Seeking Alpha
Long/short equity, special situations, value
Profile| Send Message|
( followers)  

FireEye (NASDAQ:FEYE) made its public debut on Friday, September 20th. Shares of the virtual machine based security platform ended their first day with gains of 80% at $36.00 per share.

Given the insane momentum following the public offering, the valuation has gone stratospheric, based on price/sales multiples. While growth is spectacular, it is already slowing down as operating spending has gone out of control.

I remain on the sidelines with a slightly bearish stance.

The Public Offering

FireEye has built a virtual machine-based security platform which provides security to enterprises and governments against the next generation of cyber attacks.

FireEye sold 15.2 million shares for $20.00 apiece, thereby raising $304 million in gross proceeds. All of the shares were sold by the company, as no shares were offered by selling shareholders.

The public offering values the equity of the firm at $2.33 billion. Initially the bankers and the firm set an initial price range of $12 to $14 per share, which later was revised upwards to $15-$17 per share. Besides raising the price, FireEye also raised the offer size from 14 million to 15.2 million shares.

Some 13% of the total shares were offered in the public offering. At Friday's closing price of $36.00 per share, the firm is valued at $4.19 billion.

The major banks that brought the company public were Goldman Sachs (GS), Morgan Stanley (NYSE:MS), JMorgan (NYSE:JPM), Barclays, Bank of America/Merrill Lynch (NYSE:BAC), Nomura and UBS.

Valuation

FireEye's technology is a paradigm shift from the current approach to cyber security. The core is the virtual machine-based security platform, or the MVX engine which will identify and protect against both known and unknown threats, which are not identifiable by existing technologies.

The comprehensive platform protects during all stages of the lifecycle of an attack. FireEye's software has discovered incidents in over 95% of prospective customer evaluations, in which malicious activities had successfully evaded existing security infrastructure.

For the year of 2012, FireEye generated annual revenues of $83.3 million, up an unprecedented 147.5% on the year before. Net losses more than doubled to $37.8 million in the meantime.

Revenues for the first six months of the year came in at $61.6 million, up 107.2% on the year before. Net losses rose to an incredible $66.6 million, compared to a $14.3 million loss in the year before.

FireEye operates with $54.1 million in cash and equivalents before the offering. The company operates with $20 million in long term debt. Factoring in the gross proceeds of $304 million from the public offering, and FireEye will operate with a net cash position of close to $300 million.

As such, FireEye's operating assets are valued around at $3.9 billion, the equivalent of 47 times last year's annual revenues.

Investment Thesis

As noted above, the offering of FireEye has been a great success. Shares were already offered some 53.8% above the midpoint of the preliminary offering range. After witnessing opening day returns of 80%, shares are trading a ridiculous 176.9% above the midpoint of the first guided range at the moment.

At the moment, FireEye has some 1,100 end customers in over 40 countries. This includes 100 of Fortune 500 countries. According to an IDC research estimate, found in FireEye's S1-Filing, worldwide IT spending will be approximately $17.9 billion in 2013, including investments in security technologies.

FireEye's advantage is in the fact that solutions are real-time, allowing visibility across each stage of the attack, supported by the core MVX engine. Yet competition from Cisco Systems (NASDAQ:CSCO) and Juniper Networks (JNPR) could be severe as those competitors typically have much greater assets.

I'm not convinced at all with FireEye at the current valuation, despite the incredible revenue growth rates. For starters, reported revenue growth in the first half of 2013 slowed down from 147% for the full year of 2012 to 107% for the first six months of the year.

Yet this growth resulted in severe margin compression. Gross margins fell 670 basis points to 72.1% of total revenues. Yet the real problem is that operating spending is out of control. In the first half of 2013, operating expenses were already larger than the entire year of 2012, totaling a 175% of revenues. Marketing and sales efforts alone were greater than total revenues.

As net losses increased to $67 million, and roughly $40 million in the past quarter, net losses are expanding at an alarming rate.

This makes me wonder. If the company has already 20% of top 500 Fortune customers as a current client, how much upside is really there? At the same time revenue growth is slowing down, while operating spending, including sales and marketing efforts to boost revenue growth, is exploding. The fact that CEO David DeWalt received $6.0 million in total compensation for 2012 is very steep as well, given the terrible operating results.

For now investors are cheering. Yet the focus on growth over profitability could result in significant losses in the coming years, to the point that the company might run out of cash within two year's time at the current pace. This is even after raising more than $300 million in its public offering.

I remain on the sidelines, having no interest in initiating a long position at the current valuation. Note that short positions in such highly momentum driven public offerings are dangerous as well, driven by the limited float of the shares.

Source: FireEye: No Great Investment At First Look