MorningWord 9/4/14: Fire in the Hole $FEYE

by Dan September 4, 2014 9:52 am • Commentary

Nothing like a couple of  hacks to get investors focused on data security companies. If you haven’t been keeping abreast, news recently broke of a hack on U.S. banks, followed by the iCloud hack of celebrity photos. So far no busts have been announced but shares of companies like Fireye (FEYE) and Palo Alto Networks (PANW) suddenly seem titillating to investors.

Hacks like this will only intensify over time, whether by enemy nations or groups in the form of cyber warfare/ terrorism or just by a bunch of internet pervs. So both corporations who manage our data and individuals who beam it to the cloud will need beef up security.

Of the two companies mentioned above, FEYE’s valuation makes the least sense and despite the stock’s 15% gains in the last couple weeks, the price action in my opinion remains atrocious.

Lets start with price action, since news of the bank hack broke in late August, FEYE rallied from $27 to yesterday’s high above $34, before reversing hard and closing down 6.4% on the day, and 9.4% off of the highs.  That’s some intra-day reversal for a 5 billion dollar market cap company on no news.  Put another way, the stock from the highs lost $500 million in market cap, equal to more than their entire expected sales of $428 million in 2014 (per Bloomberg consensus).  Whoah.

On the technical front, the stock clearly appears to be oversold on a longer term basis, down 68% from the all time highs made in March. BUT the RSI (relative strength index) nearly touched short term overbought territory on yesterday’s open (lower panel below), and the declining 50 day moving average (purple) suggest a momentum break:

FEYE 1yr chart from Bloomberg
FEYE 1yr chart from Bloomberg

Oh, and Valuation. FEYE CEO, Dave De Walt is a stoned cold playa.  Back in 2010, he sold McAfee, the number two internet security by revenues to of all companies, INTEL for $7.7 billion.  Whats amazing about this deal is that while at the time it didnt appear to make a ton of sense for INTC, at almost 4x trailing sales of $2 billion it seemed like a great deal for McAfee.

So on his current stint, he now presides over an upstart with a nearly $5 billion market cap that produces massive losses on expected sales of a little more than $400 million in 2014, if they are lucky. Doing some quick math, at one point, when the stock was 200% higher earlier in the year, the stock traded at more than 25x trailing sales.  Bonkers.  With the stock’s decline, it now trades at about 11x this year’s expected sales, which places it in line with $7 billion market cap company PANW, but there is a huge difference here, PANW has real earnings, and the stock trades at all time highs, with investors displaying a good bit more confidence in this company than that of FEYE.

However you slice it, relative to some historical M&A in the security software space, FEYE looks untouchable from a potential acquisition standpoint.  The company has come under fire since its Sept 2013 when they sold 17.5 million shares at $20.  On the stock’s dramatic assent, the company sold another 14 million shares at $82, on the day of the stock’s all time highs.  A deal in which many insiders sold shares, only to report disappointing fiscal Q1 results in early May, sending the shares down 22% the next day.

From an investment standpoint this company could have merits given their positioning in internet security, but at current levels the stock is a bit hard to swollen before they make a dent in their earnings losses. With 15% short interest, and down nearly 70% from the all time highs, the stock will remain a favorite of traders, as it is liquid and the hope of massive gains on a short squeeze will always draw in new buyers.  This is one that would likely make a lot more sense to me if in fact the stock was below $25 back towards their IPO price of a little less then a year ago.