Why 3D Printing Is Turning Out to Be Risky

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In a year when investors were willing to make speculative trades in emerging technologies, one of the hottest areas was (and continues to be) 3D printing. While recent rallies in the sector have yielded gains – with stocks rising several times over in a matter of months, if not weeks – the uncertainty of how 3D printing will evolve makes the high valuations that have resulted look risky.

Over the past several years, 3D printing has grown from an intriguing idea with seemingly limitless potential to a fledgling industry that each month seems to bring new real-world applications. The technology could bring dramatic changes to industries such as mass manufacturing, the delivery of consumer goods and the creation of artificial organs.

Already, General Electric is manufacturing new turbines with 3D printers, while New Balance is making custom-fit shoes and others are working on disposable panties and personalized sex toys (like the early web, 3D printing business models may be pioneered by the sex industry). Meanwhile, a DIY community reminiscent of the hobbyists who helped shape the PC is experimenting with other uses.

The promise of 3D printing isn’t just in how things are made or how goods are delivered, it’s in the ability to dramatically reduce costs of production. Already, 3D printers have made tweaking prototypes and customizing products much cheaper because the machinery involved doesn’t have to change, only the computer-aided design. In the era of 3D printing, designers may become as powerful and sought after as coders have on in web software.

All of this explains why investor are getting excited about the handful of companies that are making 3D printers for companies and hobbyists. Remember the old chestnut that the people who make money from gold rushes are the ones selling the tools? That thinking is driving a big rally in the shares of 3D printer companies. In fact, for investors, it’s as if a gold-rush mentality has seized them.

The problem is that it’s still so early in the 3D printing industry that there have mostly been small companies in the space, many of which were bought up in a wave of acquisitions. That consolidation is creating a handful of leaders.

3D Systems, founded in 1986 by the inventor of the first rapid prototyping system, has bought 28 small companies since 2011, including Geomagic and Phenix Systems this year. Stratasys, another industry veteran founded in 1989, merged with Israel-based Objet in April 2012 and bought MakerBot, a company focused on the consumer side of the industry, for $400 million last July.

For a few decades, 3D Systems and Stratasys focused on the market for designing prototypes quickly and cheaply. Even now, the bulk of 3D printers are used for such rapid prototyping in industrial design. The two companies have the biggest market caps – $9.5 billion for 3D Systems and $6.3 billion for Stratasys. But as the more disruptive potential of 3D printing has emerged, they’ve been joined by younger, smaller companies that have gone public in the past two years.

Proto Labs, founded in 1999 went public in February 2012 at $16 a share and now trades at $72 a share. ExOne, founded in 2005, went public a year later at $18 a share and now trades at $60 a share. And voxeljet, founded in Germany in 1999, debuted only two months ago at $13 a share and is trading around $39 a share.

The two veterans have performed the best, with Stratasys quadrupling in the past four years and 3D Systems rising eightfold in the same period. Neither rally is showing signs of flagging right now. The younger three, following strong first-day pops (not shown on this chart) and early rallies, have been weakening on valuation concerns.

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With or without recent corrections, these five stocks are trading at irrationally high valuations. 3D Systems, the strongest performer of the group, has a trailing 12-month price-to-earnings ratio of 199 and a price-to-sales ratio of 19. Stratasys is trading at 15 times recent sales, Proto Labs at 12 times, ExOne at 20 times and voxeljet at 30 times.

This month, following the Euromold Conference in Frankfurt Germany, several Wall Street analysts began or amped up coverage of 3D printer companies. Barron’s Tech Trader Daily blog has been faithfully cataloging the reports, which have been more favorable to recommend 3D Systems and Stratsys over the smaller companies.

In short, 3D systems is favored for its broad offerings, Stratasys for its move into the consumer market, and both for their long experience in the industry as well as their strong base of corporate customers. Both, however have grown mostly through acquisitions in the past couple of years, making organic growth harder to gauge.

Among the smaller players, analysts tend to favor ExOne for its (relatively) lower valuation, while voxeljet is still seen as overpriced given some concerns with customer loans.

Then there’s the question of how much of the speculation driving 3D printer stocks will turn in time to the steady, long-term profit growth the prices imply. Earlier speculative rallies in biotechnology and nanotechnology never panned out as hoped. Not all of the promise of 3D printing is fanciful, but it’s not clear which industries it will catch on in, and whether consumers will find it to be more than a novelty.

“We think people may be overestimating the 3D printing ramp in mass manufacturing over the next year but underestimating it over the next five years,” wrote Jeffries analyst Peter Misek in a report this month. That’s the catch with speculation: Between the potential and the profit lies a valley of uncertainty. Crossing that valley is usually harder than it looks, and a lot of hope and money can be lost in the process.

(MORE: Researchers Are Printing Body Parts in China)