019 2021 Wohlers Citi - Base Citi - Upside $0 $5,000 $10,000 $15,000 $20,000 2013 2015 2017 2019 2021 Consumer Prototyping Digital manufacturing Figure 5. Market share of install base (Cumulative systems sold) Source: Citi Research, Wohlers Report 2012 43% 20% 19% Stratasys 3D Others As Seen On TV: 3D Printing Ready For Primetime 25 August 2013 Citi Research 8 Next industrial revolution likely premature, but broader adoption of Direct Digital Manufacturing (DDM) seems inevitable The media has already proclaimed additive manufacturing as the next industrial revolution. While it is a bit early to make such