Name That Trade – $DDD: Three Dementia

by Dan February 25, 2014 3:02 pm • Commentary

Back on Jan 15th, in a post titled  Sagging DDDs, I stated that the 3D  story was a “sector I just don’t get”, while giving props to those that were early and saw gains that were multiples of their entry point.  I then stated, “from here on out I suspect it will be a much harder trade”.  While I am by no means taking a victory lap, the trade has in fact, in the very short term, been a volatile one, and I am fairly certain it will continue to be.

Back in Jan, I chose to center my attention on the largest publicly traded player in the space, DDD and had the following to say:

DDD though is the one to watch and a weaker than expected outlook could be the nail in the coffin for the trade for the time being.  Not saying this space won’t have legs for years to come, since many market participants that I respect think that the technology is revolutionary and may transform manufacturing and distribution of products in ways that were unthinkable a short time ago.  I get all that, but the math does not suggest that the stocks can continue their torrid pace of 2013.

Analysts expect DDD to book sales of $514 million for the year just ended, representing a 45% increase year over year, fairly consistent with its sales growth over the prior 3 years.  Analysts also expect this growth to slow to 30% over the next 2 years, at a time when earnings growth has seen a substantial deceleration from 54% in 2012 to 17% in 2013.  But here is the kicker, for those expecting some sort of M&A in the space, the large players seem almost untouchable.  DDD has a market cap of $9 billion, and analysts don’t expect them to hit the $1 billion sales mark until 2016. What would a larger company, forget a Tech company, but an industrial company, be able to pay for them on a multiple of sales that even on a forward basis seems egregious??

Well, since that post, 2 fairly important things have happened that could change this view.  First DDD did pre-announce worse than expected results and lowered fiscal 2014 guidance on February 5th.  And then just last week, there was a large financially nonsensical acquisition (Facebook for WhatsApp) that should call into question any dismissal of M&A that on most planets would seem far fetched.

While few investors who own DDD worry about such trivial things as valuation (stock trades 90x next year’s expected earnings and 11x expected sales), it is important to note that the 2014 guidance that was given shows a fairly material slowdown in year over year sales growth from 45% to 36% and flat earnings growth.  One more disappointing quarter, and consecutive guidance downgrades and multiples could go from three dimensions to two.

On the flip side, with the S&P and Nasdaq making new all time highs, there seems to be some animal spirits causing a flurry of M&A.  Facebook’s $19 billion purchase of a company with no sales should worry the shorts in a stock like DDD.  We are in a fairly bizzaro time, and with TSLA up 17% today alone to new all time highs, I would say short anything speculative at your own financial risk.

Taking a quick look at the technical set up, it seems awfully enticing though to play for a move back to the gap lows from the pre-announcement in early February.  The 6 month chart below shows what some technicians would call a head and shoulders top with $70 being the neckline, suggesting a break below that level would make prior support formidable resistance.

[caption id="attachment_36811" align="aligncenter" width="589"]DDD 6 month chart from Bloomberg DDD 6 month chart from Bloomberg[/caption]

From an implied vol (IV) perspective, the prices of options have not quite settled lower.  Since the pre-announcement from Feb 5th was just preliminary, and the company is set to give official results and guidance this Friday, Feb 28th prior to the markets open, options traders have still priced in some above average volatility.  The one year chart of 30 day at the money implied vol shows IV approaching prior levels pre-earnings.

[caption id="attachment_36812" align="aligncenter" width="589"]DDD 1yr chart of 30 day at the money IV from Bloomberg DDD 1yr chart of 30 day at the money IV from Bloomberg[/caption]

With high implied volatility into an earnings event that won’t be nearly as surprising as usual, but a technical and fundamental situation that suggest continued high volatility over the next couple months, we like the following put calendar structure:

The implied move into Friday’s earnings, despite the pre-announcement is a whopping 9%.  Given the prior disclosures we think this move is a sale.  While we are inclined to take a bearish view of the stock in the near term, the stock’s 18% short interest could serve to buoy the shares coming out of the event where there may not be too much new news.

We are going to take a closer look on Thursday prior to the event, but if it were today I would likely look to sell a weekly put at the implied move, which here would be about $70 and look to buy a slightly longer dated put of the same strike, possibly the March 28th weekly 70 put.  with the stock about $76, this would cost a little less than $3, and the goal of the trade would be for the stock to trade lower, ideally to $70 and have the Feb weekly put expire worthless having that premium help finance the longer dated put.

We will be sure to revisit Thursday prior to the close.