FireEye: Do Not Bet On A Buyout

| About: FireEye, Inc. (FEYE)

Summary

FireEye is still unprofitable and will continue to be for at least the next 3 years if the company continues its current trajectory.

The company's inability to turn a profit or even close to breakeven gives the company zero leverage when demanding a premium valuation.

It is highly unwise to buy FEYE solely on buyout speculations.

Expect the company to raise more capital, as cash had dwindled 54% YOY and operational cash flows are negative.

FireEye (NASDAQ:FEYE) reported disastrous earnings after the market close on August 4, 2016, which led to a 14% drop in share prices afterhours.

Although Q2 revenue increased 19% YOY from $147 million to $175 million, FireEye still reported highly disappointing operating losses of $127.5 million and a net loss of $139 million.

Furthermore, cash reserves dwindled from $402 million to $184 million (54% decrease), and total operating expenses increased 7% to $235 million from $219.5 million YOY.

With this dismal earnings report for Q2'16, it is clear to see why FireEye has not been offered a premium buyout offer-it simply does not warrant one.

On December 30, 2013, FireEye paid over $1 billion for Mandiant. But according to the balance sheet this quarter, the current book value of FireEye as a whole is only $933 million. Since the company is not profitable, nor will it be any time soon on a GAAP basis, there's simply compelling reason for a prospective buyer to pay a premium for FireEye.

Revenues are growing, but it is not growing fast enough. Looking forward, FireEye sees 3Q revenues at $180M to $186M. That is only a 2.9% to 6.3% increase-a very minor increase from today's $175 million revenue, especially when net losses were $139.3 million. In respects to the balance sheet, time is not on FireEye's side. At this rate, it will take over 3 years of maximum top-end growth just for the company to finally break even. In that span of time, the company will undoubtedly have to raise more capital via convertible bonds or a secondary stock offering.

The buyout thesis must be put to rest for now. Regardless of Mandiant's competitive advantages, it has not yet translated to profits. Therefore, any prospective buyer with any negotiating skill is going to low bid for FireEye. And apparently, companies have done just that, as FireEye did not accept any of its most recent offers that have caused FEYE to appreciate in price prior to earnings.

The main problem with FireEye's position in a buyout negotiation is that the company is simply not profitable. No profits, no premium-end of story. FireEye has no leverage without positive operational cash flow, and any negotiator worth their pay is not going to offer a premium for FireEye, knowing that all it takes is another negative earnings report to knock the company's stock price down.

Profitability is the key-even breakeven will do. Potential buyers are most likely to wait for FireEye to solve that problem for itself before making an offer, if at all. FireEye also seems to be going in that direction: refuse the sub-$30 offers now, and demand a higher premium when the company is closer to profitability.

At this point in time however, I believe that investing in FEYE on the basis of a buyout speculation is misguided and unwise, as the company's fundamentals are extremely poor and will take more time and more capital to iron out. Although anything can happen at anytime, all indicators point to FireEye being on its own for now.

Looking forward, I would advise traders to watch for the $12.40 price range, as FEYE has tended to trade towards that range after earnings.

Disclosure: I am/we are short FEYE.

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.