Is FireEye a Buy?

Former cybersecurity darling FireEye (MNDT) has been in a serious slump for the last few years. Following its September 2013 IPO, the company's shares gained ground rapidly for five months, peaked, and then headed sharply down again. Since early 2016, it has been relatively flat, hovering in a range well below its offering price.

Its revenues have continued to climb, but at a far slower pace than early investors in the company were expecting. Cybersecurity technology has advanced, and FireEye simply hasn't been quick enough to pick up on new trends. No doubt the company has a future, but its prospects -- and its value -- are unclear given the amount of competition out there.

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Grow too slow, and it's not growth at all

When FireEye made its debut, its hardware-based security offerings were in high demand and it was making sales at a torrid pace. However, many cybersecurity companies -- FireEye included -- have seen their revenues trail off dramatically as cloud computing has taken over as the digital process of choice. Many remote data center-based operations and the geographically dispersed workforces they support don't get adequate protection from security appliances tethered to specific office buildings.

FireEye has been promoting its new cloud-based security suite, but its slow migration to that route is nevertheless showing up in revenue trends.

*year over year from 1H 2018. Data source: FireEye.

While the company is no longer delivering the double- and triple-digit increases it achieved a few years ago, one might ask what's wrong with 7% annual growth? Many businesses out there would be plenty happy with that. Cybersecurity, however, is a different animal.

As organizations around the globe transition to more digital-forward operating models, the demand increases for system security. According to researcher Global Market Insights, annual spending on cybersecurity is expected to grow at an average of 12% a year through 2024 and reach about $300 billion a year -- with cloud-based services leading the charge.  

If cybersecurity spending is, in fact, rising at a double-digit pace, and FireEye's revenues are only growing at a single-digit rate, that implies it is losing market share to its competitors. Plus, the company is losing money as spending to support sales and other expansions remain high. (Its operating loss was $120 million the first half of 2019.) That's not exactly a good situation for a company forecasting only single-digit revenue growth.  

Image source: Getty Images.

A tidal wave of competitors

It's not as if FireEye is completely missing the boat on cloud security. During the second quarter, its cloud subscriptions and managed security billings grew 26% year over year. But revenue from its older, hardware-based products declined 4%, dragging down what would otherwise have been a stellar headline figure.  

It also made the strategic acquisition of Verodin, with its security measurement and management platform. The plan is to combine features from Verodin with FireEye's Helix security orchestration software, capitalizing on industry trends toward automating tasks using artificial intelligence. It's a high-growth area that is sure to offset declines in the company's legacy operations. But even in this, FireEye isn't a sure bet.

That's because a slew of small cloud-based start-ups have been gobbling up the lion's share of the next-gen security services business -- names like Zsclaer, CrowdStrike Holdings, and Okta. Companies larger than FireEye -- most notably industry leader Palo Alto Networks -- have also been transitioning to the cloud. Palo Alto has been growing at a 20% rate, supported in large part by an aggressive acquisition strategy. Even firms from outside of the security niche have been getting in on the action, among them big data analytics firm Splunk and VMware.

All of this is to say that, while FireEye's results on the surface look good enough, the cybersecurity industry looks headed for a shakeout in which the top dogs will get bigger and everyone else will struggle. Given that FireEye can only tout single-digit sales growth and is barely running free-cash-flow positive (revenue less cash operating expenses and capital expenditures, see chart above), I think there are better places for investors who want a position in the fast-evolving cybersecurity industry to put their money.