Better Buy: Palo Alto Networks Inc. vs. FireEye Inc.

By Leo Sun Markets Fool.com

Last November, I compared Palo Alto Networks (NYSE: PANW) with FireEye (NASDAQ: FEYE) to see which one was the better play on the growing cybersecurity market. I concluded that FireEye was a slightly better pick than Palo Alto, due to its cost-cutting measures, lower valuation, and takeover potential.

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Since that article was published, shares of Palo Alto have fallen 30%, while shares of FireEye have declined 8%. So while FireEye fared better than Palo Alto, both stocks would have lost you money. Therefore, it's time to take a fresh look at both stocks to see if either stock is a worthy investment at current prices.

Image source: Getty Images.

What do Palo Alto Networks and FireEye do?

Palo Alto Networks provides companies with next-gen firewalls, which beef up traditional firewalls with network device filtering tools. The company serves over 37,500 customers in over 150 countries, which includes 85 of theFortune 100 and half of the Global 2000.

FireEye provides threat detection services, which try to intercept threats beforethey breach perimeter defenses like next-gen firewalls. The company serves over 5,000 customers in 67 countries, including nearly half of the Global 2000.

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Both companies are considered "best in breed" players which have been granted major certifications by the U.S. government. Palo Alto's firewalls areapproved for major U.S. government agencies like the Department of Defense, and FireEye became the first cybersecurity company certified byHomeland Security in 2015.

Image source: FireEye.

How fast are the two companies growing?

Palo Alto's revenue rose 49% to $1.4 billion last year, andanalysts expect another 25% growth this year. Those numbers look robust, but the bears have noted that its growth could plateau in the near future.

FireEye's revenue rose15% to $714 million last year, but analysts expect just 1% growth this year. That massive slowdown was caused by two main factors. First, demand for its on-site appliances is declining. Second, FireEye's strategy of moving customers to cloud-based services generates lower initial revenues than the installation of on-site appliances.

FireEye's sales growth looks dismal compared to Palo Alto's, but FireEye's EV/Sales ratio of 2.8 is also much lower than Palo Alto's EV/Sales ratio of 6. FireEye has an enterprise value of just $2 billion, compared to Palo Alto's value of $9.4 billion.That lower valuation and price tag could make FireEye a much more lucrative takeover target than Palo Alto.

How profitable are Palo Alto and FireEye?

Palo Alto is profitable on a non-GAAP basis, but its GAAP losses are widening. Its non-GAAP earnings nearly doubled last year, but its non-GAAP loss widened from $165 million to $226 million. The main culprit was stock-based compensation (SBC), which gobbled up 30% of its total revenues. Analysts expect its non-GAAP earnings to grow 49% this year, but its GAAP numbers are expected to remain deep in the red.

FireEye wasn't profitable by either non-GAAP or GAAP metrics in 2016, but its losses narrowed by both measures. This was mainly attributed to layoffs and other cost-cutting measures implemented byCEO Kevin Mandia, who took over the top spot last June. However, SBC expenses still ate up 28% of its revenues during the year.

Palo Alto and FireEye face similar SBC problems because they are both based in the pricey Bay Area and their cash flows can't support higher cash salaries. This is problematic because both companies will eventually need to boost R&D and marketing spending to develop new products, win new customers, and widen their moats.

The headwinds and tailwinds

Palo Alto and FireEye both face tough competition from bigger tech companies like Cisco and Microsoft, which can use acquisitions and bundling strategies to reduce the need for stand-alone cybersecurity providers. In response, Palo Alto and FireEye are both expanding their services into all-in-one "platforms" which add additional features to their core firewall and threat detection products.

FireEye's Helix bundles its network, endpoint, Threat Analytics Platform, Advanced Threat Intelligence, and FireEye Security Orchestrator together in a unified system witha single user interface. Palo Alto's Next-Generation Security Platform offersa similar suite of services. These platforms are expected to stabilize both companies' top lines with recurring revenue growth over the next few years.

The winner: FireEye

I'm still not a buyer of either stock, because I personally believe that consistently GAAP-profitable players like CyberArk and Check Point Software are still safer plays on the cybersecurity market.

But if you must choose one over the other, FireEye is still the better bet, due to its lower valuation, higher takeover potential, tighter financial discipline, and the long-term growth of its Helix platform. Palo Alto's business is still growing, but I wouldn't touch it until it can narrow its GAAP losses.

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Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Leo Sun owns shares of Cisco Systems. The Motley Fool owns shares of and recommends Check Point Software Technologies. The Motley Fool recommends Cisco Systems, CyberArk Software, FireEye, and Palo Alto Networks. The Motley Fool has a disclosure policy.