- An experienced management team focused on innovation and acquisitions.
- A mid-cap sweet spot that allows for flexibility and innovation but the financial power to deliver acquisitive success.
- An industry pioneer with real-time monitoring capabilities and the ability to create an innovation advantage.
By Peter Peng
The cybersecurity landscape is intensely competitive, characterized by the need for constant innovation and few with pockets deep enough for a strategic acquisition program. FireEye (NASDAQ:FEYE) is the second largest pure-play in the space but still able to remain flexible and innovate around an evolving market. The company benefits from an experienced management team and the financial power to consolidate smaller players and products that will add to its line. While shares are the most expensive in the space, growth is expected in the triple-digits and the acquisition program could help surprise on the upside. Investors may want to accumulate shares slowly, buying on any near-term volatility to the downside.
This article is the second in our megatrend series, a look at the trends that will drive markets over the next decade. Within each megatrend, we will focus on two companies with the potential to outperform. The idea is that, even if the individual companies fail to execute on their strategic plans, the overwhelming force from the megatrend should drive strong returns.
Earlier this week, we covered the potential growth and key drivers in the cybersecurity space and highlighted mega-cap Symantec (NASDAQ:SYMC). While Symantec has lagged the rest of the pure-play companies considerably, it benefits from significant sector tailwinds and should provide strong returns off of an extremely low relative valuation.
Strong team of experienced management
FireEye only posts financials to 2010 and just started to trade publicly in September of last year, though this doesn't mean that the management team lacks experience. The company is run by some technology heavy-hitters including founders Ashar Aziz and CEO David DeWalt. Ashar previously sold Terraspring, a virtualization and security business to Sun Microsystems, a company Ashar worked for 12 years.
DeWalt was previously CEO of McAffe until he helped orchestrate the acquisition by Intel (NASDAQ:INTC). Over the course of his career, DeWalt has helped build companies from start-up to mega-cap and has became a true expert in acquisitions, most recently FireEye's acquisition of Mandiant. The owners have very different skill set but also complement each other well. Ashar is focusing on organic growth through new product innovation and break-through technology and David is focusing growth through strategy and M&A.
Innovation drives growth
FireEye offers a wide range of services including threat prevention, central management and forensics analysis, and an endpoint threat prevention system. It equips security organizations to confidently detect, analyze and resolve security incidents in a fraction of the time it takes using conventional approaches.
The company continues to lead the sector in innovation and has invested R&D totaling $66 million over past 3 years. With $173 million of cash and no debt, the company has the financial flexibility to be innovative and pioneer the next generation of solutions.
FireEye is among the new breed of cybersecurity firms that, instead of focusing on keeping attackers out, it monitors in real time and can spawn thousand of instances to check its network. This has proved to be an effective solution and has propelled FireEye as the industry pioneer at defending against the latest cyber attacks replacing the old breed of legacy signature-based security technology.
Acquisitions fuel add-on innovation growth
At a market cap of $10 billion, FireEye is the second largest pure-play cybersecurity firm, behind Symantec. In an industry of many small innovative firms, FireEye is small enough to remain flexible around its product line but is large enough to use its financial resources to add accretive acquisitions.
A few months after its IPO, the company announced the acquisition of Mandiant. The acquisition brought to the company an advanced endpoint security product and security incident response management solution to boost its cybersecurity offerings and fortified FireEye's position as an end-to-end security software vendor. This has boosted its ability to cross-sell and provided a full suite of solutions to fight against advanced hackers. The combination creates the industry's leading advanced threat protection vendor with the ability to detect, prevent and resolve cyberattacks at every stage of the attack life cycle.
Looking to positive earnings and potential
The company posted negative earnings of $2.98 per share for fiscal 2013 and is expected to lose money for at least the next two years. While it is not practical to forecast when earnings will turn positive, expectations are for a loss of just $1.63 per share in 2015 on revenue growth of 45%. The company's continued growth and leadership in the sector should drive sentiment and accretive acquisitions may quickly lead to positive earnings.
FireEye's guidance for first quarter billings disappointed at $84 to $88 million but management is confident it can meet full-year revenue of between $540 and $560 million. The weakness in first quarter may be a result of the Mandiant acquisition since the company bills annually, instead of upfront as does FireEye.
We expect growth to surprise on the upside given a 50% increase in sales & marketing staff over the last year and the fact that there are more customers testing proof of concept than in the current customer base. Strong customer growth should build on itself as the company becomes the go-to leader in the space.
Price multiples are always a problem with high-growth, nascent industries like the new crop of cybersecurity companies. Few pure-play companies have positive earnings or EBITDA and some have just begun to book sales. Most of the smaller players trade for significant enterprise-to-revenue multiples based on the hope of becoming an acquisition target.
The table below presents enterprise multiples on 2013 and expected 2014 revenue for the pure-play cybersecurity companies. FireEye is relatively expensive in the space but also is expected to lead revenue growth by a significant margin. My own estimate for sales to reach $670 million in 2015 and more than $950 million by 2016 brings the EV/Revenue ratio down to low-double digits. The company's financial power and acquisition drive makes it difficult to forecast revenue with strong confidence and FireEye could beat even my aggressive estimates.
Trading at such a high premium on expected growth, share prices may not go much higher for the rest of the year. Catalysts should come from guidance on 2015 revenue and any acquisition news. Any acquisitions could significantly lift sales forecasts and move the shares so investors may want to start building a position even at the current price. On expected revenue of $950 million by 2016, my three-year target is $160 on a enterprise to sales multiple of 20 times. This includes the issue of 5.6 million shares priced last week.
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FireEye is the financial and innovation leader in the latest technology to defend against cyberattacks. As worldwide security spending is expected to reach $86 billion in 2016, FireEye is expected to be the major beneficiary. While the shares trade for a significant premium, revenue growth is expected to continue in the triple-digits and management's expectations to continue a strong acquisition program should help to meet top-line goals. Investors should be prepared for volatility in the shares, especially around earnings, but the long-term outlook is firmly intact.