FireEye: Watching the Tiger

 | May 27, 2014 | 9:00 AM EDT
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Shares of Wall Street darling FireEye (FEYE) are off 65% from their 52-week high. Is this an opportunity to get into the stock of a fast-growing company or is FireEye just another busted IPO?

The shares of FireEye were trashed after investors turned their backs on high multiple, momentum names. Last week, before total despair set in, Barclay's upgraded the stock. Happy thoughts caused the shares to bounce about 3% higher.

Despite the nice words from one of the company's BFFs (best friends forever), investors are still smarting from the expiration of the post-IPO lockup of 82.2 million shares. If that weren't enough, the company did a follow-on offering back in March of an additional 8.4 million shares at $82. Don't forget there are still 25 million to 30 million shares owned by investors not under any kind of selling restrictions.

Those rapid-fire deals doubled the float. If my math is correct, it looks like FEYE will have well over 145 million shares outstanding. Clearly, there's no shortage of FEYE fish wrap to go around!

Analysts have been urging investors to look past the tsunami of new shares and instead focus on the opportunity in front of the company. The acquisition of Mandiant allows FireEye to provide an end-to-end security solution for enterprise customers.

FireEye brings a cloud-based system that tracks and detects security breaches. Mandiant's software runs down cyber-criminals and the methods they use to break in. Incident response, managed defense systems and forensic analysis are a fairly new ideas and FireEye has had to spend heavily to evangelize the use of the company's software tools.

FireEye uses a virtual "sandbox" to "detonate" suspicious incoming executable files. These dangerous files usually come into the network as an email attachment, or through what is called an "SSL tunnel". Cybercriminals keep finding clever ways to trick firewalls into delivering malware, viruses and Trojan horses.

Instead of hoping a package has a suspicious signature -- like a fundraising email from the Chinese Army or an email attachment from the National Security Agency -- FireEye's software opens the file inside a secure sandbox. If the package is evil, the system destroys it. Then, Mandiant's software kicks into action to document the damage so experts can track down the attackers.

Although FireEye's approach is innovative, they are not without competition. Companies such as Fortinet (FTNT), Palo Alto Networks (PANW), Trend Micro (TMICY) and Check Point Software (CHKP) are all hot on FEYE's tail. Trend Micro recently introduced a tool called "Deep Discovery" that does much the same thing. Fortinet and Palo Alto both have sandbox offerings as well.

According to a Forrester survey of 229 network security professionals, from organizations with 1,000 or more employees, 71% of the respondents said advanced threat capability (i.e. sandbox) was the most important feature in selecting a next generation firewall.

Analysts are expecting sales of $411 million (up 47%) and $603 million (38%) for fiscal 2014 and 2015, respectively. As I mentioned, FireEye is spending heavily to gain market share and the losses are expected to continue for the next two years as the company focuses on top line growth.

To buy FireEye, you have to believe revenue will approach $830 million by 2016 and the company will remain a leader in the field. I think the Mandiant acquisition will pay off. Mandiant will help FireEye to exceed analyst estimates, which should get the stock moving higher. One better-than-expected quarter should get the growth junkies to pile back into the stock.

There are plenty of analysts on the sidelines with "hold" recommendations that will upgrade the stock once it's clear the company can consistently beat estimates.

As I see it, there are two ways to win with FireEye. First, the company is successful in growing its revenue and blossoms into a nice sized company. Or second, a larger firm that needs additional capability acquires FireEye.

Remember that CEO David DeWalt sold his last company, McAfee to Intel (INTC) for over $7 billion, so he's not afraid to move on. FireEye is well positioned in the network security space, so it is an attractive buyout candidate.

If you have a strong tolerance for risk and high valuation, FireEye has the eye of the tiger for sure.

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