As Cyber Crime Grows, Buy This Firm?

Published Thu, Oct 16, 2014  |  Marty Biancuzzo, Chief Technology Analyst

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Every year, this threat costs companies and consumers $100 billion in losses.
Around 12 people fall victim to this menace – every second, according to Russia’s Bureau of Special Technical Measures.
In a Kaspersky Labs and B2B International survey, 62% of people claim it has directly impacted their finances.
In fact, the FBI says it’s becoming the No. 1 terrorist threat against the United States.
What can you do to protect yourself and your family?

“The Bad Guys Are Winning”

If you haven’t guessed yet, I’m talking about the nightmare that is cyber crime.
This year, we’ve seen high-profile cyber attacks on eBay (EBAY) and PayPal, Snapchat, plus Silk Road hacking the Bitcoin market and making off with $2.7-million worth of Bitcoins.
“The bad guys are winning,” concludes Verizon’s (VZ) 2014 Data Breach Investigations Act.
With the incredible growth of mobile devices and more people connected to the internet, there no doubt that cyber crime will continue to rise.
Which makes companies like this one all the more critical.
But is it worthy of your investment dollars? Let’s find out…

The Lowdown on This Cyber Sheriff

FireEye (FEYE) is one of many companies that provide cyber-attack prevention and resolution services. Its technology helps secure email, websites, servers, networks, and files from malicious software and attacks.
With cyber crime increasing and costing companies billions each year, business should be booming, right?
Well…
~Cash
The good news? In FireEye’s short time as a publicly traded company (since September 2013), its top-line figures have grown tremendously.
The bad news? The more FireEye grows its revenue, the further its profits sink.

The reason for this ugly equation is simple…
Since 2011, the company’s R&D expenditure has ballooned by 804% – from $7.3 million to $66 million. However, you can rationalize this by considering that it’s a necessary expense in the highly competitive cyber-security market.
What isn’t so easy to justify, though, is FireEye’s soaring overhead expenses – up 532% since 2011. While this would suggest growth, it’s paid for much of it by selling blocks of shares… at shareholders’ expense.
In a word: ugly.
C.H.A.O.S. Meter: 8/20
~High Impact
Today’s approach to tackling cyber attacks is to “layer” as many levels of defense as possible to prevent attackers from breaching a network.
The trouble is, while cyber criminals are destructive, they’re not stupid. And if they’re intelligent and determined enough, it’s not long before they find a way to breach that security.
FireEye looks to prevent cyber attacks before they happen. It does this with Multi-Vector Virtual Execution (MVX) Architecture.
FireEye CEO, David DeWalt, says the company doesn’t just use this technology. It also harnesses data analysis and intelligence experience. Together, these elements offer a suite of cyber-protection solutions to stay ahead of criminals.
That’s what the company says, anyway. The “process” it describes is essentially very similar to other cyber-security firms.
C.H.A.O.S. Meter: 14/20
~Acceleration
Since FireEye’s IPO (priced at $20), shares have blasted to almost $100… only to come crashing back down recently amid a serious spike in short interest.

At the moment, institutions own 64% of the company, so any acceleration (be it up or down) will be amplified by big banks and hedge funds.
Plus, traders on CNBC’s Fast Money scoffed at any upward acceleration for FireEye shares when they accused DeWalt of manipulating the price with overly optimistic news.
The basis for the claim was DeWalt’s decision to sell 485,656 shares back in March at an average price of $79.54 – just days before announcing quarterly earnings and before the stock tanked.
When FireEye started trading, the timing was perfect. Shares soared on IPO enthusiasm, heightened cyber-security fears following a string of attacks, plus Edward Snowden’s damaging intelligence leaks.
But for the stock to see those dizzying heights again, it will need to start justifying its hype.
C.H.A.O.S. Meter: 10/20
~Orders
The main way FireEye can prove its worth is through consistent earnings growth. And the company enjoyed a good second quarter…
Not only did it report strong year-over-year revenue and operating margin growth, the firm also raised revenue guidance to $423 to $430 million, in line with estimates.
Revenue growth came as FireEye’s year-over-year customer base more than doubled to 2,498 and billings surged by 153%. The company also expanded its international presence to 65 countries.
FireEye says it expects third-quarter revenue to top $100 million for the first time in the company’s history.
FireEye also reported strong deferred revenue of $232 million in the quarter – up $130 million year over year. While that’s certainly a positive, I’ve also seen firsthand that this can be unpredictable, as the money isn’t guaranteed.
Some companies include this revenue in their reporting as a way of “fluffing” the numbers. So when you see hefty deferred revenue, check for “accruals” – a form of accounting that reports non-monetary or intangible assets.
It’s clear from FireEye’s accruals that the company uses its deferred revenue and intangible assets in its reporting – and has since 2011.
So while revenue is growing, the firm relies too heavily on deferred orders. I want to invest in companies that are growing because of real, actual demand from customers parting with their money at the time. Not a company that uses a deferred payment plan. That’s not money in the bank… it’s cosmetic sales growth – pretty on the outside, ugly underneath.
C.H.A.O.S. Meter: 7/20
~Scalability 
Put simply, FireEye relies on fear of cyber attacks and demand for cyber-security solutions.
While short-term accelerants (like the Snowden revelations) can provide a boost, they aren’t enough to convince companies to spend more money to overhaul their security infrastructures.
And that’s the point…
FireEye’s customers don’t spend large chunks of their budgets on FireEye’s products. And it’s why the company spends more than it makes on marketing efforts, cutting deferred payment deals just to attract new clients.
Ultimately, while FireEye’s business focuses on crucial services, it’s a highly competitive market that demands unique reasons for potential clients to pick FireEye’s products over more established, household names.
C.H.A.O.S. Meter: 10/20
OVERALL C.H.A.O.S. RANKING: 49/100
Final Verdict: FireEye hit the market with some of the most unsubstantiated hype I’ve ever seen. But when it came time to fulfill that hype, the stock tanked.
And that’s what it boils down to. FireEye is more hype than substance, with a chief executive who’s more of a salesman than a leader.
So I like this company as a downside play.
With interest up substantially in the December 2014 $24 put options, I’d consider jumping in.
Your eyes in the Pipeline,
Marty Biancuzzo