After releasing better-than-expected third-quarter results last month, FireEye (NASDAQ:FEYE) last week announced a cloud acquisition and a strategic investment to accelerate its transformation as a cloud cybersecurity player. Following the news, the stock price jumped by more than 6%, but investors shouldn't get too excited.
Transition to cloud and services
Over the last several years, FireEye developed a portfolio of cloud and managed services to offset the decline of its legacy hardware businesses. And during the last quarter of 2019, the cybersecurity specialist reached an inflection point: Revenue from on-premises businesses dropped below half of total revenue. And thanks to the company's new initiatives, revenue increased 6% year over year to $238 million during the third quarter.
In particular, FireEye's platform Mandiant Solutions, which leverages cybersecurity experts' knowledge to propose cybersecurity services, fueled that growth. That trend should continue as the company released in October its Mandiant Advantage -- a cloud-native security-as-a-service (SaaS) version of Mandiant Solutions.
Why Respond Software
The acquisition of the cloud-cybersecurity specialist Respond Software, announced last week for approximately $186 million in cash and stock, represents a smart step to accelerate the company's transition to cloud and services. Respond Software proposes extended detection and response (XDR) capabilities.
In plain English, that means it leverages cloud-based machine learning and artificial intelligence to detect cybersecurity threats by processing large volumes of alerts and logs (information generated by computing devices such as servers) from multiple vendor-independent sources. If you're familiar with larger cybersecurity players, Palo Alto Networks proposes similar services with its Cortex XDR platform.
Respond Software's XDR technology provides FireEye with strong operational synergies with its existing offerings, including Mandiant Advantage. Indeed, the company will integrate Respond Software's capabilities to enhance its cloud platforms, and FireEye's consultants will leverage the tool to detect cybersecurity threats for customers.
In addition, management announced a $400 million strategic investment led by the investment outfit The Blackstone Group. That investment, which consists of convertible preferred stock, isn't so much about the financing of the acquisition of Respond Software. Instead, it corresponds to a long-term commitment to the company's transformation.
Management didn't indicate any immediate use for that fresh cash infusion. Those extra $400 million will add to the $942 million of cash, cash equivalents, and short-term investments FireEye accumulated at the end of the last quarter, which provides more dry powder for potential acquisitions.
However, you should keep in mind the company must remain prudent with the use of its cash as it also must deal with its total debt of $950 million and has already spent $116.9 million in cash to acquire Respond Software (in addition to the stock component of the deal).
Small steps in the right direction
The Respond Software acquisition and the strategic investment will accelerate the modernization of FireEye's cybersecurity portfolio, but they remain small steps.
Respond Software's revenue will stay modest relative to FireEye's scale, even if you assume strong growth. During the earnings call following the announcement of the acquisition, management indicated Respond Software generated less than $10 million of annual revenue -- approximately 1% of FireEye's forecast full-year top line.
Also, the $400 million of extra cash from the strategic investment doesn't represent a game-changing opportunity, as the currently high valuations in the cloud cybersecurity area limit the possibilities for large acquisitions. As an illustration, FireEye agreed to acquire Respond Software at a price that exceeds 18 times revenue.
Going forward, FireEye will need extra important decisions to fuel its growth. Indeed, its declining on-premises businesses should keep dragging its top-line growth beyond the short term. During the last quarter, legacy products and related services still represented 46% of revenue, or $106 million, which led to the modest forecast fourth-quarter year-over-year revenue growth of 2%, based on the midpoint of guidance.
Taking into account the acquisition of Respond Software, the market values FireEye at an enterprise value-to-sales ratio of 4, based on the midpoint of full-year revenue guidance range of $930 million to $934 million.
The tech stock's valuation corresponds to optimistic growth expectations compared to the company's modest steps in accelerating its transition to the cloud. Thus, investors should consider staying on the sidelines as long as the company's transformation doesn't lead to stronger revenue growth. In that regard, pay close attention to FireEye's next earnings call in February, as management will discuss its 2021 outlook.