FireEye: No Margin Of Error
Summary
- FireEye has vastly improved financial results in the last couple of years.
- The cybersecurity company still isn't predicting generating large cash flows and profits.
- The stock won't rally much farther until FireEye shows that the business isn't structurally low margin.
Last year, FireEye (FEYE) became a compelling turnaround story as business under the surface improved from a shift to subscription services while the cost structure was finally aligned with the revenue stream. Unfortunately, the company is still running into some of the legacy cost issues that will hold the cybersecurity specialist's stock back.
Low Margin Targets
The biggest thesis of the last couple of years was the shift from insanely negative margins towards breakeven levels. Changing the out of control spending culture was a fundamental reason that FireEye has bounced to $17.50 now after trading at a 52-week low near $10.
The biggest disappointment with leveraging up the growth story is that 2017 results and 2018 guidance don't support much in the way of gains once reaching breakeven. The below chart shows how the company cut out the -20% operating margins from 2015 and prior, but the margin profile hasn't improved since reaching -1% in Q4'16.
Source: FireEye Q4'17 presentation
The guidance for 2018 continues this trend. The company only forecasts a 100 to 200 basis point improvement for the year, placing EPS and free cash flow targets at only breakeven levels.
Source: FireEye Q4'17 presentation
FireEye is clearly losing steam in improving the financials and highlights the prime problem starting with margins so far in the hole. Getting to breakeven just isn't good enough. FireEye is projecting revenues and billings in the $800 million range which is a very sizable organization in the cybersecurity space.
Conversely, an old cybersecurity stock like Check Point Software Technologies (CHKP) trades at double the sales multiple of FireEye on lower growth due to the massive cash flows generated. For 2017, Check Point delivered cash flows from operations of almost $1.1 billion for nearly 60% of sales.
Plenty Of White Space
FireEye shows that the company only captures around 10% of the total market opportunity in every market segment. The key 20,000+ employee businesses are only 11% covered by their cybersecurity products.
Source: FireEye Analyst Day 2018
Despite this market opportunity, FireEye doesn't forecast much in the way of market share capture in 2018. The targeted revenue growth doesn't even predict capturing an additional 1% of the market in every sector.
Takeaway
The key investor takeaway is that FireEye still hasn't proven the cybersecurity products can be highly profitable. The stock is a soft buy as the sector demand will only grow as hackers become increasingly sophisticated. The company needs to prove to the market that generating cash flows are part of the pricing structure and business model, especially with growth rates targeted below 10%.
FireEye just doesn't have a large margin of safety for the next recession or product issue that would quickly send the company to generating losses and negative cash flows again.
This article was written by
Stone Fox Capital (aka Mark Holder) is a CPA with degrees in Accounting and Finance. He is also Series 65 licensed and has 30 years of investing experience, including 10 years as a portfolio manager.
Mark leads the investing group Out Fox The Street where he shares stock picks and deep research to help readers uncover potential multibaggers while managing portfolio risk via diversification. Features include various model portfolios, stock picks with identifiable catalysts, daily updates, real-time alerts, and access to community chat and direct chat with Mark for questions. Learn more.Analyst’s Disclosure: I/we 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.
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Comments (32)
Nothing about the results suggest 20% growth is possible. Why aren't you happy with 10% growth? The problem is the expenses. $FEYE already as the same operating expenses as $CHKP.
Are you happy for a goal of 1-2% operating margins after reaching -1% in Q4'16?
$PFPT is highly profitable. Kinda confirms my thesis on profits.
the technicals no doubt suggest a potential breakout above the current price. My point is that the company is missing a grand opportunity to ensure it happens my driving operating margins into the 5-10% range before being so satisfied with their progress. $FEYE acts like that basketball team that battles back from a 20-pt deficit to only let up once they tie the score. The goal is to get and maintain a lead and the company hasn't done that yet.
Unpredictable buyouts don't make for a very good investment thesis. Would appear that an acquirer could strip from fat from the operations of $FEYE, but making the deal accretive is tough when the company isn't profitable and has limited growth.