Almost on a daily basis now, a major cyberattack is plotted and taken out against a large company, government or nonprofit organization. Financial media firm CNBC even runs a popular page on its website that tracks major cybersecurity attacks.
Most recently, a student in Japan knocked out hundreds of Japanese school networks, and the SWIFT financial network is supposedly full of holes that hackers are actively exploiting to steal consumer’s personal and financial records.
Incumbent technology giants and smaller upstarts are crowding the market to help firms and organizations protect against cyberattack. FireEye Inc (FEYE), founded just recently in 2004, has quickly positioned itself as a leader in the space.
Overall stock market malaise has helped push the shares down nearly 75% from recent highs. This could represent a buying opportunity.
FireEye has a malware protection system, as well as a global threat management platform to help companies protect their virtual worlds. Its key competitive advantages lie in its software and ability to detect threats across a company’s digital platforms, be they through the web, email, files or other mobile platforms.
Few other firms focus on software and a comprehensive solution to combat cyber warfare.
Threat is FEYE Stock’s Opportunity
FireEye’s raison d’etre is to address the rapid changes needed to ensure cybersecurity stays ahead of crooks. In short, its goal is to reduce cyberattacks and their severity.
By its estimates, the market for digital security spending was $68 billion in 2014 and will jump 50% to $100 billion by 2019. Security services will constitute the bulk of this market — right in FireEye’s wheelhouse.
FireEye cites four areas ripe for development. In the company’s analysis, cyberattacks happen more often and by increasingly sophisticated attackers.
It sees too many vendors out there selling a disjointed array of cybersecurity solutions, and unfortunately many are of dubious quality. This type of security also increasingly needs to protect the physical world, such as attacks on infrastructure including power plants, and even nuclear facilities.
Finally, a shift to the Internet of Things (IoT) means software is changing to retrieve data and related information from the cloud. At the same time, it must be developed so companies can rest easy that the retrieval is done securely.
FireEye is benefiting big from the rise of software as a service. Last year, 41% of its $800 million in billings stemmed from product subscriptions. Another 32% stemmed from the lucrative categories of support, maintenance and professional services. Software is a lucrative business model because it can easily be scaled (through subscriptions) once it has been developed.
Service revenue is also high margin and requires little ongoing spending to maintain it. FireEye’s gross margins are well above 60% and are expected to continue to expand. Operating margins are more of a work in progress, but we’ll cover the potential later on.
FireEye’s Impressive and Improving Financial Profile
FireEye’s sales are growing gangbusters and are up nearly 20-fold in only four years, from $34 million in 2011 to $623 million last year. Analysts project another robust 28% increase for this year and total sales of nearly $800 million.
71% of sales stemmed from the U.S. last year, but sales are growing more rapidly in international markets. Last year, U.S.-based revenue grew a very respectable 38% but jumped 73% overseas.
The firm’s success is just starting to flow down to profits. Operating cash flow of $37 million was the best in the company’s history last year. Free cash flow should be right around this level for the coming year — management estimates at least $70 million and $50 million in capex, for $20 million in free cash production.
Its finances are also sound, with nearly $1.2 billion in cash and short-term investments on the balance sheet. This works out to nearly $8 per diluted share — important downside protection that investors need until profit trends are more robust and visible.
The Threat for Investors
FireEye is a new company just starting to hit its stride. There are both opportunities and threats to where the firm is in its growth cycle.
One of the nearer-term issues is the lack of reported profits. Analysts project an earnings loss of $1.24 per share this year and $0.55 next year. This suggests it will be at least another three years before earnings are positive for a full calendar year. Many investors don’t have the patience to wait and could end up missing out.
The company also sees itself as a disruptor in a fast-moving segment of technology that includes Symantec Corporation (SYMC), Trend Micro Incorporated (ADR) (TMICY), Cisco Systems, Inc. (CSCO) and Inte Corporation (INTC), which bought McAfee in recent years and is beefing up its cybersecurity efforts.
Being the disruptor has its advantages but there are plenty of competitors looking to disrupt FireEye itself.
More Upside than Downside
Weighing the investment merits against the drawbacks, there is still significantly more upside than downside for FireEye investors.
For starters, and perhaps most importantly, the stock has fallen significantly. Its 52-week high is above $55 per share. Right now, the stock sits at about $15.50.
With cash in the bank representing nearly half of that value, I am comfortable with the downside protection. That also gives me some comfort until there are more ample profits and cash flows to run a more detailed discounted cash flow valuation to estimate the stock’s value.
FireEye is evolving rapidly and will need to continue to do so to stay ahead of the competition and cyber attackers.
If it does, investors stand to benefit handsomely, such as by the stock returning to above $50 per share.
As of this writing, Ryan Fuhrmann did not hold a position in any of the aforementioned securities.