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Should FireEye Investors Start Jumping Ship?

By Harsh Chauhan - Aug 27, 2018 at 11:35AM

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FireEye investors aren't buying the company's story because of these red flags.

FireEye (MNDT 0.27%) investors weren't impressed with the company's fiscal second-quarter results, even though the headline numbers were at the higher end of its guidance issued in May. Investors had similar sentiments when the cybersecurity specialist reported earlier this year.

The bottom line is that investors aren't buying into FireEye's progress. A closer look at its latest quarterly report will make it clear why that might be the case.

A cybersecurity shield covering random numbers.

Image Source: Getty Images.

Not solid enough

FireEye customer growth has left a lot to be desired in recent quarters, but there was some respite on this front this time around.

Chart showing growth in FireEye's customer additions.

Data source: FireEye's quarterly presentation. Chart by author.

The company bucked the trend during the second quarter as its customer base jumped nearly 24% year over year. FireEye also says that it struck 37 deals greater than $1 million during the latest quarter, with 95% of its customers buying more than one product family and half of them buying at least four products. By comparison, FireEye had struck 27 such large deals in the prior-year period.

But investors didn't buy into these positives, as they won't be boosting FireEye's financials in the long run as its deferred revenue was almost flat year over year, at $880 million.

Deferred revenue is the amount of revenue received in advance by a company for services to be delivered at a later date. So, a higher customer base and an increase in the deal size should have boosted this metric, but this wasn't the case. In fact, FireEye's deferred revenue has been trending lower over the past few quarters.

Chart showing FireEye's deferred revenue trends.

Data source: FireEye's quarterly presentation. Chart by author.

This is a red flag for investors as healthy deferred revenue growth indicates that a company is able to secure long-term contracts that will ensure a steady flow of business. But this hasn't been the case with FireEye as its customers have started signing shorter contracts.

Chart showing the average contract lengths of FireEye.

Data source: FireEye's quarterly presentation. Chart by author.

FireEye explains that the decline in contract length is a result of the company's shift from a product-based model to subscriptions. Earlier, the company was offering four-year licenses when it was selling cybersecurity appliances, but customers now have the flexibility to choose shorter contract lengths within the subscription model.

FireEye now is exposed to the possibility of its customers jumping ship in case they find a better solution that suits their needs. As such, it has to fight hard to retain customers by investing in product development and marketing.

This is why the company's combined outlay on sales and marketing and research and development increased 3% year over year during the latest quarter, to $158 million, outpacing the increase in deferred revenue. As a result, the company's GAAP net loss increased 7% year over year, and it won't be surprising if expenses start trending higher as the company tries to boost customer growth and hold on to existing customers.

Tough road ahead

All in all, FireEye has not been able to capitalize on the massive cybersecurity opportunity, as it's growing at a snail's pace. By comparison, cybersecurity peer Palo Alto Networks has been running away with the market.

Palo Alto is witnessing a rapid growth in its customer count as it's winning share from rivals, and its top customers are spending more money on its solutions. The pure-play cybersecurity specialist was able to slash its GAAP net loss by 23% as it reduced customer acquisition costs. More importantly, Palo Alto's deferred revenue increased big time last quarter, rising 22% annually, to $2.15 billion.

Similarly, Cisco has been able to leverage its influence in networking hardware and has expanded its wings into the cybersecurity market. The company's cybersecurity business has been growing at a commendable pace and it looks all set to overtake its pure-play rivals this year in terms of revenue. Cisco's advantage is that it can cross-sell its cybersecurity solutions to existing networking customers, posing a big challenge for the likes of FireEye.

As such, it will be difficult for FireEye to jump-start its growth anytime soon. The company is deep in the red and doesn't look like it will get out anytime soon, given how the competition is shaping up. In fact, FireEye has the weakest margin profile when compared to other pure-play cybersecurity specialists.

FEYE Operating Margin (TTM) Chart

FEYE Operating Margin (TTM) data by YCharts.

It doesn't make sense to stay long FireEye as there are better options available from an investing standpoint. It isn't surprising to see investors have started jumping ship.

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