FireEye will now start to Acquire

What’s next for the man with the golden touch and the product that markets itself as the silver bullet?  This is a delicate time as FireEye (FEYE:NASDAQ) has just IPO’ed, and is doing extremely well.  However for FireEye to survive it will start to acquire technology, and fast.  Why? The facts are straightforward:

Game plan

What are the next moves for FireEye? People have a tendency to repeat what was successful in the past.  Dave DeWalt turned McAfee into a successful company by:

  • Increasing sales infrastructure
  • Reducing Development Costs
  • Moving laterally in their product line
  • Acquiring Technology and Revenue

Where we are in the plan

Let’s add up these facts and see where in this plan we are.

Step One: the reason for FireEye’s negative cash flow quarter over quarter is that they are investing it into sales and marketing.  Most of the glitter on the IPO is because they have done this very well, to the point of almost perfection.  Yet this has come at the cost of exhausting their cash.  So much so that they raised their initial offer size from 14 million to 15.2 million shares to increase the incoming capital.  On the Dave DeWalt checklist they have accomplished step one.

Step Two: they are decreasing their technology investment by offshoring the research and development.  FireEye is outsourcing their research and development to India.  Historically this reduces cost but stagnates the development of new ideas beyond that of incremental improvements.  The development group is now separated from the initial thought leaders.  It is not a far stretch to say that one should expect the product to have small incremental improvements, as did McAfee’s Indian operations, as Dave has hired the same management that once worked that role for McAfee.

Step three: We should see lateral movement.  Looking at the product line we can already see lateral movement.  If you are to look at the technology behind FireEye’s products, you will see that this is the same technology implemented into different aspects of the network.  There is no new innovation, just incremental changes in how artifacts are down-selected and captured.

FireEye’s products are:

  • Web (This was their initial product)
  • eMail
  • File
  • Malware Analysis

But this lateral movement is not enough.  The technology base of FireEye hinders it from being able to get into a unified firewall or an application firewall.  There are also a growing number of competitors in this field (Last Line, Reversing Labs and McAfee). The intellectual property and market space need to increase in order for lateral movement to occur.

Step Four: Acquire.  This is where FireEye is now.  FireEye continue to try to expand their product space, but they seem unable to innovate past their sandbox technology.  They will need to acquire both technology and revenue streams. This means that they are going to have to bargain shop.  This is not going to be easy when people see security as hot. They need to find companies that have revenue streams and offer them multipliers of five or six, when the going rate in security is around nine.

Time to execute

Dave and company have been in this position before needing their merger and acquisition strategy to target both technology and revenue.  This time however, the stock market is betting hard they can from the beginning; they are not just bringing back a company from mediocre performance.  They have a honeymoon period coming up and since they are not profitable, their price to earnings (PE) will be “not applicable”, and thereby hiding how much they are losing.  Until there is a PE, the pressure on the company will be to raise revenue and shorten the date until they are profitable.  Meaning the savy investor will be watching for a reduction in the loss per share quarter over quarter.

A Slight Bearish Stance by Long Term Investors

Like many IPOs, the fans of the company showed up the first day to buy.  There is still a crowd movement that is positive on the stock.  Yet hardcore investors that look at numbers are slightly bearish on the company and the position it is in.  Such an example is an interesting read from Seeking Alpha, where much of my financial knowledge of the company comes from.

“This makes me wonder. If the company has already 20% of top 500 Fortune customers as a current client, how much upside is really there? At the same time revenue growth is slowing down, while operating spending, including sales and marketing efforts to boost revenue growth, is exploding. The fact that CEO David DeWalt received $6.0 million in total compensation for 2012 is very steep as well, given the terrible operating results.

For now investors are cheering. Yet the focus on growth over profitability could result in significant losses in the coming years, to the point that the company might run out of cash within two year’s time at the current pace. This is even after raising more than $300 million in its public offering.”

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