“Save the internet” is a red flag for me. Without the Internet, of course, Stock Gumshoe doesn’t have much of a business… which would make me very sad. And, of course, crush my jet-setting lifestyle and force me to sell my private yacht.
OK, fine, so my investing acumen has not yet led me to a jet-setting lifestyle, and I don’t have a yacht. It’s OK — I get seasick, anyway.
But yes, a relatively stable internet is important to me. So what’s this pitch from Manny Backus’ Wealthpire folks about “The $12 Stock That Could Save the Internet?” And, frankly, what does it need saving from, anyway? That’s our assignment here at Gumshoe U today — figure out what they’re is talking about.
The ad is actually from Michael Carr, and it’s a pitch for his Triple Digit Returns newsletter service ($299/year).
And as you’ve probably surmised, it’s got something to do with cybersecurity — here’s the intro to the ad:
“You might remember a couple years ago when Apple’s iCloud service was hacked…
“Almost 500 pictures of various female celebrities were leaked, most of them of a personal nature.
“It was a dark day for those women AND for the Internet.
“And I only bring it up because it was one of the most public displays of computer hacking we’ve ever seen.
“Something that normally happens ‘behind the scenes’ where ordinary citizens have no idea what’s happening suddenly had experts questioning cloud computing services and the general safety of our online world.Are you getting our free Daily Update
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“It’s a problem… a BIG problem.
“In fact, it’s so big that $122 BILLION is spent annually on the solution to this issue, something known as cyber security.
“And this market is growing exponentially. By 2021 it’s expected to nearly DOUBLE, breaking the $200 BILLION mark.”
And, of course, we get the promise of astronomical gains:
“… there will never be one true solution since as computers evolve so do hackers.
“BUT, there is a way to put a dent into this ever-growing issue that plagues our daily lives.
“And it’s the $12 company I’m telling you about today.
“Thing is, it won’t be $12 for long. In fact, I see this stock hitting $85 in the near future – a 430% gain.”
The argument from Michael Carr is that the particular specialty of this secret $12 company is Specialized Threat Analysis and Protection (STAP), which he says is a $930 million market of which the unnamed company has a 38% share.
So who is it?
This is, sez the Thinkolator, almost certainly FireEye (FEYE), the cybersecurity stock that went from darling to disaster very quickly following its 2014 IPO, and has been mostly in a holding pattern right around $12 this year after the stock bottomed out around $10 — though it has gotten some attention following the hacked emails during the election campaign, and has popped up to about $14 falling the election (that’s not company-specific, pretty much all cybersecurity stocks popped up by at least a little bit).
FireEye’s specialty is, indeed, threat analysis and protection — to oversimplify, their systems aim to intercept attacks before they hit firewalls. You can see a pretty good explanation of what that means in a market report by IDC that’s about a year old (that’s also the source of the claim that FireEye has 38% of that market, by the way).
And this is where I get gummed up whenever I look at a cybersecurity company — I worry about the role of smaller and independent security vendors like FireEye and Imperva and newer “hot” stocks like Infoblox in relation to the large enterprise providers or much larger vendors like Cisco (CSCO) (which bought SourceFire — a company that was, coincidentally, teased by Matthew Carr back when he worked for Oxford in 2011 — so I guess cybersecurity is not a new field for him) or Intel (INTC) (which bought McAfee years ago but seems to have struggled a bit to figure out what to do with it) or Check Point Software (CHKP), just to name a few of the larger players. I don’t really know who is going to get the best access to customers, and I certainly don’t have enough specific cybersecurity expertise to be definitive about assessing which company has the best product.
Which means, for the most part, that investing in individual cybersecurity companies, for me, has to come down to the financials and the analyst expectations — because even though analysts tend to be quite wrong in their estimates, they are, as a group, at last far more informed about and expert in the specific business prospects for each company than I am. So I do sometimes look through to see if there are cybersecurity stocks where a valuation disconnect exists, and sometimes I’ll speculate on those or on a basket of stocks, but I wouldn’t ever bet big on one cybersecurity stock.
The most recent position I had in that sector was, as a way of essentially giving up on differentiating the prospects of the companies involved, the PureFunds ISE Cyber Security ETF (HACK) — I don’t have a position in that ETF right now, but that would probably again be the first place I’d look if I were interested in a “big picture” buy in the cybersecurity market in general. Unfortunately, because of the wildly different performance of stocks in that ETF, including some dramatic losers like FEYE in recent years, you certainly do miss out on some of the upside of the companies that turn out to have the most investor appeal.
There is also an investing motif for cybersecurity that you can research if you’re interested in the sector — even if you don’t use motif investing, they provide a list of stocks that you can follow up on. And the performance of those stocks over the past year is reported on the Motif page, so that again calls attention to the fact that this sector includes stocks with seriously different levels of performance, they do not all trade together — you can see 50%+ gains for Symantec and Infoblox versus 30%+ drops for several firms (including FireEye and Imperva).
So how do things look for FireEye right now? Well, they did beat nicely on their earnings last week, which is much of the reason for the stock’s pop — and that’s good, because the stock has been in dire need of some optimism all year to encourage investors. There’s a Fool article here about the earnings report that goes into some of the detail, but essentially their sales were a bit stronger than expected and they’ve been adding some “cost discipline” this year as their new CEO (appointed in May) has pushed for cost cuts. And there’s at least some reason for continued revenue growth optimism because of their push into new markets as they expand their “security as a service” threat detection and analysis offerings to smaller companies for whom expensive FireEye enterprise-scale appliances don’t make sense. So it appears that having some optimism for this company on the operational side is at least rational — their products are being bought, revenues are up, and they are increasing their recurring revenue as they continue to focus more on subscription services. You can see the company’s quarterly presentation slides here for more detail.
But what about the valuation? This is a company that has never come particularly close to being profitable, and there’s no obvious trend line that indicates they’re going to start turning a profit in the near future, though cost cutting will no doubt help if they remain aggressive on that front and they can really cut costs aggressively without harming their product or their sales.
Selling and marketing expenses are huge for FireEye, and presumably that number has to be huge for them to push for sales growth, but that sales and marketing line has been much larger than their gross profit every quarter until this year, when the last two quarters finally saw that the marketing costs dropped below the gross profit number. That’s not necessarily sustainable, unless the company was hugely wasteful before (which is possible, I have no idea), they’re not going to be able to cut 10% from their marketing spending each quarter and still get revenue growth. If we assume that R&D spending can’t fall that much more without hurting product quality (it too has been cut by almost a third over the past year), and that the regular general and administrative expenses, which have also been cut by a third, might not be all that fatty… but their plan, which they do include some slides on in the presentation, is for still continuing cuts in operating expenses and cost of goods sold.
But it’s worth noting that a fairly large chunk of that expense is of a non-cash nature — they do have huge stock-based compensation, so that’s about half of their losses each year and they have had a positive number for “cash flow from operations” in each of the past two quarters. So that is worth some optimism, as is the growing deferred revenue number from their subscription business, but clearly they do still need to post continuing revenue growth.
On that front, the analysts are still a little skeptical — the company is still guiding for revenue to be substantially above 2015 levels, though the guidance is dramatically lower than it was six or nine months ago when the company was far more optimistic (which perhaps explains why they have a new CEO). Analysts have run with that guidance and forecast now that the company will have revenue of $800 million next year (which would be about 12% revenue growth from this year) and $921 million in 2018, and they expect that FEYE will continue to lose money next year, a loss of 47 cents per share, but that they will be hitting roughly break even the following year. (Those are both non-GAAP numbers, the ones the company reports that exclude stock-based compensation… which is what analysts generally still look at. On a GAAP basis, they’re nowhere near hitting profitability by 2018.) Estimates have been rising for the current year, following a couple upside surprise quarters and some growing confidence in the new management team, but this is still a pretty speculative bet on both accelerating revenue growth and continues cost cutting — and it’s hard to do both of those things well at the same time, so I’d suggest holding on to at least a little caution as you assess FEYE’s prospects.
The cyber security market is almost certainly growing, with a high likelihood of revenues to the sector doubling over the next few years… but it was also growing last year and the year before, and the average stock (at least if you go by the HACK ETF) is still roughly where it was two years ago. I would assume that the sector’s rise will eventually impact all of the major stocks in that sector, but it’s pretty clear that it hasn’t yet — whether that’s because of competition, price pressure from customers, or a mentality that the expected sector growth means these firms all want to take market share at any price, or some other cause, I don’t know. FEYE is a brand name in the sector and among investors, and they are in the midst of a turnaround that could, if they’ve able to hit their revenue growth, subscriber growth, and cost-cutting goals in the next 18 months, make the prospects look really attractive — but it’s going to be a bumpy couple of years if they don’t hit those goals. Companies that are in turnaround and in “hot” sectors trade on sentiment, particularly if there isn’t some level of underlying profitability to the business that creates a foundation for the stock, and sentiment can change a lot more quickly than the actual business changes.
So that’s all I’ve got for you on this one — the Triple Digit Returns folks are almost certainly pitching FireEye, and there’s a wide range of possibilities for that one about how things will turn out coming out of their management change, product transition, and cost-cutting push. If you’ve got a feel for FEYE or any thoughts to share on favored or hated stocks in the sector, please chime in with a comment below to share your wisdom with your fellow investors. Thanks!