Did FireEye Inc (NASDAQ:FEYE) make a mistake with its 2014 billion-dollar purchase of Mandiant? The 65% decline in FEYE stock since the announcement could certainly lead you to that conclusion.
And what about the move in May 2016, promoting Mandiant founder Kevin Madia to replace FireEye’s long-time chief executive Dave DeWalt? For investors, that’s where the story gets interesting. While FEYE stock initially took a hit, it’s bounced back nicely trading around $15.
CEO Kevin Mandia stayed with FEYE after his company was acquired. DeWalt left the company in February to become chairman of an Israeli cyber security startup funded by some big hitters including Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG) Executive Chairman Eric Schmidt.
FireEye’s board clearly sees something in Mandia, and investors are starting to take notice.
Never Say Never
This author quoted Charles Dickens’ timeworn expression from The Pickwick Papers in January suggesting that FireEye stock has about as much of a chance getting back to its IPO price of $20 as the Cleveland Browns have to get to the Super Bowl. (Both FEYE shareholders and Browns fans were equally offended by my remarks. I assure you, they weren’t personal. I simply have an aversion to investing in companies that don’t make money.)
That doesn’t mean I haven’t recommended stocks in the past whose companies weren’t profitable, because I have — I’m a big fan of Tesla Inc (NASDAQ:TSLA) — but when push comes to shove, I’ll only make an exception if the person behind the company is brilliant. Elon Musk is such a person.
I have no idea if Kevin Mandia qualifies as brilliant, though we’ll find out soon enough.
If I had that answer, I’d be buying or shorting its stock. Unfortunately, I don’t. However, what I do know is two numbers give us a hint whether it’s likely to go up or down in the next 12 months.
Non-GAAP vs. GAAP loss
Financial accounting has become such a game of hide-and-seek that the typical investor couldn’t possibly read between the lines. Strategic Finance contributor Thomas King suggests the simplest thing is to disallow non-GAAP earnings in quarterly press releases.
“A simple way to help implement this recommendation is to forbid SEC registrants from issuing non-GAAP earnings (or EPS) figures in corporate press releases,” wrote King on April 1, in what I hope wasn’t an April Fools joke because it was a very good read. “Firms would remain free to discuss non-GAAP performance measures in venues such as earnings conference calls, investor relations events, and industry conference presentations.”
Amen to that.
In the case of FireEye, it reported Q1 2017 earnings May 2. It had a GAAP loss of 48 cents, more than halving the 98-cent loss in the same quarter a year earlier. Its non-GAAP loss was just 9 cents, a vast improvement on the 47 cents loss a year earlier.
Either way, you look at it, FEYE is doing a good job of reducing its losses. So, here’s a way to value the progress:
I’d weigh the GAAP earnings at 75% and the non-GAAP at 25%. That gives us a weighted decline of 58% or a loss of 38 cents a share. Do the same in the next quarter, and you’ll get a good idea of the progress made by FireEye.
Or, better yet, just use the GAAP figure.
Whacking Operating Leverage
In the latest quarter, FireEye took a weed wacker to its operating expenses, trimming them by $72.1 million, or 28.5% year over year. As a result, its operating leverage was -104.1%, considerably lower than -150.5% in Q1 2016, -164.1% in Q1 2015, and -197.2% in Q1 2014.
FEYE’s cut its operating leverage in half over the past four years. That’s the good news. The bad news is that it still isn’t anywhere near making money.
So, it could grow the top line faster — product revenues in Q1 2017 declined by 29.7% while subscription and services revenues increased 11.7% — or, improve its gross margin on those revenues.
It did the latter, improving gross margins by 600 basis points in the quarter to 63%. In its subscription and services segment — 86.4% of its revenue — FireEye increased by 500 basis points to 65%.
Candidly, if it wants to make money, that number has to jump to 80%; it’s got to boost subscription and services’ quarterly revenue by 20% or more year over year and cut another 10% from its operating expenses.
Then it will start making money.
Bottom Line on FEYE Stock
It certainly is headed in the right direction. The question is whether it’s growing fast enough to merit a $20 valuation.
I’m not convinced FEYE is there yet, but unless the company has a real stinker of a quarter in fiscal 2017 or the tech correction turns into a meltdown, I see a better-than-50/50 chance of hitting $20 within the next 12 months.
And that’s something that I certainly didn’t think was possible at the beginning of the year.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
