Our Post Mortem For Desktop Metal ($DM)

July 12, 2022

It’s never easy admitting your process needs a bit of fine-tuning.

But that’s exactly the admission we’re making today regarding portfolio holding Desktop Metal (DM).

No investor is perfect. Not even the legends like Warren Buffett. Stanley Druckenmiller. Bill Ackman. Jim Rogers. Seth Klarman. Etc…

George Soros, one of the best traders of all time, had a win rate in the mid-30s. Granted he was a trader, not an investor. But still, it means he lost money 2/3 times he put on a trade. Yet his track record returned something like 30%+ gains for over 30 years straight.

Alex Barrow from MacroOps said it best:

“Being good at being wrong is one of, if not the most, important skills a trader can develop.”

This applies to investors too.

Everyone gets it wrong. Being in finance means making mistakes is inevitable. But it’s about how much you make when you’re right. And how little you lose when you’re wrong. Then course correcting for the future.

Our job as investors is to try and make smaller and smaller mistakes over time. By looking back at previous investments. And figuring out what went wrong to reduce those same mistakes in the future.

That’s why it’s important to do post-mortems on your positions — ones that are still in your portfolio or ones that you’ve exited.

Here’s legendary investor Seth Klarman on the importance of post-mortems (emphasis added):

"We spend a lot of time on post-mortems. I am big fan of those because every investment at some point or another feels like a mistake that after you buy it it goes down, after it goes up you didn't own enough and what could you have done differently. Not trying to be perfect but trying to pull what kernels of information you might have for next time. A bull market teaches one kind of lesson, and a bear market teaches very different lessons. I work really hard with the team, many have never seen a bear market because it's been 12 or 13 years to understand that there'll be a day when everything you buy goes down, everything you waited on will seem like a heroically good decision, and everything you buy will seem bad, everything you thought about selling and didn't, you'll feel like you'll also start to lose confidence in yourself because everything you thought now looks wrong, so suck it up and deal with that, but how do you deal with it, and part of it is being prepared by talking about it in advance."

As you well know, the markets have been insanely volatile.

Most stocks are in a bear market — down 20%+. Most Nasdaq stocks are down 50-90%.

We’ve been endlessly telling clients and readers the knife has been falling since last November. It still is today.

Which makes it all the more important to refine one’s investment process now. During bear markets.

As we run through our portfolio, Desktop Metal comes to mind.

We’d like to clarify, however, that what we got right was position sizing… which is everything when it comes to managing risk. Especially when managing other people’s money.

What we got wrong was jumping the gun on our investment thesis before scaling in.

But let’s take a step back for all those who don’t know about Desktop Metal.

Desktop Metal is a 3D additive manufacturing (AM2.0) company. They’re able to 3D print industrial parts at scale faster and cheaper than any of their competition.

They’re 100x faster. Energy efficient. Make little to zero waste. And have arguably the largest and widest set of patents in the industry.

Desktop Metal checks off significant secular tailwinds like ESG. Help onshoring of supply chains. And reducing a company’s input costs — aka improving the bottom line. (Which is opportune during periods of high inflation like today.)

(For a deeper dive on these tailwinds, we suggest you read our Twitter thread below.)

Desktop Metal had a $3-5 billion valuation when we added them to the portfolio.

The additive manufacturing industry is expected to reach $150 billion by the end of the decade. Up from $12 billion in 2021.

Meaning Desktop Metal’s total addressable market (TAM) is expected to more than 10x within the next 8 years.

Adding the leading company in an industry that is expected to grow more than 10x — or 25% CAGR — was an opportunity we felt compelled to take.

Desktop Metal’s goal is to capture 10% of the market by the end of the decade. If they succeed, they’d be making $15 billion in revenue annually.

Our assumptions put their net income margins at 10% — or $1.5 billion in net income.

A 10x multiple puts them at an $11.5 billion market cap. Which means our annual rate of return would be between 23%-27%.

Our thesis hasn’t changed. Which is why we’re still holding (we’ll get to that at the end). But here’s two areas where we went wrong.

1. We trusted management’s ability to execute its original deadlines.

Desktop Metal’s true differentiation versus the competition is its P-50 printer. It’s the size of a bus and weighs nearly 11,000 pounds. This is their big kahuna that’s 100x faster than its competition.

The P-50 was still being built when we invested. Management’s original expectations were to ship to its customers by Q3 2021.

They reiterated an all-hands on deck to finish up the P-50. They even took engineering resources away from their other printers to complete the P-50.

But it still wasn’t enough. Management announced delays in Q4. And then again in Q1 2022. To be fair, they also dealt with supply chain issues. But they should’ve reset expectations long ago versus leading on investors.

The first P-50 finally got shipped to Stanley Black & Decker toward the end of Q1 ‘22. Which is great news. And will help Desktop Metal break away from the competition as more get shipped out.

Due to its size, only one is expected to be shipped per month. There’s a long ramp time here. And it takes time to ship these big boys out. So that needs to be baked into new estimates.

But had they hit their original deadline, several customers would’ve had the P-50. Not just Stanley Black & Decker.

Mike and I assumed everything would go according to plan. That didn’t happen.

We’re making sure not to make the same mistake as it comes to expectations of shipping the P-50s from here on out. We are assuming the P-50s will hit just a couple customer’s doorstep in 2022. Not several.

The ramp will come mid-next year. So this year is all about their current printer portfolio. And getting to cashflow breakeven.

2. We underestimated the amount of cash used for acquisitions.

Desktop Metal went public via a special purpose acquisition company (SPAC) late 2020.

They had $600 million on the balance sheet. And told investors acquisitions were going to play a big part in its long-term goal to capture 10% of the AM2.0 industry.

So it wasn’t a surprise to see Desktop Metal make several acquisitions in 2021.

First, they acquired EnvisionTEC in February 2021. Adaptive3D in May. Aerosint in July. Then ExOne in August.

The acquisitions themselves make sense. Desktop Metal is rolling up the industry. Including human capital and patents.

But the all-in price tag for these companies was $1+ billion — which includes stock and milestone payments.

It took on those company’s liabilities too.

Acquiring four companies in a six month period is a lot. Not just from a cash outlay perspective. But from a company integration standpoint.

Cost synergies can take up to 18-24 months before you streamline jobs, processes, technologies, etc…

They have to do that 4x over for each company.

By Q1 2022, Desktop Metal had just over $200 million left in the bank. Which took their burn rate — how much money they lose — from a couple years to a couple quarters.

This is what led Desktop Metal to raise another $100 million in convertible notes in May 2022.

The raise diluted us shareholders. Plus they raised while their stock price was already down significantly. But it was the only way to remain “default alive.”

This hurt us as shareholders. You can read our thread about why below:

(Ric Fulop seemingly agrees with our reasoning as he “liked” our thread).

Desktop Metal was early in raising money before capital entirely dried up.

(Longtime readers know we’ve been writing about capital markets drying up for months. You can read our April 5th post The Ripple Effects Are Happening as a primer. We’ve started a series of the economic fallout titled The Ripple Effects which you can find in our archive.)

Mike and I had many internal discussions about DM’s cash balance and burn rate after the announcement of the ExOne acquisition — which was their biggest at $575 million.

We should’ve de-risked the position then. But decided not to until a couple months later.

The market is/has punished all money losing companies. Desktop Metal included.

Desktop Metal isn’t off the hook. But we could’ve been more proactive during the heavy acquisition period. Not reactive.

The Bottom Line With Desktop Metal

The Mighty Flagship Portfolio is built on three pillars: Disruptors, Trophy Assets, and Income/Hedges.

These three pillars allow us to weather significant volatility. And keep us invested in our Disruptor companies we have the most conviction in — including Desktop Metal.

In our opinion, Desktop Metal presents a significantly better return at these levels than ever before.

Buying at these levels means we’re getting in at the same levels as the Series C investors.

Desktop Metal is focusing on cost synergies and profitability now.

The decade-end thesis hasn’t changed. Their goal is to capture 10% of the $150+ billion additive manufacturing industry by 2030.

The real risk with Desktop Metal is getting to profitability. The $100 million raise gives them a little more runway. But it’s not a guarantee they can hit cash flow breakeven.

Meanwhile, we want to see them beat projections on delivery of the P-50. But that will take a couple more quarters. So we’re still bullish. But they have to impress Wall Street now.

Desktop Metal is in the doghouse. They’re in the “prove it” relationship with Wall Street.

That’s where the catalyst can come from to send Desktop Metal higher.

  1. Beating P-50 delivery expectations

  2. Beating projections on cashflow breakeven

  3. Beating projections of already high revenue estimates

Either way, the thesis remains intact. But we’ll remain cautious moving forward until they prove it to us as well.

We’re holding steady. Not panic selling. As anyone who has conviction in their own positions should when the price goes down.

Here’s Seth Klarman again on buying when prices go lower:

"One of the most supportive things I do is, if we buy something and it goes down, as any value investor, you look at it, and you check and recheck your work. Then if nothing's different, you should like it more. It's a better bargain. If you knew the sweater you bought yesterday is going on sale today, you might be frustrated that you bought it yesterday. What you should do is stock up. We do that with stocks and bonds.”

Takeaways Of Post-Mortem

So far, we’ve been early — a.k.a wrong — on Desktop Metal. We were eager to jump the gun by starting with a full position. But we’re at a comfortable weighting (2.7%) in order to watch the thesis play out.

We see our mistakes as a learning lesson for the future. We’ve been thankful to have incredible clients who share our vision. Who aren’t short term investors who gawk at us during periods of volatility. But who stick with us to watch these theses play out over the years.

Mike and I take legendary investor Ray Dalio’s quote to heart when it comes to making mistakes:

“I learned that everyone makes mistakes and has weaknesses and that one of the most important things that differentiates people is their approach to handling them. I learned that there is an incredible beauty to mistakes, because embedded in each mistake is a puzzle, and a gem that I could get if I solved it, i.e. a principle that I could use to reduce my mistakes in the future.” 

Good investing,

Lance

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