FireEye Inc (FEYE) is Making Progress But $20 is Not On the Horizon
It’s been three weeks since FireEye Inc (NASDAQ:FEYE) delivered better-than-expected second-quarter earnings yet FEYE stock is down about 1% since that and off 12% from its 52-week high of $16.40 hit on July 19.
Source: David via Flickr (Modified)
What gives?
Well, the day before FireEye announced its Q2 2017 earnings August 1, InvestorPlace.com’s Luke Longo wrote that cybersecurity stocks were overbought.
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“That is why FEYE stock, along with many of its peers, has rallied strongly this year. FEYE stock is up 22% year-to-date. But the more recent trend in these red-hot cybersecurity stocks is much more bearish for FEYE stock,” wrote Longo. “The broad theme seems to be robust revenue growth in the second quarter, weak revenue growth expected in the third quarter due to international market weakness and margin compression as a result of competitive pressures.”
Simply put, healthy second-quarter revenue growth won’t carry over in the third quarter and earnings will be tougher to come by, something a money-losing operation like FireEye can ill afford if it wants to keep its revitalization story intact.
FEYE stock is currently stuck in neutral. Any step backward when it announces Q3 2017 earnings as expected on November 1 could result in decline into the single digits, somewhere it’s never been.
It’s not often that someone can get me to change my opinion about a company and its stock, but that’s exactly what happened with FireEye.
Testing Investor Patience
After I wrote in May that FEYE stock would never make it back to $20, a person close to the company sent me several emails arguing FireEye’s case, both on the strength of its business and the quality of its people, including former CEO Dave DeWalt. DeWalt is someone who benefited greatly from its March 2014 secondary offering — he sold a more than 485,000 shares at $79.54 each for a total of $38.6 million haul — so I took another look at FireEye’s business.
That led me to turn a little more positive, as I wrote on June 19:
“It certainly is headed in the right direction. The question is whether it’s growing fast enough to merit a $20 valuation. I’m not convinced FEYE is there yet, but unless the company has a real stinker of a quarter in fiscal 2017 or the tech correction turns into a meltdown, I see a better-than-50/50 chance of hitting $20 within the next 12 months.”
A month later, in mid-July, I shared with readers that my inclination was toward buying both FEYE stock and Check Point Software Technologies Ltd. (NASDAQ:CHKP). “One for growth and one for stability. However, I might wait until after FireEye reports its Q2 2017 results on August 1.”
Why wait? “Investors will be watching to see how subscription and services revenues are growing. If it’s not by double digits, all bets are off when it comes to FireEye,” I noted.
Worth the Wait?
In addition to the growth in subscription and services revenue, I’m also interested in gross margins, which need to get to 80%. Equally important, I want to know how its reduction of operating expenses is coming along.
If there are positive signs in all three areas, I’ll keep the faith, but if not, I’m not sure I can continue to allow FireEye to test my patience. I’ll reverse course once more.
On the first score, subscription and services revenues grew 14.9% in the second quarter to $154.3 million. It’s not 20% growth, but at least it was solidly in double digits. That’s a pass.
On the second metric — gross margins — FireEye’s Q2 number was 64%, 250 basis points higher than a year earlier. On a non-GAAP basis, they were 74%, 100 basis points higher than the previous year.
The gross margins for its subscription and services segment, which accounts for 83% of its overall revenue, increased 460 basis points in the quarter to 66.3%. That’s the second pass.
Finally, I need to see that FEYE is continuing to trim operating expenses. In the first quarter, it cut opex by 24% year over year to $178.2 million, or 96.1% of revenue. That was considerably lower than a year earlier when it spent $1.34 on operations for every dollar of revenue. I’ll give this a pass with a need for improvement.
By comparison, Check Point had second-quarter operating expenses of $236.9 million or 51.7% of overall revenue and 88.4% gross margins.
That’s how you make money.
Bottom Line on FireEye Stock
Going from money-loser to money-maker in a competitive marketplace isn’t easy. That said, FireEye has upped its full-year revenue guidance and expects its Helix platform to grow its customer bases.
At this point, it’s hard to see FEYE stock slipping much more until it fails to deliver slower revenue growth and a lower cost structure.
It won’t see $20 in 2017, but if business keeps improving, 2018 is still very much on the table.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
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