FireEye Inc (NASDAQ:FEYE) lives on the bleeding edge of computer security. It should be a great place for FEYE stock to live, but that’s only true if what it can deliver what the market wants.
FireEye sells computer security and anti-malware products, which it calls an Adaptive Defense strategy. It has a next-generation firewall and experts who monitor client networks for intrusions.
But FEYE’s solutions are not what the market wants to pay for. FireEye stock is down 66% since its launch on the public market in 2013. What customers prefer are the solutions of Palo Alto Networks Inc (NYSE:PANW), which focuses on security as a service, built around its own firewalls, the Wildfire Threat Intelligence cloud and an endpoint protection system called Traps.
We know this is true because, since FEYE went public, shares in Palo Alto Networks are up 200%. But even PANW may have flown too close to the sun. A year ago, it was trading near $300.
There Are Problems Ahead for FEYE and PANW
What is happening in computer security is a good example of what happens across the technology landscape. It’s called the 90-9-1 rule. That is, 90% of a market’s gains go to one company, 9% go to the company finishing second and everyone else winds up fighting for scraps.
In a new area like advanced computer security, the name of the game is growth, not profit. Palo Alto doesn’t make money, because it’s focused entirely on advancing its system. But it does deliver growth. PANW’s revenues grew nearly 50% last year, and operating cash flow during the July quarter hit $700 million, double its level of a year earlier.
While FEYE revenues look great on an annual basis, they have been falling behind more recently. Sales for the June quarter of 2016 were actually lower than they were six months previously and operating cash flow has flatlined.
Computer Security: Getting Into the Weeds
Both FireEye and Palo Alto seem to be in the same business — next generation firewalls — and to the laymen, their products may seem similar. It’s only when you get deep into the weeds of the technology that you can spot differences.
Take the fight against spam. PANW’s researchers recently found that a malware program that turns PCs into spambots was checking its host IP address against industry blacklists, and only activating if it was not. This made the malware, and the spam, much harder to detect, but by looking for behavior rather than the mere presence of a program, Palo Alto could help its customers fight back.
This is the kind of news that you only find by paying close attention to specialized industry papers and web sites. Investors need to ask, not which is the better stock, but which company has a better product. The answer can change quickly.
Because security changes so fast, both PANW and FEYE face threats from both above and below them on the industry food chain.
Startups like Cylance and CrowdStrike can become billion-dollar “unicorns” very quickly. In the past, such start-ups might have sought a take-out by a firm like FireEye, but now they can do better on their own.
At the same time, enterprise software giants like International Business Machines Corp. (NYSE:IBM), Cisco Systems Inc. (NASDAQ:CSCO) and Intel Corporation (NASDAQ:INTC) have identified the fast-growing cyber security field as key to their own futures.
They can invest more in the field than FireEye, they have the cash to sell their images as a safe pair of hands to enterprise security managers and thus they’re applying heavy pressure, not just in the marketplace, but in the stock market, on companies like FEYE.
Bottom Line on FireEye Stock
FireEye stock thus guided toward lower growth when it announced its most recent quarter in August. When FEYE reports Nov. 3, it is expecting a loss for the current quarter of 30 to 32 cents per share, on revenue of $181 million. That’s just $8 million ahead of June.
FireEye stock is between a rock and a hard place. It can’t buy the unicorns and get ahead of the curve. It can’t compete, on a marketing basis, with companies that can throw billions of dollars claiming they have better, more integrated solutions.
What both FEYE and PANW should probably have done was seek a deep-pocketed buyer a year ago, when their stocks were hot. My view is that FireEye stock still needs to be acquired if shareholders are going to get a return on even these price levels.
Dana Blankenhorn is a financial journalist and author of the science fiction story Into the Cloud. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing, he did not hold a position in any of the aforementioned securities. As of this writing, he owned shares in INTC.
