Many tech investors chase high-growth stocks, but others like to bottom-fish for contrarian bargains. However, it's important to recognize the difference between a broken stock and a broken company -- the former might recover, while the latter might not. Let's examine three such broken companies which I never plan to buy.
InvenSense (INVN) makes motion sensors for smartphones, tablets, smartwatches, and other devices. While those sound like solid growth markets, the company respectively generated 40% and 16% of its sales from Apple (AAPL 0.22%) and Samsung last year. Peaking sales of both companies' mobile devices are weighing down InvenSense's revenue, which is expected to decline 24% this year and another 52% next year.
To make matters worse, InvenSense faces fierce competition from larger rivals like STMicroelectronics (STM 0.40%) and Bosch. Apple installed STMicro's motion sensors instead of InvenSense's into the Apple Watch last year -- raising concerns that Apple would eventually use STMicro's motion sensors for its flagship iOS devices.
InvenSense tried to offset that loss by diversifying into virtual reality headsets and Internet of Things gadgets, but both rivals are expanding into the same markets. Facebook's Oculus Rift, for example, uses Bosch's motion sensors. This ongoing competitive pressure could eventually crush InvenSense's margins. InvenSense was unprofitable by both non-GAAP and GAAP measures last quarter, and its losses could keep widening due to slowing sales and rising competition.
Cybersecurity firm FireEye (MNDT) provides threat detection services which monitor the perimeters of enterprise networks. This market is a growing one due to rising data breaches, but it's saturated with many rivals like next-gen firewall provider Palo Alto Networks and networking equipment giant Cisco's bundled security services.
That competition caused FireEye's sales to rise just 19% annually last quarter, compared to 34% growth in the previous quarter and 56% growth in the prior year quarter. FireEye expects sales to rise just 15% to 17% this year, compared to 46% growth in 2015. The company attributes that slowdown to its shift from on-site appliances to its new cloud-based platform, FireEye as a Service (FaaS). Appliances generate revenue immediately, but subscription-based FaaS revenues are recognized over longer periods of time.
But with sales growth slowing down, FireEye's net losses will likely widen -- and its hefty stock-based compensation expenses (35% of its revenues in the first half of 2015) could prove unsustainable. The company's cash and equivalents also fell from $402 million at the end of 2015 to $184 million last quarter -- raising the possibility of additional secondary or convertible debt offerings.
To top it off, FireEye's longtime CFO Michael Sheridan resigned last July amid cash burn concerns, and CEO Dave DeWalt resigned in June. FireEye's new CEO Kevin Mandia wants to cut costs to improve profitability -- but that strategy could reduce its competitiveness and result in even slower sales growth.
Seagate (STX) has constantly struggled with declining sales of its core HDDs (hard disk drives), which are being replaced by smaller, faster, and more power-efficient SSDs (solid state drives) -- which the company lacks a meaningful presence in. The ongoing slowdown in PC sales has also exacerbated that decline.
Seagate's revenue fell 19% in 2015, and analysts expect its top line to fall another 5% this year due to weak PC sales and demand from data centers. Its earnings are expected to rise 35% this year, partially recovering from its 84% decline last year. Those forecasts sound bullish, but they're inflated by easy year-over-year comparisons and buybacks.
Seagate relies heavily on buybacks, spending over $1 billion on debt-funded buybacks over the past 12 months. To make matters worse, it's promised to keep paying its forward dividend yield of 6.5% -- which looks unsustainable relative to its earnings payout ratio of almost 300%. Meanwhile, low interest rates have caused investors to flock to high-yielding stocks like Seagate, boosting its trailing P/E to 47 -- a steep premium to the industry average of 19 for data storage companies.
Seagate also refuses to make a major acquisition, like Western Digital's purchase of SanDisk, to remain relevant in the flash storage and SSD markets. Instead, CEO Steve Luczo convinced activist investor ValueAct Capital to take a big stake in the company and help the company turn around its data storage business. That bizarre move indicates that Luczo simply doesn't have a clear plan for Seagate's future.
The bottom line
InvenSense, FireEye, and Seagate all still have bullish supporters, but I'm not buying their turnaround stories. InvenSense remains at the mercy of larger rivals, FireEye is shrinking its business when it needs to expand, and Seagate is treading water with big buybacks and unsustainable dividends. Therefore, investors should look elsewhere for better contrarian plays.