FireEye Inc. Bombs Earnings And Loses Its CEO: Time To Buy?

Shares of FireEye plunged 19% on May 6 after the cybersecurity company posted weaker-than-expected first quarter sales growth and disclosed that CEO Dave DeWalt will resign. DeWalt, a former McAfee CEO who joined FireEye in late 2012, will be replaced by President Kevin Mandia, the founder of Mandiant (which FireEye acquired in 2014), in mid-June. This isnt the first major departure at FireEye -- CFO Michael Sheridan resigned last July amid major concerns about the companys cash burn rate.

Image source: FireEye.

The combination of weak sales and an executive shakeup spooked investors, and the stock now trades at a 35% discount to its IPO price of $20. Was that selloff justified or an overreaction which now presents a contrarian investment opportunity? Lets take a closer look at FireEyes first quarter numbers, potential catalysts on the horizon, and its valuations to see if the stock is a worthy turnaround play.

Slowing sales growthFireEyes billings improved 23% annuallyto $186 million during the quarter, which exceeded expectations by nearly $10 million thanks to growing demand for its cloud-based threat prevention solutions, e-mail protection solutions, andits FireEye-as-a-Service (FaaS) platform. However, that still represents a slowdown from 53% billngs growth in the prior year quarter.

Revenue rose 34% to $168 million, but missed estimates by nearly $4 million due to a higher mix of recurring product subscriptions, which are recognized over a longer period of time. However, FireEyes guidance for 21% to 26% sales growth in the second quarter completely missed expectations for 31% growth. FireEye also expects its 2016 sales to rise 25% to 30%, which is below the consensus estimate of 33% growth and represents a slowdown from 46% growthin 2015.

That slowdown raises concerns that bigger competitors in the threat prevention space, like Cisco , are gaining the upper hand with aggressive acquisitions and bundling strategies. Ciscos acquisitions of Sourcefire, ThreatGRID, and other security players boosted its security revenue 11% annually to $462 million last quarter -- nearly three times higher than FireEyes quarterly sales.

Burning through cashFireEyes GAAP net loss widened from $0.88 per share a year ago to $0.98, while its non-GAAP net loss narrowed by a penny to $0.47 per share, which beat expectations by three cents. However, the company's cash and equivalents fell 56% sequentially to $175 million during the quarter, due to its lack of profits and its acquisitions of security peers iSIGHT and Invotas.

FireEye finished the quarter with a negative operating cash flow of $22.5 million, compared to negative $3.2 million a year ago. Thats an ominous sign since FireEye already relied on a secondary stock offering and a convertible debt offering to raise cash within its first two years of going public.

FireEye believes that its cash flow willturn positive in the second half of 2016 (when it usually records 60% to 65% of billings), since it expects its sequential growth in billings to exceed its growth in cash expenses. For the full year, FireEye expects to generate positive operating cash flows between $70 million to$80 million.

Potential catalysts on the horizonFireEyes sales growth is slowing and its still burning through cash, but its transition from on-site and cloud-based appliances to FaaS could pay off in the long run. Doing so would decrease its dependence on product revenue, which fell 16% annually to $33.7 million last quarter, and increase the weight of higher-growth services and subscriptions revenue, which soared 58% to $134.3 million. FireEye classifies FaaS in its standalone product subscription category, which is expected to generate 35% of its total sales this year -- up from 26% in 2015 and 21% in 2014.

Moreover, FireEye still remains the best in breed player in threat prevention solutions, has over 4,700 customers in 70 countries, and was the first cybersecurity company to be certified by the Department of Homeland Security. That brand strength widens its moat against bigger bundled rivals like Cisco, and makes FireEye -- which has a fairly low enterprise value of $1.7 billion -- to be a compelling acquisition target for larger companies.

The valuations and the verdictAfter falling nearly 70% over the past 12 months, FireEye is looking fundamentally cheap. The stock trades with an EV/Sales ratio of 2.7, which is much lower than Palo Alto Networks ratio of 10 and CyberArks ratio of 6.

However, FireEye still has a lot to prove. It must pivot towards FaaS and reduce its dependence on appliances, generate positive cash flow by ensuring billings outpace expenses, fend off bigger rivals like Cisco, and inch towards profitability. If you believe that FireEye can achieve those goals, it could be a bargain at todays depressed prices.

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Leo Sun owns shares of CyberArk Software. The Motley Fool owns shares of and recommends FireEye. The Motley Fool recommends Cisco Systems, CyberArk Software, and Palo Alto Networks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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