- FireEye shares have been selling off following downgrades by UBS and Barclays
- Both analysts cited FireEye's huge runup
- FireEye shares have limited near-term upside
- The shares, however, remain good investments over the long-term
Shares of cybersecurity company FireEye (NASDAQ:FEYE) have been selling off after UBS analysts downgraded them to Neutral from Buy, citing FireEye’s huge runup. FireEye Stock rose 70% YTD prior to the downgrade but has fallen about 5% since. Barclays followed UBS by issuing its own downgrade of Equal-weight from Overweight just four days later, but oddly raised its PT from $47 to $56. Barclays similarly cited overvaluation concerns on the shares. Both downgrades echo a common sentiment among investment circles that the easy money in cybersecurity stocks has already been made after the sector in general rallied massively following a series of huge hacks that have been uncovered in recent times.
Are the Wall Street Downgrades Justified?
Looking at the seasonality chart for FEYE, the summer has traditionally been a weak season for the company which suggests that UBS and Barclays might have partly relied on previous cycles when making their calls. The calls might therefore be spot on for short term investors looking at 3-6 months out.
Currently trading at around $48.9, FEYE shares are still well below their post-IPO high of $100. The shares fell out of favor with the investing world after FEYE developed a penchant for lowballing its guidance. This coupled with its mounting losses spooked investors. But, the company later managed to pull out a string of encouraging financials that helped return it to investors’ good books.
Viable Long-Term Investment
While the UBS sentiment is not entirely without merit, the bigger picture suggests that FireEye remains a viable investment due to its deep expertise in busting up massive hacks, courtesy of its Mandiant unit. FireEye has already unraveled the identity of the infamous Chinese hackers who recently stole personal records of millions of federal government workers. Sony (NYSE:SNE) hired the Mandiant unit last December when it suffered a massive attack on its computer network that almost brought it to its knees.
FireEye is now very well-positioned to continue gaining market share in the hypercompetitive cybersecurity industry. FireEye competes with Palo Alto Networks (NASDAQ: PANW) in some key market niches. The company’s Threat Prevention Platform is quite similar to Palo Alto Network’s WildFire. FireEye’s virtual sandbox, however, is reputed to be better than Palo Alto Networks.’
This perhaps explains why FireEye has managed to maintain industry-leading growth. During the last quarter, FireEye’s top line expanded an impressive 69.5% to $125.37 million. The company, however, still languishes in the red.
The biggest reason why FireEye is yet to turn a profit can be chalked up to the fact that the company relies heavily on subscription revenue, effectively making it a SaaS, or Software-as-a-Service, company. During the last quarter, FireEye’s subscription revenue accounted for 68% of the company’s top line. Young SaaS companies are for the most part unprofitable simply because they spend so heavily on sales and marketing functions. A young SaaS company tries to grow its customer base as wide as possible to guarantee itself a nice recurring revenue stream. Once a customer is acquired, the company has to try and minimize churn by ensuring that they stick around for as long as possible and maximize their lifetime value. High marketing expenses are therefore more of a necessary evil for SaaS companies in the growth phase.
But once a SaaS company attains a certain size, it can go easy on its customer acquisition splurge. This in turn means its marketing expenses stop growing so fast thus allowing the company to finally become profitable. Looking at FireEye’s latest report, the company guided for an EPS of -$1.75 to -$1.85, a big improvement compared to last year’s EPS of -$3.12. This suggests that the company is on the right track to achieve profitability before long.
FireEye should not have much trouble maintaining top line growth of 45%-55% over the next 2-3 years. Cybersecurity spending is projected to grow at around 8% over the next couple of years, more than double the rate for overall IT spending. Cybersecurity spending is not discretionary and is therefore not affected much by economic cycles. This means that we are likely to see good growth in the sector whether the economy cools down or not. FireEye’s losses are also likely to continue coming down, which is good not only for the company’s investors but also because it boosts its chances of receiving a good offer in the event of a buyout.
Only a few months ago, Cisco was reportedly mulling a FireEye buyout. Though Cisco’s CEO John Chambers later refuted the rumors while FireEye was unequivocal that it would not be interested in a merger until it achieves $1 billion in revenue, the alleged offer price of $9 billion for the company would have been a 36% premium to its share price back then. All things held constant, FireEye could achieve profitability as early as 2017, around the same time that it will hit the $1 billion revenue milestone. That would justify that kind of premium for its shares, or perhaps a bit higher. After all, few company executives would want to have to explain to disgruntled investors they are splashing that kind of money on a company that is losing money.
Over the long-term, I believe that FEYE shares can grow at 20% CAGR over the next two years. So while the shares might have limited upside over the next 3-6 months, they remain a good long-term investment.