As Vladimir Putin continues to flex his military muscle in Ukraine, U.S. stocks were lower on Monday, as the benchmark S&P 500 and the narrower Dow Jones Industrial Average (DJINDICES:^DJI) declined 0.7% and 0.9%, respectively. Still, those drops pale in comparison with the 12% loss suffered by the RTS Cash Index, which makes the Russian stock market one of the cheapest in the world. The same can't be said of the U.S. market, much less of certain parts of the technology sector, which are displaying clear signs of investor euphoria. The latest manifestation of this phenomenon is a secondary share offering from IT security firm FireEye (NASDAQ:FEYE), which went public only last September, but has seen its share price surge more than four-fold from the $20 initial public offering price.
Today's announcement from FireEye follows last week's $2 billion convertible debt offering from Tesla Motors (NASDAQ:TSLA) -- the largest of its kind in the U.S. bond for the past two years. Tesla's stock is up nearly two-thirds year to date and nearly sevenfold over the past 12 months. Combine the hope of future stock gains with the conversion feature, and that is how Tesla Motors was able to entice investors to take five-year notes paying a miserable 0.25% coupon and seven-year notes paying 1.25%. The deal is a fine display of financial acumen on the part of Telsa's management; I'm not sure the same can be said of investors who continue to bid the stock up into the stratosphere.
In selling common shares, FireEye is taking direct advantage of the extraordinary run-up in its stock. Note that existing shareholders who are cashing out represent the majority of shares on offer. If a stock you owned quadrupled in less than six months, wouldn't you consider taking some money off the table?
I'm not a complete skeptic regarding FireEye -- I think businesses that operate in the area of IT security can develop a competitive moat and, indeed, FireEye lists a number of competitive strengths in its prospectus. Nonetheless, at a market capitalization of nearly 29 times the next 12 months' revenue estimate, overvaluation is not just a specter hanging over this offering -- it looks very material indeed.
Investors who are thinking about buying FireEye shares at current levels ought to read the most recent Berkshire Hathaway shareholder letter, in which CEO Warren Buffett writes:
When [Berkshire vice-chairman] Charlie [Munger] and I buy stocks ... we first have to decide whether we can sensibly estimate an earnings range for five years out, or more. If the answer is yes, we will buy the stock (or business) if it sells at a reasonable price in relation to the bottom boundary of our estimate. If, however, we lack the ability to estimate future earnings -- which is usually the case -- we simply move on to other prospects.
Compare that with one of the risk factors FireEye includes in its prospectus:
Our limited operating history makes it difficult to evaluate our current business and prospects and may increase the risk that we will not be successful.
[...] Our limited operating history and our recent acquisition of Mandiant make it difficult to evaluate our current business and prospects and plan for and model our future growth.
Some cultists .. er, investors will argue that this text is boilerplate, but the fact that similar warnings are often included in offering documents does not make it any less true. When you're buying from insiders, it's always worth asking yourself what value you're receiving for your investment dollar. Caveat emptor.