The cyberattack that shut down U.S. gas pipeline Colonial Pipeline is a good reason for investors to take a renewed look at enterprise security stocks. There’s one name that’s been largely overlooked in this space: FireEye (NASDAQ:FEYE). Let’s take a look at why investors have been ignoring FEYE stock recently. And why that’s a mistake.

Source: Michael Vi / Shutterstock.com

Investors are discounting the stock for some short-term hiccups as the company transitions its business model. At the same time, the company recently reported strong results and guidance and is benefitting from a product transition to the Cloud, which will help drive earnings upward over the next several years.

Here’s why the stock is a buy right now.

The Details

First thing’s first. Let’s get into the details surrounding the cyberattack on the Colonial Pipeline, as well as the market tailwinds for the cybersecurity space and FireEye’s Q1 results.

• Gas pipeline hack, cybersecurity getting more attention from President Joe Biden’s administration. The attack, one of the most disruptive digital ransom operations ever reported, follows the highly publicized December 2020 hacking incident at software supplier SolarWinds (NYSE:SWI) and underscores critical gaps in enterprise security. While President Biden didn’t directly blame or implicate Russia in the Colonial Pipeline attack, he did suggest that Russia may deserve some blame for the attack since the hackers and/or their software are allegedly located within Russia’s borders. With the U.S. likely to bulk up safety standards, FireEye is a key beneficiary, given the company’s demonstrated expertise.
• FEYE stock: The real value is services. FEYE, with a market capitalization of just under $5 billion, is a first responder for cybercrime. The company was the first to detect the SolarWinds breach and was reportedly called in to respond to the Colonial Pipeline breach as well. FireEye makes intelligence-based cybersecurity products that allow organizations to prevent and remediate cyber attacks. But its real value is in its security expertise and services, which are sold under the name Cloudvisory.
• Market tailwinds: Covid-19 has accelerated the shift to Cloud, heightening security risks. The cybersecurity space has all of the important characteristics of an investable long-term growth market: It’s big, growing rapidly and changing quickly. From working to spending, education to entertainment, more and more networking operations have gone virtual, making them increasingly susceptible to cyber attacks. Another catalyst for the bad guys: 5G technology. 5G enables a slew of new devices to connect to the internet, expanding the scope for IoT (Internet of Things) and AI (artificial intelligence).
• Q1 results and raised guidance underscore strong demand pipeline. FireEye posted Q1 revenue of $246 million (well above guidance), representing 10% year-over-year growth. Looking closer, revenue from the company’s Cloud subscription and managed services segment — which includes threat intelligence and cloud-based network services — grew 26% year-over-year to $86 million and accounted for 35% of overall revenue for the quarter. Partly due to increasing cybersecurity threats, FEYE’s professional services business grew by about $13 million year-over-year to $64 million. The strong performance in Cloud and consulting underscores the long-term secular drivers for the business and allowed management to raise its full-year outlook.

How to Get an Edge in FEYE Stock

It’s clear that FireEye’s Q1 earnings results were strong. Here’s what else investors need to know to get ahead with this cybersecurity stock.

• FEYE stock has been unfairly discounted for mix shift, which is a near-term drag on growth. Like many tech companies, FireEye is in the midst of a business-model transition from legacy hardware to software. This transition is a drag on near-term revenue and earnings results. But, investors are failing to see the bigger, long-term picture, and they’re discounting the stock as a result. This disconnect offers an excellent entry point for long-term investors. Sales from FEYE’s legacy products, mostly on-premises appliances that detect advanced threats, dropped 8% year-over-year to $96 million. As a result, FEYE’s hardware-based business comprises 39% of sales, down from 47% last year. And this shift isn’t about to slow down anytime soon. The good news is that FEYE’s move to Cloud is in exactly the right direction to meet demand. The legacy business will become much less material in the coming years. Numbers also show FEYE CAN make this shift successfully. Take a look at billings from Cloud and services. These grew 46% year-over-year and now make up almost 70% of total billings. This continued shift toward Cloud should have an impact on FEYE’s valuation over the next several quarters. Cybersecurity specialist peer Check Point Software Technologies (NASDAQ:CKPT) also proves a good case study. The company has been able to stabilize its legacy hardware business. The result: CKPT stock has been moving steadily higher.
• Margins are lower than peers … but moving in the right direction. FEYE stock trades at a discount for another reason. It’s effectively a services company, as opposed to a software company. Services businesses are harder to scale, and tend to have lower gross margins than software companies. FEYE’s Cloud security competitors have better margins (closer to 80%, versus 65% for FEYE) because their entire business is subscription-based. While there’s not as much earnings leverage in FEYE’s model right now, that will change as the company benefits from 1) a continued mix shift from hardware to software and services and 2) accelerating top line growth.
• Operating costs are high, but for good reason. FireEye is still far from profitability. Last quarter, net losses were $50.6 million, an improvement to net loss of $76.3 million in the prior-year quarter. With increasing scale and more top-line growth, the company should continue to close this gap. But, in the near term, FEYE is also spending significantly on research and development (29% of sales) and sales and marketing (40% of sales) to fuel its growth. With demand for security services already in place, this investment should become a smaller portion of total sales. The investment should also translate into improved top-line growth in the coming quarters.

The Bottom Line

FEYE trades at a very reasonable 4.7x forward sales, a discount to the company’s growth rate of 8% for the year and well below peers Crowdstrike (NASDAQ:CRWD) at 32x, CHKP at 13x and Palo Alto Networks (NASDAQ:PANW) at 8x. At these levels, the stock is oversold relative to near-term headwinds of a transitioning legacy business and high operating costs.

With demand ramping and the company well-positioned to continue to execute on its business model shift to Cloud, FEYE is an attractive long-term holding at these levels.

On the date of publication, Joanna Makris did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Joanna Makris is a Market Analyst at InvestorPlace.com. A strategic thinker and fundamental public equity investor, Joanna leverages over 20 years of experience on Wall Street covering various segments of the Technology, Media, and Telecom sectors at several global investment banks, including Mizuho Securities and Canaccord Genuity.