When revenue starts decelerating, corporations like to make acquisitions to reinvigorate growth or to cover up weakness in the current product lineup. Typically, the company will portray the new product as a strategic addition to the current lineup, but in a lot of cases the purchase will actually signal a shift in the market towards the acquired product.
After the close on Wednesday, FireEye (NASDAQ:FEYE) announced preliminary December quarter numbers and a deal to purchase iSIGHT Partners. The deal is peculiar in that analysts were recently questioning whether the security specialist had the right technology set going forward. At $15 though, the stock gets interesting regardless of the indications of the deal.
The preliminary view of Q4 was mostly inline with previously reduced expectations. The encouraging news was that quarterly billings came in at the higher part of the previous range of around $260 million.
Ultimately though, the story on FireEye is that the company is now forecasting organic billing growth of around 20% in comparison to the market expectation for 30% revenue growth. The readjustment of growth expectations is the prime reason for the stock collapse from $55 to $15 in the last year and from $95 at the peak in 2014.
Along with the billings growth, the company forecast achieving positive free cash flow for 2016 after making around $36 million in 2015. A big key to the investment story was whether the new CFO could turn the out of control spending from exceptionally fast growth into a cash flow machine at more reasonable growth rates. My recommendation has been to remain on the sidelines until signs of better discipline emerge.
The deal is peculiar due to the timing. FireEye forecasts the deal being accretive and iSIGHT is taking mostly cash in the transaction.
The financial terms are $200 million in cash on closing and another $75 million in additional cash and equity upon reaching booking targets by 2018.
Considering the stock valuation of FireEye now, one might expect an interest in taking equity for the deal if iSIGHT saw the combination creating a market leading organization. Remember that FireEye trades for only 3x the forecasted revenues of $815 million.
Guess the good news is that iSIGHT will improve operating income and cash flows though one has to question whether that offers much benefit. FireEye forecasts Q4 operating income to remain negative and cash flow to hit roughly $8 million. The most alarming number remains the forecast for a negative operating margin approaching the 32% level of Q3.
Similar to a lot of growth stocks over the last year, FireEye shareholders have seen the stock absolutely blow up. At $15, the market is pricing in more missed targets this year.
The stock is a speculative buy at this point though I'm not positive on the signals of the iSIGHT deal. Not only does iSIGHT signal that the company founders want to cash out, but also it signals that FireEye has no interest in being acquired as suggested by FBR to start the year. Neither adds up to the valuation that exists in the FireEye stock if the company is truly on pace for 20% organic billings growth and better financial discipline this year.
Use this dip to build a position if you must, but the recommendation is to not be married to a long-term investment at this point.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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