FireEye: a Bad Bet?

FireEye (FEYE) reported its second quarter 2016 results on 4th August. The company reported better financial results compared to the same quarter a year ago but still has a lot of work to do in order to be investment grade.

The company’s revenue for the last quarter was $ 175 million which was up 19 % compared to the second quarter of 2015. Similarly, billings also showed a 10 % increase over the year ago quarter and totalled $ 196.4 million.
The non-GAAP operating margin also improved from 41 % in Q2 last year to 28 % in Q2 this year. Even more importantly, the non-GAAP loss narrowed to $ 0.33 per share compared to $ 0.41 per share.

However, the company’s operations generated negative cash flows again in contrast to the year ago quarter. The cash outflow from operations was $ 13.1 million compared to a positive cash inflow of $ 39.1 million in the second quarter of 2015. One relief to the investors regarding this would be that positive operating cash flow of Q2 2015 was an exception. Otherwise, it has always been negative at FireEye. This means that this time it was not that bad. In fact it was better than the negative $ 23 million of the sequentially preceding quarter.

Factors contributing to the decline:

The results might not look bad at all at the first glance. But on careful examination, we find that the revenue growth (which is indicative of the business growth) has in fact slowed down significantly for FireEye. Revenue rose just 19 % year over year, down from 34 % growth in the previous quarter and 56 % growth a year earlier. Further, the rate at which and the purposes on which it is spending its cash cast doubts whether the management is even eyeing any growth. The company has spent 35 % of its revenue on stock-based compensations this year in the first two quarters. And such reckless cash burn activities have brought down its cash position from $ 402 million at the end of 2015 to $ 184 million at the end of June 2016.

The above factors have contributed toward the decline in FireEye stock price over the past 1 year. Because of concerns about its slowing sales growth, rapid cash burn rate, rising competition, and executive departures, the stock has lost almost 60 % of its market value in the last 12 months.

Future plans:

The company aims at achieving non-GAAP profitability by the fourth quarter of 2017. That’s great! But the bad news is that the focus is still more on the cost structure rather than on revenue growth. For instance, FireEye expects that the approved restructuring plan and workforce reduction will reduce total non-GAAP costs by at least $ 20 million in the fourth quarter of 2016. True, the revenue and billing guidance are there in the earnings report but there is almost no mention of the path to be followed to achieve all that.

From this, we can take only one hint that the company is going to use downsizing as a tool to achieve profitability. This is not sustainable by the way. And this only makes FireEye a less capable player against bigger rivals like Palo Alto Networks and Cisco. We have already heard Palo Alto boast of its recent competitive wins that include replacing FireEye to secure more than 10,000 workstations and servers with a global semiconductor company. Hence, FireEye is losing out to the competition right now.

Further, one of the reasons behind the slowing revenue growth that FireEye quoted is that “The average duration and size of each incident response engagement was smaller than in years past.” This means that cyber threat to software is getting smaller in scale and scope resulting in lesser requirement of the best security services and products that the company sells. The customers are now okay with “good enough” options available at cheaper prices. But all it does is further makes the chances of achieving the company’s profitability goals even more difficult.

Conclusion:

FireEye is not in good shape. Its business growth is slowing down. The reason may be lack of opportunity or increased competition. But it is ultimately losing its business. In this condition, only a great product or service or change in the sales mix similar to the case of cloud based MVX detection engine could now boost the revenue and push the company close to profitability.

On the other hand, the believers of the “cyclicality” of the cyber security business may invest in FireEye at these low prices. Its P/S ratio at below 4.0 is anyway far better than the competitors!
Published on Sep 2, 2016
By Vinay Singh

Copyrighted 2016. Content published with author's permission.

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