FireEye Stock Still Has Room to Run (FEYE)

After a very unpleasant 2014, cybersecurity company FireEye (FEYE) has enjoyed a roaring year so far, with FireEye stock gaining 60% year-to-date.Fireeye 185

The YTD performance includes an 8% gain by FireEye stock since the end of May, fueled by news that government officials had uncovered a major hack on the Office of Personnel Management.

Personal data for 4 million federal workers was stolen by Chinese hackers. The same hackers are believed to be behind the recent attacks on leading health insurance firms Anthem and Premera Blue Cross.

Cybersecurity stocks across the board are gaining steam in the wake of the recent hack. PureFunds ISE Cyber Security ETF (HACK) has gained 2.5% after the reported heist, with FireEye’s gain being among the best in the industry.

Renewed Interest in FireEye Stock

The recent gains in FireEye stock are due mostly to its Mandiant unit, whose forensic division has been deployed in the past to investigate massive hacks and data breaches such as Sony’s recent cyberattack which nearly crippled the company’s computer network.

The Mandiant acquisition, which is one of the reasons FireEye stock has become a favorite in the investing world, is ironically one of the major reasons FireEye stock sold off badly in 2014 after the company doled out $1 billion for it.

The renewed interest in FireEye stock has come as a sharp turnaround from last year. FEYE soared 300% above its IPO price in just a few months … only to lose more than half its value after the company posted a series of widening losses and developed a penchant for lowballing its guidance.

Nevertheless, the company has been able to maintain robust industry-leading top line growth and has cut its losses considerably despite intense competition from the likes of Palo Alto Networks (PANW). Those improvements have helped allay investor fears regarding the qualitative health of its business.

FireEye reported first-quarter revenue of $125 million, good for 69% year-over-year growth, and above the company’s earlier guidance of $118 million-$122 million. Meanwhile, its GAAP net loss clocked in at 88 cents per share, and adjusted EPS came in at -48 cents, which was slightly above guidance.

Even better, the company’s billings grew 51% to $151 million, well above the company’s $130 million to $140 million guidance, while deferred revenue balance jumped 78% to hit a record $379 million. These metrics are good measures of what to expect from the company in the future.

So why is FireEye still taking losses?

SaaS Company

The biggest reason why FireEye still languishes in the red can be chalked up to the fact that it operates primarily as a software-as-a-service — often referred to as SaaS — company.

FireEye sells software that is designed to detect and weed out advanced persistent threats long before they become a menace. FireEye’s virtual sandbox is reputed to be best-in-class, which is a good thing considering that it competes head-on with solutions from Palo Alto Networks and Trend Micro, both regarded as industry leaders.

Indeed, 68% of FireEye’s revenue during the last quarter came from selling subscription software. Revenue from this segment grew 70% year-over-year, outpacing overall growth.

A young SaaS company concentrates on growing its userbase as fast as possible to ensure a steady revenue stream. SaaS companies typically incur customer acquisition expenses upfront but realize the revenue benefits slowly over a period of several years. These companies invest heavily in sales and marketing functions, which places their bottom lines under a lot of pressure.

But once a SaaS company matures, its marketing expenses stabilize and allow it to consistently turn a profit. The good thing about FireEye’s marketing expenses is that they only grew 40% during the last quarter, significantly slower than top-line growth.

The other major drag on FireEye’s profitability is its high stock-based executive compensation. The company spent $50 million, or 40% of revenue, on stock-based compensation. Even more worrying is the fact that this expense almost doubled compared to the previous year’s comparable quarter. Doling out too much stock when share prices aren’t going anywhere can easily lead to excessive share dilution; it’s not a problem just yet, but it’s something FireEye should be careful about in the future.

Bottom Line

FireEye expects EPS of -$1.75 to -$1.85 during the current fiscal year, a considerable improvement on last year’s reading of -$3.12. As long as the company keeps moving along this track, it won’t be long before it eventually becomes profitable.

Even though FireEye stock has made impressive gains, the company’s business is plenty healthy, able to support further share gains in the future. Meanwhile, the valuation of FireEye stock, though pricey by industry standards, remains reasonable for the company’s growth profile, which limits near-term downside potential.

All things considered, FireEye stock is a good long-term holding.

As of this writing, Brian Wu did not hold a position in any of the aforementioned securities.

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