Cybersecurity specialist FireEye's (NASDAQ:FEYE) stock is down sharply this year due to slowing sales growth and rising operating losses. The 30% year-to-date decline has lessened the risk for investors just by virtue of the bar being lowered for what might be considered a healthy rebound for the software company.
However, the stock could continue its poor trajectory and leave shareholders with hefty long-term losses from here. With that in mind, let's take a look at two key risks facing FireEye's business right now.
Disruption doesn't take
The single biggest concern is that FireEye's unique approach to cyber security fails to catch on with IT managers. The company aims to disrupt the market with a virtual-machine-based security platform that's different from the package of firewalls, gateways, and antivirus solutions that most enterprises and governments now depend on. Its offering focuses on protecting against advanced cyber attacks, which most IT budgets currently don't prioritize.
"As a result," executives explain in their annual report, "to expand our customer base, we need to convince potential customers to allocate a portion of their discretionary budgets to purchase our platform."
Failure here would mean slower growth for the company's market niche. Ironically, FireEye could also be hurt by success, to the extent that it convinces more established rivals to co-opt aspects of its approach and provide them at lower costs.
These risks help explain why investors punished the stock lately as FireEye's sales and billings growth trends slowed. Revenue rose by just 19% last quarter, compared to over 50% in the prior-year period. Some of that decline is a natural consequence of customers moving toward subscription purchases rather than outright product buys, but management isn't satisfied with the current sales pace. As a disruptor of the massive IT security industry, FireEye should be seeing firming, not declining, growth trends.
Profits don't materialize
Slower growth also gets in the way of management's goal of finally achieving profitability. In fact, operating loss has expanded to $283 million over the past six months, compared to $260 million in the prior-year period. FireEye is running at an annual-loss pace of nearly $600 million -- far above rival Palo Alto Networks' (NYSE:PANW) $215 million loss. Both companies are running at negative operating margins right now, but FireEye has a steeper hill to climb than its larger peer.
The good news for investors is that FireEye appears to have plenty of room for cost cuts to improve profitability. Expenses fell by $17 million last quarter despite the higher sales base. As a result, operating costs fell to their lowest level yet: down to 101% of sales from 114% last year.
FireEye anticipates achieving non-GAAP profitability by the end of 2017, and progress toward that goal would make the stock a less risky investment. Yet with sales and marketing expenses making up the largest single category of costs, and research and development coming in second, positive earnings won't be worth celebrating if they come at the expense of spending to attract new business and to stuff the company's product development pipeline.
Ultimately, investors can be compensated for these risks by grabbing shares at a discount. Right now, for example, FireEye is valued at just 3 times the past 12 months of sales, compared to a price-sales ratio of over 13 for most of last year. Palo Alto's stock is currently fetching a much higher price-sales of 9.
FireEye's business isn't as diverse, and its outlook has worsened lately, with revenue growing at a slower pace than expected. Shareholders have to balance that decline -- and the risk that it accelerates -- against improving finances and a stock that's looking particularly cheap right now.
Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool owns shares of and recommends FireEye. The Motley Fool recommends Palo Alto Networks. 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.