Is Imperva's Guidance an Indication to Avoid Cyber-Security Stocks?

In a rather ugly Thursday for the broader market, shares of Imperva (NYSE: IMPV  ) were particularly crushed following disappointing guidance. The security software vendor lost nearly half of its valuation, and in the process affected the stock prices of peers like Palo Alto Networks, FireEye (NASDAQ: FEYE  ) , Fortinet (NASDAQ: FTNT  ) , and Proofpoint. Yet, given this performance, combined with that of the last month, are these losses overdone, or are they just getting warmed up?

What happened?
Imperva sells Web Application Firewalls, or WAFs, which aim to block cyber threats. The outlook for such technology has been bullish in recent years, as clients acknowledge security limitations in the face of sophisticated threats and aim to better protect customer information.

Imperva reached a valuation multiple of nearly 13 times sales, with operating margins of -18.5% at its peak; investors apparently believed the company's 30% growth was sustainable. However, the stock's near-50% decline on Thursday, the result of unfavorable guidance, paints a very different picture.

The company was expected to earn first-quarter revenue of $36.5 million, but is now guiding for just $31 million, a significant miss on a percentage basis. Furthermore, the company admitted that competition for large orders has grown, and that extended sales cycles could mean more bad weather ahead. In other words, revenue is becoming harder to earn in an industry with increased competition, including large corporations that are building their own security networks.

Different, but very much the same
One of the reasons so many security software vendors have become momentum stocks in the last year is because of complicated products that sound necessary in a world that's continuously threatened by cybercrime. These companiesoperate in the same space, yet offer services that differentiate themselves from peers, regardless of whether the software is actually necessary.

For example, FireEye sells appliances to prevent advanced persistent threats, or APTs, which are newer threats that traditional firewalls and web gateways cannot detect. However, APTs don't prevent or eliminate threats, but rather simply identify them, which leads to additional security measures to eliminate and prevent those identified.

Palo Alto Networks provides network security infrastructure; Fortinet develops threat management systems; Proofpoint develops on-demand security software. While each is different, all trade in the same industry, one that is valued mostly on expectations, not fundamentals.

 

Market Cap

12-Month Revenue

2014 Revenue Growth Estimate

Price/Sales Ratio

Operating Margin

Imperva

$733 million

$177 million

28%

5.3

(18.46%)

FireEye 

$6.65 billion

$161.5 million

152%

42.7

(101.22%)

Palo Alto 

$4.76 billion

$483 million

44.7%

16.6

(6.3%)

Fortinet  

$3.35 billion

$615.3 million

13.8%

5.75

11.8%

Proofpoint

$1.19 billion

$138 million

27.5%

8.63

(19.35%)

As you can see, there is a large disconnect in the fundamental size of these companies and the market capitalizations given. This can be seen clearly in Imperva versus FireEye, as investors have given the latter a premium due to its growth. However, investors should note that FireEye's growth is in large part due to acquisitions, not necessarily demand for its existing business.

With that said, Fortinet is the only of these companies that are profitable, and appears to be valued at a rather conservative price. Hence, it might present investors with a value opportunity.

Final thoughts
Imperva's sales cycle and competition remarks might be a sign of a larger trend within this industry. If so, this could spell trouble for the company's peers, as each is connected to the overall demand of cyber security, meaning that large losses might just be warming up.

Company

One-Month Stock Performance

Imperva

(53%)

FireEye

(40.4%)

Palo Alto

(18%)

Fortinet

(11%)

Proofpoint

(26.5%)

Clearly, there is a connection between stock performance and valuation premium. Imperva is the top loser, but Proofpoint and FireEye have both fallen significantly as well, with poor margins and a steep price/sales ratio.

It appears as if such losses could continue if the Nasdaq falls. Albeit, Fortinet has decent growth, good margins, and is attractively priced following an 11% loss. Thus, at 33 times forward earnings on a double-digit revenue growth company, Fortinet looks fairly valued in a very expensive space.

If you're going to invest in this space, Fortinet is likely a good bet. If not, excessive valuations and increased competition could indicate a much larger fall could come.

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Related Tickers

8/27/2014 10:37 AM
IMPV $29.21 Up +0.10 +0.34%
IMPERVA INC CAPS Rating: ***
FEYE $29.50 Up +0.59 +2.04%
FireEye CAPS Rating: ***
FTNT $25.92 Up +0.05 +0.17%
Fortinet CAPS Rating: ***

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