On Monday, May 12, FireEye (NASDAQ:FEYE) held an analyst open house in an effort to regain credibility with the analyst community (presentation available here). Last week, the company reported disappointing results, as spending on sales and R&D was significantly higher than consensus (financial and operating details available here). It is absolutely critical that FireEye regain some credibility, as there is a major lock-up expiration next week that could push shares much lower.
In fact, this expiration is very similar to Twitter's (NYSE:TWTR). Several weeks ago, a post-IPO lock-up expired, which sent TWTR shares spiraling lower as investors took profits. Shares fell around 15% in the post lock-up session, and shares are still 13% lower than before the lock-up. Going into the lock-up expiration, Twitter shares dropped nearly 50% from their recent highs as concerns about slowing user growth mounted. With a still high valuation, many insiders decided the prudent thing to do was sell some stock. As a consequence, lock-up expiration significantly increased the supply of stock and pushed shares lower.
On May 21, FireEye faces a major lock-up expiration, as 91 million shares can now be sold. For perspective, there are about 145 million shares outstanding. Venture capital firms, which mainly have low-cost basis, can sell 42 million shares, while management has 19 million shares it can now sell. Now to be clear, the expiration of a lock-up does not mean insiders will sell stock. Rather, it means that insiders now have the ability to sell. Over the past three months, FireEye has done secondaries, and investors have sold shares, which suggests this lock-up expiration will lead to some selling. FEYE shares have dropped 70% from their recent high, so some investors may simply want to sell the stock and move on once they are allowed to.
Now, one could argue the steep drop in the stock would make it so cheap that few insiders want to sell. However, that was not true for Twitter. After the drop, some investors may actually be more inclined to sell, fearing even further losses. Importantly, while FireEye has gotten cheaper, it is by no means a cheap stock. FireEye is still trading 9x sales, which is an extremely rich valuation for a company that is nowhere near profitability. I expect FireEye to lose about $2.20 this year and $4.50 cumulatively from 2014-2016 before breaking even in 2017. Paying 9x sales for a company that is at least three years away from breaking even is still excessive.
Yes, the company will double revenue this year, but expenses are growing even faster. In the most recent quarter, sales jumped 217% while revenue jumped 161%. FireEye is in the highly competitive cybersecurity space, which requires massive R&D spending to keep up with hackers. R&D spending now accounts for 57% of revenue, and FEYE is spending aggressively on its sales force to grow its foothold in the high growth market. Sales and marketing account for 104% of revenue. FEYE will need to dramatically grow revenue to justify this investment in sales. Unfortunately, we are seeing slowing growth; revenue growth will be 100% this year but closer to 50% in 2015. FEYE is spending too much to see such deceleration. The security business is a great one, but there is no guarantee FEYE will be a long-term leader.
With disappointing guidance, insider selling and a secondary, FireEye has lost the confidence of investors, and an analyst day cannot repair three months of damage. Nonetheless, FEYE needs to engender some goodwill to avoid a messy lock-up expiration like the one Twitter recently suffered. At this point, I would not be surprised to see selling similar to Twitter, which could push shares towards the low $20s. FireEye is still an extremely expensive stock at 9x sales with no short-term or medium-term profits. Even after the drop, I would be a seller of FEYE. The lock-up could be a very disruptive event, and the only trade in FEYE is on the short side. Even at $27, FEYE is grossly overvalued. With no profits for several years and an impending Twitter-esque lock-up, I would be a seller of FEYE for the foreseeable future.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.