Cybersecurity firm Carbon Black (NASDAQ:CBLK) priced shares in its May 4 IPO at $19, and the stock rose 26% that first day on the market, closing at nearly $24. The stock subsequently rallied above $30, even as concerns about trade tensions and interest rates weighed down the broader market. Should investors chase this rally, or is the stock getting too hot to handle?
What does Carbon Black do?
Carbon Black provides endpoint security solutions, which shield a company's network from external threats originating from mobile and virtual devices. Many endpoint security providers "filter" samples of data to find potential threats.
Carbon Black, however, scans an enterprise customer's "unfiltered" activity. Unfiltered activity includes a lot of data, but Carbon Black uses its proprietary technology to compress and analyze that data through machine learning algorithms.
This open-architecture platform is designed to be integrated with a customer's other cybersecurity products, and the company currently holds strategic partnerships with IBM and Dell's VMware.
How fast is Carbon Black growing?
Carbon Black's revenue rose 65% to $116.2 million in 2016, and climbed another 39% to $162 million in 2017. Its customer base more than doubled from 1,774 in 2015 to 3,739 in 2017, with most of its growth coming from cloud-based customers.
Acquiring those customers wasn't cheap, however. The company's sales and marketing expenses jumped 33% in 2017 and accounted for 66% of its revenue. That was a decrease from 70% in 2016, but the company still plans to "invest further in our sales and marketing activities" to grow its customer base, as well as in research and development to improve its technology.
Unlike many other high-growth cybersecurity companies, Carbon Black doesn't spend a massive amount of money on stock-based compensation (SBC) expenses. Its SBC expenses rose 22% annually in 2017, but accounted for less than 6% of its total revenue.
Yet Carbon Black remains deeply unprofitable. It reported a net loss of $55.8 million last year, compared to losses of $44.6 million in 2016 and $38.7 million in 2015. Looking ahead, Carbon Black's future depends heavily on its ability to attract new enterprise customers to stabilize its revenue growth and narrow its losses.
In its S-1 filing, the company warned: "If we are unable to attract a sufficient number of new customers, we may be unable to generate revenue growth at desired rates." That could already be happening, since analysts expect Carbon Black's revenue to rise just 25% to $202 million this year as its bottom line remains in the red.
How tough is the competition?
Carbon Black faces much larger competitors that bundle endpoint security solutions into their diversified platforms. In its S-1 filing, it lists legacy antivirus solution providers McAfee and Symantec, established network security players FireEye (NASDAQ:FEYE) and Palo Alto Networks (NYSE:PANW), and start-ups Crowdstrike and Cylance as its main competitors.
FireEye and Palo Alto likely pose the biggest threats to Carbon Black as they are considered the "best-in-breed" players in threat detection and next-gen firewalls, respectively, and both companies are bundling specialized endpoint security tools into their expanding platforms.
FireEye serves nearly half of the Forbes Global 2000 companies, while Palo Alto provides its firewalls to over 60% of that list. Carbon Black could have a tough time chasing those two market leaders, even with the support of enterprise giants IBM and VMware.
Is Carbon Black's stock too expensive?
Since Carbon Black is unprofitable, we need to value the stock with its price-to-sales ratio. At $30, the stock trades at about 10 times this year's sales. That makes it pricier than FireEye and Palo Alto -- which trade at four and nine times this year's sales, respectively.
Analysts expect FireEye's revenue to rise just 10% this year, but Palo Alto's revenue is expected to climb 28%. This indicates that Palo Alto, which has a much higher market cap, is actually growing at a faster rate with lower valuations than Carbon Black.
The verdict: Stay away (for now)
Carbon Black boasts some impressive growth figures, but its decelerating revenue growth, widening losses, and high valuation are keeping me away from this red-hot stock. The stock might look interesting once its growth stabilizes and its valuations cool down, but I think investors should steer clear for now.