McAfee (NASDAQ:MCFE) stock went public last month to muted Wall Street reception. Shares hovered at its IPO price before sinking 15% as investors fretted about the company’s debt load and ownership structure.
These fears are well-warranted. Years of private equity ownership saddled the once-innovative company with $4.8 billion in debt and a corporate culture more interested in hitting sales targets than creating new products.
Yet, it’s a mistake to write off McAfee as a wholly failed IPO. Though its management team has a lot to prove, McAfee is re-entering public markets when demand for cybersecurity is skyrocketing. And if management can grab onto this fast-growing trend, then McAfee could still become the next “millionaire-maker” stock.
MCFE Stock: In Need of New Ownership
As a growth stock investor, I stop in my tracks whenever I see “private equity ownership” written anywhere in a company’s history. That’s because private equity has a terrible habit of turning fast-growing companies into zombies.
In the late 1980s, Wall Street investors realized they could use declining interest rates to make enormous amounts of money. If they could find a company earning 10% returns, buy it out with borrowed money at 6% interest, then that 4% difference was theirs to keep. These deals became known as leveraged buyouts (LBOs).
There was just one problem: maintaining 10% returns meant that most bought-out companies stopped investing for future growth. As CEO, why risk falling below 6% returns (and miss your interest payments) when you can stay the course at 10% and receive your year-end bonus?
And that meant hundreds of company failures. Companies from Hertz (OTCMKTS:HTZGQ) to Toys “R” Us became corporate shells of their former selves as management funneled cash toward interest payments instead of R&D or capital expenditure.
McAfee’s Private Equity Days
To overcome its lackluster IPO, McAfee will have to shed its private equity past (and lower its mountain of debt). That’s because, under private equity ownership, it concentrated too hard on meeting short-term numbers while missing the boat on cybersecurity.
Over the past decade, hackers have shifted their focus from viruses to phishing and other cybercrime. According to Google’s Transparency Report, the number of phishing sites overtook malware sites in 2016. Today, there are almost 100 times more phishing sites than traditional malware ones.
And that’s a problem for McAfee. It still earns most of its income from legacy antivirus software, which concentrates more on malware.
Can McAfee Move into Cybercrime?
Despite still having almost $4 billion of debt and 60% shares still owned by private equity, McAfee is reasonably positioned to shift its business into cybercrime. That’s because the company already generates more than half of its revenue from its enterprise segment, a business that serves 78% of the Fortune 500 companies.
And that means the possibility for upselling and cross-selling.
Two competitors in the space, CrowdStrike (NASDAQ:CRWD) and FireEye (NASDAQ:FEYE), spent 61% and 45% of revenues on sales and marketing, respectively, in 2019. Suppose McAfee could come in with a product that links its device-to-cloud offerings with more pressing issues (i.e., network security offerings and endpoint security solutions). In that case, the legacy security company could bypass much of the initial sales process in cross-selling its wares.
Adapt or Die
Here’s the million-dollar question: can McAfee recruit talented engineers to produce such services? As my colleague at InvestorPlace.com notes, MCFE has some poor financials under its belt. Years of high debt and underinvestment in R&D has taken its toll on the once fast-growing company, something Wall Street noted with MCFE’s lackluster IPO. Its ownership structure also favors its private equity owners.
But I’m not as bearish about McAfee’s prospects. The company’s management has seen the importance of moving into cloud-based cybersecurity, a term Gartner has coined Secure Access Service Edge (SASE). And that starts to pit McAfee against industry heavyweights like Palo Alto Networks (NYSE:PANW) and Akamai (NASDAQ:AKM), companies that have returned 360% and 244% respectively since mid-2012 (compared to 158% from the S&P 500).
Too Early To Tell for MCFE Stock
All this, however, still amounts to “hope” – the most dangerous four-letter word in investing.
So, investors looking to catch MCFE might take a small position in the company today but wait several quarters to see whether the newly listed firm is genuinely ready to fight in the big leagues. Don’t expect its private equity owners to tolerate big bets. But if the company does start moving in the right direction, it could well become the next hidden “millionaire-maker” stock. Just make sure you’re ready to pull the trigger.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.