7 Signs You Should Sell FireEye Inc Stock

Cybersecurity firm FireEye (MNDT) has lost almost 70% of its market value over the past 12 months and currently trades at a 25% discount to its IPO price of $20. Some contrarian investors might think that FireEye could rebound from these depressed levels, but I believe that the stock could crash and burn for seven simple reasons.

FireEye's threat detection map. Image source: FireEye.

1. Declining revenue growth

A look back at FireEye's past five quarters indicates that its sales and billings growth have slowed to a crawl.

Source: FireEye quarterly reports.

FireEye attributes these steep declines to its shift from on-site appliances to its new cloud-based platform, FireEye as a Service (FaaS). Appliances generate revenue immediately, but revenue from FaaS, a subscription service, is recognized over longer periods of time. However, billings growth -- which reflects future contract revenues -- has also hit a brick wall.

2. Widening GAAP losses

Like many other cybersecurity firms, FireEye uses non-GAAP measures to gauge its profitability. By that measure, FireEye's net loss of $52.7 million last quarter looked like an improvement from its loss of $62.6 million in the prior year quarter.

However, FireEye's biggest expense, stock-based compensation (35% of its revenue in the first half of 2016), isn't included in those results. On a GAAP basis, which includes that hefty expense, its net loss actually widened from $133.6 million to $139.3 million.

3. Running out of cash

FireEye is also burning through lots of cash. It finished last quarter with just $184 million in cash and equivalents, compared to $402 million at the end of 2015.

To stay afloat, FireEye did an $800 million convertible debt offering last May. In early 2014, FireEye used a secondary offering at $82 per share to raise about $460 million. That happened just half a year after it raised over $300 million from its IPO. Therefore, FireEye could soon employ additional share-diluting strategies to avoid running out of cash.

Image source: Getty Images.

4. Management heads for the exits

Faced with all these problems, FireEye needs reliable executives to lead a turnaround. Unfortunately, longtime CFO Michael Sheridan abruptly resigned last July, and CEO Dave DeWalt stepped down as CEO in June to become executive chairman.

Sheridan was replaced by Informatica CFO Michael Berry, and DeWalt was replaced by Kevin Mandia, the founder of Mandiant -- a company FireEye acquired in 2014.

5. Cutting costs as competition rises

Last quarter, Mandia and Berry announced that FireEye would reduce its annual operating expenses by about $80 million through cuts to its workforce and infrastructure. Mandia believes that those cuts will help FireEye achieve non-GAAP profitability, but reducing operating expenses by 9% annually probably won't be enough, since it expects non-GAAP operating margins between negative 26%-28% for the full year.

Scaling back as competition in the threat prevention market rises could enable major rivals like Cisco (CSCO 0.61%) and Palo Alto Networks (PANW 3.70%) to marginalize FireEye. Cisco's acquisitions of ThreatGRID, SourceFire, and other security firms have given it tremendous bundling power with enterprise customers. Palo Alto's acquisition of Cyvera also added robust threat prevention features to its next-gen firewall.

6. Mandia might not sell FireEye

Faced with these challenges, the best outcome for FireEye seems to be a buyout. Many investors believed that DeWalt -- who previously engineered the sales of Documentum to EMC and McAfee to Intel -- could do the same for FireEye.

But in June, Bloomberg reported that FireEye already rejected at least two suitors that made offers below its expectations of over $30 per share. Bloomberg also claimed that after Mandia took over, the sales process was "no longer active."

7. Low institutional ownership

Low institutional ownership can be a positive indicator for a "hidden gem" if the stock isn't widely covered by Wall Street analysts. But it's a negative one for a widely covered one like FireEye, which has 30 analysts and just 51% institutional ownership at the end of June -- down from 59% a year earlier.

This indicates that big investors are watching FireEye, but they aren't willing to load up on shares. By comparison, Palo Alto Networks is followed by 40 analysts and has 93% institutional ownership.

Don't be fooled by its valuations

FireEye's trailing price-sales ratio of 3.5 might look "cheap" compared to Palo Alto's, which trades at 9.4 times sales, but it's dropped to that level for the aforementioned reasons. I seriously doubt FireEye can boost its sales and profitability as it downsizes, so it might be time for investors to cut their losses before things get worse.