FireEye, Inc. (NASDAQ:FEYE) is a provider of cyber security solutions. Their solutions are used in the detection of unknown, highly sophisticated malware, and persistent attacks. Management has been rapidly growing operations and revenue. They have increased their sales and support reach from a few countries to over 65 countries and nearly 2500 customers. FireEye's revenue growth has been staggering. Revenue has grown from $1.6 million in 2009 to $161.6 million in 2013 or at a CAGR of 215.0%. This rapid growth is expected to continue in 2014. Revenue is expected to grow 161.8% y/y. Although revenue has grown fast, operating expenses have actually grown even faster. From 2009-2013, total operating expenses increased at a CAGR of 329.3%. The rapid rise in operating expenses has resulted in larger and larger operating losses. The company's operating loss in 2013 was $120.6 million. In the first half of 2014, operating losses have already reached $218.0 million. Revenue growth has been impressive but operating expenses need to be better controlled.
Despite rapid revenue growth, FireEye's stock has significantly underperformed. In fact, the company's stock is down 22.3% from the IPO's opening day price and has declined 71.3% from its 52 week high. The recent stock performance has been subpar as well. Since Q2 earnings were released (Aug 5th), the company's stock has fallen 20.7%. The recent subpar performance has occurred despite management's decision to increase focus on expenses. During the conference call, they announced they will be reducing overhead in the second half. This will result in one-time expenses related to severance and excess lease commitments. These expenses will hinder short-term profitability but will improve the company's long-term prospects.
FireEye's decline in profitability has been the result of a rapid expansion plan which included several acquisitions. These acquisitions have helped expand FireEye's product offerings but still need to be fully integrated. Management is starting to focus more on controlling operating costs with overhead reductions expected in the second half and an increased focus on slowing overall expense growth. This renewed focus will help increase profitability and will lead to operating profits. However, FireEye will need to continue its rapid revenue growth in order for management's cost control efforts to be effective. FireEye's growth should continue to outpace the industry due to several key advantages and industry trends. Additionally, the equity's recent decline offers investors a reasonable price point into this rapidly growing company.
Cyber Security Needs A Better Solution
The protection of large computer networks and systems is a difficult task. In the past, the Cyber Security industry relied on antivirus software. The software uses library databases to store virus signatures. Then, these signatures are used to identify threats when scanning. Over the last decade, this method of security has increasingly failed to fully protect computers and networks. The reason for this failure is due to the rapid explosion of malware and viruses. Panda Security reports there was 30 million new malware created in 2013 which represents 20% of all malware ever created. Antivirus libraries can't keep up with the increasing number of malware signatures. In fact, LastLine Labs reports antivirus detection rates for previously unknown threats are as low as 50% on day one. Additionally, the report showed there were 10% of antivirus solutions which couldn't detect malware after a year. The security industry has long since abandoned relying solely on antivirus software. They also realized the need for quicker intrusion detection methods for when hackers get into their system.
When hackers penetrate parameter defenses, security professionals need to quickly detect these threats. However, the security industry hasn't been very good at rapid threat detection. Verizon's 2014 data breach report shows 75% of attacks are executed in under a day but only 25% of attacks are detected in a day. This problem and the increasing number of threats are the reasons why the Cyber Security industry is expected to grow double digits. Markets and Markets estimates the Cyber Security industry will grow at a CAGR of 10.3% from 2014-2019 and reach $155.74 billion. Additionally, the US Government Cyber Security sector is expected to grow at a CAGR of 7.41% until 2018, according to Market Watch. Government agencies are important FireEye customers due to the ability to detect sophisticated state sponsored cyber attacks. FireEye's is well position to continue to take advantage of the Cyber Security industry's growth due to the company's effective rapid threat detection solutions and expertise.
First Mover Advantage
FireEye was one of the first companies to produce a virtual sandbox machine. A virtual sandbox machine simply analyzes and executes files away from the main operating system. Even if malware is present, the file is already isolated and can't infect the main operating system. The advantage of a virtual sandbox compared to an emulated one is the ability to more easily scale and run applications at normal speeds. These virtual machines are extremely complex which makes them very difficult to replicate. FireEye has grown rapidly because their system are so effective.
FireEye has a clear competitive advantage due to its superior product offerings. This can clearly be demonstrated by the company's competitive record. Dave DeWalt CEO estimates a win rate near 100% when competing directly. This rate is probably overly optimistic but would still demonstrate a competitive advantage even at 90%, 80%, or 70%. FireEye is winning against the competition and isn't sacrificing gross margin. On the Q2 earnings call, Dave DeWalt talked about a deal with an Indian Bank "That deal was particularly competitive as Cisco (NASDAQ:CSCO) and Trend Micro (OTCPK:TMICY) both offered large price discounts prevent us from getting a foothold in Indian banking market. We are able to demonstrate our technical superiority in the customer purchased multiple products and services at much higher prices." Not only does FireEye have an advantage, several major competitors are falling behind. Gartner analyst Neil MacDonald believes large competitors like Trend Micro and Symantec Corporation (NASDAQ:SYMC) are lagging behind. Additionally, Eric Ogren stated in a CRN article "Fortinet (NASDAQ:FTNT) is way behind on sandboxing,...They've focused on performance and building their own sandboxing capability while their competitors have come to market faster through the cloud or by quickly acquiring the most established players." FireEye's system is providing a competitive advantage and several competitors are lagging behind. This will allow the company to continue growing rapidly and help create another competitive advantage expertise.
Data breaches can cost tens or hundreds of millions especially if the breach goes undetected for a long period of time. The FireEye system is very good at indentifying new threats. However the system is only good at detecting threats, security experts are still needed to tell whether the threat is real and what to do. This is where FireEye's expertise is needed and could have helped prevent one of the largest data breaches last year. Target's (NYSE:TGT) data breach resulted in 40 million credit and debit cardholders data being stolen and over a hundred million in expenses for Target. Surprisingly, FireEye's system was installed on Target's network prior to the breach. Why didn't FireEye's system prevent the breach? The system worked exactly like it was suppose to and detected the data breach on Nov. 30 but Target's internal cyber security personal ignored the warning, according to a Bloomberg Businessweek. Bloomberg also reports the system alerted Target of another breach on Dec. 2nd but the threat was once again ignored. The FireEye's system is great at detecting threats but still requires experts to determine the right course of actions. FireEye employees have years of expertise and plenty of resources to better manage threat detection. This is a major competitive advantage for FireEye which has already translated into significant revenue growth.
FireEye offers customers the ability to have FireEye internally manage their security system. This service is becoming a vital and increasing part of revenue. In 2009, subscriptions and services were $288 thousand. This was mainly due to the lack of systems. Yet by 2013, subscriptions and service revenue was $73.3 million while product revenue was $88.3 million. So far in 2014, subscriptions and service revenue ($106.5 million) has already outpace 2013 levels and 2014's product revenue of $61.9 million. FireEye's system is an important differentiator for the company but their expertise is increasingly becoming a significant competitive advantage.
Fairly Valued Compared To Close Competitor
FireEye's stock has been extremely volatile since its IPO. During its first day of trading, the stock opened at $40.30 which was more than double its IPO price of $20. Since then, the stock reached a 52 week high of $97.35 which is a gain of 386.8% from the IPO price. Yet, the stock has since fallen to around $27.57. FireEye's stock has risen 386.8% and fallen 71.6% within less than a year. Does the recent decline present a good buying opportunity?
|Palo Alto Networks, Inc. (NYSE:PANW)||N/A||12.3||11.6||-2221.9|
|Trend Micro Inc.||22.1||4.2||3.4||9.7|
Data: Yahoo Finance-Key Statistics
At first glance, FireEye would be considered overvalued compared to Trend Micro and Fortinet but those companies are growing much slower. Additionally as mentioned above, Fortinet and Trend Micro haven't been quickly adapting to industry trends. This makes comparison between Trend Micro, Fortinet, and FireEye difficult. FireEye needs to be compared to a more similar company. Palo Alto Networks is a very similar company with a similar growth rate.
Palo Alto has grown very quickly like FireEye. Palo Alto's revenue has grown 2866% or at a CAGR of 133.4% since 2009 while FireEye's revenue has grown at a CAGR of 215.0% and a total of 9744.7%. Although, Palo Alto's growth has slowed down compared to FireEye. In 2013, Palo Alto grew 55.3% and has grown 48% in 2014. FireEye grew 93.9% in 2013 and 173.3% in 2014. FireEye is the faster growing company but the less profitability one. In 2014, Palo Alto's operating margin is negative 45.2% while FireEye's is negative 139.1%. So, FireEye is the faster growing company but relatively (both producing operating losses) less profitable. Yet, FireEye is trading at a better EV/EBITDA and only slightly higher based on P/S and EV/Revenue. With the recent stock decline, FireEye can be considered fairly valued compared to Palo Alto. This wasn't the case a couple of months or even weeks ago. Both are growing at different rates but significantly faster than the industry average. They are both producing operating losses and as a result are very similar in value.
Growth Stock With More Reasonable Price
FireEye has rapidly grown over the last several years. Both revenue and expenses have grown exponentially. The company is expected to generate revenue of slightly over half a billion dollars but still produce an operating loss. Management has grow the company through several acquisitions. These acquisition are not fully integrated which has caused significant expense growth. Management is starting to focus on better integration and operating cost control which will begin with the reduction in overhead during the second half. Management's expense control efforts won't help investors unless the company continues its rapid growth.
This growth should continue due to the company's virtual machines and expertise. These machines have been able to compete successfully with top industry competitors. The complex nature of these machines and the limited number of competitors should help FireEye continue its rapid growth. Additionally, the FireEye system still requires security expertise which FireEye is willing to supply. FireEye employees have help contribute to the company's growth and their value increases with every new threat detection. Although FireEye is still a growth stock with significant risk, the recent decline has brought the stock to more reasonable levels. The current stock price combined with the company's several competitive advantages presents a great opportunity for a growth investor.
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The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.