FireEye: Should You Buy on the Upgrade?

FireEye has soared by offering technology deemed necessary in today's cyber world, but with new competition and a pricey stock, should you buy?

Apr 10, 2014 at 10:30AM

 FireEye (NASDAQ:FEYE) has become the king of all momentum stocks, but after a 35% one-month loss and two upgrades on back-to-back days, some are believing that now is a good time to buy. However, with potential competition looming from the likes of Cisco (NASDAQ:CSCO) and Symantec (NASDAQ:SYMC), along with a variety of other concerns, investors shouldn't hit the buy button just yet.

A market that could get crowded
FireEye has soared with valuation multiples unseen within its cybersecurity industry due to the growing problem of Internet or software-related company crimes. The company sells appliances to prevent advanced persistent threats (APTs), which provide warnings of potential threats; unlike firewalls or web gateways, these FireEye products don't prevent or eliminate the threat but rather identify the hidden threats.

Currently, FireEye looks well-positioned with appliances that companies and organizations want, especially given the massive attack on Target a few months back. Still, like many momentum stocks, FireEye remains valued very much so on expectations for the distant future while other large networking vendors and traditional IT solution companies like Cisco and Symantec, respectively, lurk around the corner with products to compete.

For example, networking vendors like Cisco implement various security technologies into its products, both in hardware and software to accommodate their customers. In addition, Cisco is very acquisitive, including the purchase of Sourcefire, a company with services that mirror FireEye in many ways, identifying the newest threats. Symantec is the largest pure-play IT security solutions company in the market, and has been developing new services and appliances to both identify and fight new threats.

With all things considered, FireEye operates in a busy segment of the market, one that's deemed valuable, and this fact has in large part helped to boost its valuation multiple. Prior to the filing of its IPO in September of last year, there had been several acquisitions in the space. These acquisitions have been plentiful: Last month, Palo Alto Networks acquired Cyvera for the latest buyout in the space. Thus, many thought FireEye would be acquired sooner rather than later, although this assumption is yet to materialize, and instead, FireEye has made acquisitions itself, taking advantage of an expensive stock.

Small company with a big valuation
FireEye is the quintessential small company with a big valuation. The company sports a rather large $7.2 billion market capitalization despite 12-month revenue of only $161.5 million. For those not keeping track, this represents a price/sales ratio of nearly 45, and with net losses of $120 million, FireEye spent more than $1.70 for every $1 in revenue it earned last year.

Symantec earned revenue of $6.8 billion with an operating margin of nearly 21% last year. However, despite being many times larger -- who knows if FireEye will ever grow to be this large -- it trades at just 2.0 times sales with a market cap premium of only two times larger FireEye.

Cisco has similar margins as Symantec and created $47.8 billion in revenue last year. However, Cisco also has nearly $50 billion in cash on its balance sheet, meaning if it wanted to acquire FireEye it would, but instead Cisco is building and investing in services to compete.

With all things considered, it really is hard to justify paying 45 times sales to invest in FireEye. The company is expected to grow 150% this year, to revenue of $407 million. Furthermore, much of this growth was acquired with its $1 billion purchase of Mandiant -- FireEye paid mostly in stock -- which is why the year-over-year increase seems so impressive. However, in 2015, that growth will come back down to earth, to 45% and revenue of $592 million. Still, the best-case scenario is that FireEye is trading at more than 12 times its sales estimates for 2015 -- two years from now!

Don't buy
Given FireEye's insane multiples relative to its peers and the potential competition it could soon face, some might wonder how buying the stock could even be a question.

Surprisingly, many are calling it a good buying opportunity, but when you look at the actions of insiders, it appears that no one except retail investors are buying this stock. First off, there is the acquisition of Mandiant with nearly 90% stock, which supports the belief of the stock being overpriced. Thus, FireEye was able to buy a company for 10 times revenue with a stock trading for 70 times trailing-12-month revenue at the time -- a deal that greatly favors FireEye.

Then, despite only being a public company for less than seven months, it's already managed to complete a secondary offering of 14 million shares, with many of FireEye's executives selling stock. Lastly, with lockup expirations in full effect, there's no doubt that much of the stock's 40% loss since the end of February is connected to even more selling pressure from original investors, a sign that the stock is too expensive.

Therefore, at every angle you take, it's hard to find a reason to buy, and for investors seeking opportunity in the midst of a market pullback, this lack of reason should be a good indication to avoid FireEye.

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Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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