Morgan Stanley Dissects FireEye's 'Complex' Second Quarter Results

FireEye FEYE reported its second quarter results after market close on Tuesday. At first glance, a top and bottom line beat and coupled with an upwardly revised full year fiscal 2014 guidance confirm an overall positive quarterly result. According to analysts at Morgan Stanley, this is not necessarily the case as FireEye's results are “complex” and “transitional.” In a note to clients on Wednesday, Keith Weiss of Morgan Stanley dissected FireEye's results and concluded that investors may be left with more questions than answers on the company's sustainable growth profile. “Investors came into the second quarter with the knowledge they'd have to sort through the inorganic impacts of the Mandiant transaction to gain visibility into the underlying growth at FireEye,” the analyst wrote. The analyst adds that while FireEye's management did offer directional guidance on the growth trajectory of both FireEye and Mandiant, investors could be dragged along for a bumpy and complex ride for several reasons. First, FireEye announced a new global sales leadership with the hiring of John McGee while reassigned Jeff Williams to SVP of America Sales. Second, FireEye indicated that the company plans to now shift its corporate strategy towards “much more aggressively moving toward profitability” following a period of aggressive investments to fuel growth. Third, FireEye plans to restructure its organization to reduce some of the redundancies accrued following five recent acquisitions. Finally, FireEye announced an accounting change in the revenue recognition of its Email appliance, which adds $13 million to $15 million in revenues to the second half of fiscal 2014, according to the analyst. What does all this mean? According to Weiss, “the level (and type) of changes taking place into the second half of 2014 likely exacerbates the investor debate around the sustainability of growth at FireEye, keeping the shares range bound.” Weiss adds that FireEye will need more time for its product portfolio to mature within the distribution network that the company built over the past two years. In other words, the analyst believes there is a long path towards profitability, despite an impressive growth in the second quarter where product billings and total billings grew 87 percent and 153 percent, respectively. Weiss points out that total expenses were up 152 percent year over year. Coupled with an estimated $730 million in expenses in the remainder of 2014, relative to a revenue base of $427 million, FireEye's “wide profitability gap will take a long time to narrow.” FireEye raised its fiscal 2014 billings target by $10 million to $550 million to $570 million to $560 million to $580 million. However, the analyst notes that this implies organic growth decelerates to 48 percent. The analyst also assumes FireEye will see heavy free cash flow losses of $217 million in fiscal 2014 which will improve to $155 million in fiscal 2015 and assumes a “more modest” ramp in free cash flow through fiscal 2019. Bottom line, “investors have to rely on long-term free cash flow estimates (five plus years) to gain comfort on FireEye's valuation which may pose some challenges.” Weiss lowered his “base case” price target to $35 from a previous $50, assuming a discount of 32x on an estimated $300 million of free cash flow in fiscal 2019. Weiss maintained a $64 price target in a “bull” case scenario which assumes a discount of 35x on an estimated $500 million of free cash flow in fiscal 2019. Weiss maintained a $15 price target in a “bear” case scenario which assumes a discount of 25x on an estimated $155 million of free cash flow in fiscal 2019.