Earlier today I wrote about the once hot tech stock bubble that was 3D printing (here), specifically about 3D System’s (DDD) 1000% rise from 2011 to early 2014, and its subsequent 90% decline to today’s trading levels. Another sub-sector in tech that had a similar sort of inflation then deflation was internet/network security, specifically FireEye (FEYE), whose stock had risen nearly 40% from its late 2013 ipo to its early 2014 highs, and now having round-tripped the entire move, yesterday breaking its IPO price for the first time. That’s an 80% decline from the highs:
After yesterday’s 80% take-over premium was announced for beleaguered Green Mountain to be taken private, I started to consider other stocks that were beaten up at multi-year lows, with very poor sentiment and possible strategic value to larger competitor, or financial buyer. DDD could fit that bill, and FEYE might also. Despite FEYE’s continued earnings losses, the company this year should grow sales to about $625 million, rising 47% yoy, with consensus calling for a 30% increase in 2016 to about $820 million. The stock is up 8% today on a rare upgrade by Citi, per Bloomberg, citing checks:
Says recent survey of Chief Information Security Officers suggested acceleration in security spend in 2016, with FEYE showing “exceptional strength” in survey
Barron’s Tech Blog quotes the upgrade note offering valuation support at current levels:
FEYE is still in the territory of EV/sales valuations, which is difficult to solidly call a bottom. However, shares below average of plot of EV/sales to revenue growth, suggesting market may already be looking for 2016 rev growth closer to 21% vs. our modeled 28%.
I have made the case in the past (from Sept – Fire in the Hole), that it too could have strategic value for potential buyers, specifically Intel (with the aid of private equity), who bought FEYE CEO’s last network security company McAfee for $7.7 Billion in 2010:
Thinking about Mcafee for a second, it appears that the division has not been run too well inside of INTC. In 2014, the Software & Services Group (page 13 of 10k), of which Mcafee is a part, was 4% of their $55 billion in annual sales. Not all of that is McAfee, which means the business has not grown in revenue terms since it was acquired.
Recently I had a friend suggest to me that INTC should spin out the group given the valuations of stocks like FEYE and (PANW) Palo Alto Networks (8 and 11x sales respectively). But maybe private equity takes a stab at Mcafee and merges it with a company like FEYE. Then, all the sudden, you have a quick path to profitability, a management that knows the company and product well and a formidable global player in what will be one of the strongest secular moves in enterprise computing in decades.
That’s obviously pie in the sky sort of stuff, but anytime we see a bubble inflate, and then burst and round-trip the entire move from inception, it makes sense to start thinking a bit creatively.
So whats the trade?
The next identifiable catalyst will be Q4 earnings that should fall in February expiration (Feb options not yet listed, will be on Dec 21st). Given Citi’s findings it makes sense to target the earnings event as a catalyst for the shares, NOT a low probability event like a takeout. Without Feb listed, those looking to target earnings for the next week and a half will need to use March expiration.
There are a couple of ways to go about it but it’s important that any trade idea be defined risk as these once hot but now beaten up stocks could see further downside without a quick change in sentiment. With the stock up 8% on the day, we think it makes sense to enter bullish directional trades on a bit of a pullback closer to $20, but we’ve been looking at a couple of different ways to play:
The first strategy (defined risk – risk reversal) selling a downside put spread to buy a wider out of the money call spread. This would define risk to the width of the credit put spread if the stock made new lows, while leaving significant profit potential in the event of a sharp reversal. For instance with the stock at $21.70, you could sell the March 18/15 put spread at .70 and buy the March 25/31 call spread for 1.10. The debit for the risk reversal would be 40 cents. If the stock were between 18 and 25 on March expiration then you would lose the 40 cent premium paid for the structure. If the stock was between 18 and 15 your risk is losing up to the width of the put spread plus the premium paid. If the stock were between 25 and 31 on March expiration then you could make up to $6, the width of the call spread (less the 40 cent premium). But I’d much rather enter such a trade on a pullback.
The second strategy (call calendar) is selling a January call to own a March call. We’d look to choose a strike a few dollars out of the money. Right now, with the stock 21.70 the Jan/March 25 calendar is 1.20.
But again, we don’t want to do either trade at the moment with the stock up 7.5% on the day. The calendar is a much less aggressive trade from a delta perspective so on a minor pullback that’s where we’d lean. The put/call spread risk reversal is where we’d lean given a larger pullback.