Monday, December 21, 2009

Looking at the Fundamental Story of Sourcefire (FIRE)

I began a position in Sourcefire (FIRE) last Thursday, but did not have time to write a proper entry on the fundamental story here.  While there are many stocks whose charts are in good shape, I definitely prefer a company who can capture our interest both from a secular growth (fundamental) story AND technicals, so Sourcefire is the type that can fit the bill.

A simple company description as follows; in general this is a company focused on IT security - most investors would know it's larger peers, McAfee (MFE) and Symantec (SYMC); another smaller firm in the wider space is ArcSight (ARST).  Sourcefire is facing the enterprise more than the retail consumer.

Sourcefire, Inc. provides enterprise threat management and intelligent security infrastructure solutions in the United States and internationally. The company offers Sourcefire 3D system, which comprises its hardware and software products for protecting computer network assets. It also provides open source projects comprising Snort, which is the traffic inspection engine; and ClamAV that identifies embedded threats.

After fending off a takover bid in early 2008 for under $200M, Sourcefire is now valued at close to $700M - obviously resisting the "fast money" buyout was the right thing to do. Its 300 employees are not based in Silicon Valley, but Columbia, Maryland placing it close to (I am not being facetious) the center of American commerce nowadays; Washington D.C.  To that end, just under 30% of all sales last quarter were to government, and year over year growth in that niche was over 60%.  An presentation from the Barclays Capital Global Technology Conference earlier this month can be found here.

Revenue growth, which is the one thing companies cannot "play with" (unless you are Enron), has been solidly growing every year since it began generating meaningful revenues in 2003:

2003: $9.5M
2004: $16.7M
2005: $32.9M
2006: $44.9M
2007: $55.9M
2008: $75.7M
2009 est: $99-101M

It is a seasonal business, as IT departments place orders most heavily in the last two quarters to fill their budget allowances. As stock investors we have to care about this because when expectations get too high for a stock, short sighted followers of a stock might be expecting continuel sequential revenue growth and when Q1 (reported in April) disappoints on that end, you could have lemmings jumping off a cliff.  But January 2010 will be the report reflecting the strongest quarter of the year ... so it's not an issue yet.

Last earning report was October 29th, so we should expect the next in late January.  Then (once more) it's time to be wary since if performance continues the type of investor who will pile into this type of stock will not be kind to seasonality (nor be expecting it).  So the April 2010 earnings report could be a roadblock for intermediate term performance. 

Reviewing October's impressive numbers:
  • Revenues for 3Q09 were $27.4 million compared to $20.3 million in 3Q08, an increase of 35%.
  • Net income was $2.7 million for 3Q09, or $0.09 per diluted share, on the basis of generally accepted accounting principles (GAAP), compared with GAAP net loss of $1.7 million, or a loss of $0.07 per diluted share, in 3Q08. (remember, GAAP accounting does not count in America - because it would punish stock prices)
  • Adjusted net income for 3Q09, which excludes stock-based compensation expense, was $4.6 million, or $0.16 per diluted share in 3Q09. This compares to adjusted net loss in 3Q08, which excludes stock-based compensation expense as well as costs associated with the transition to our new chief executive officer, of $0.2 million, or a loss of $0.01 per diluted share.
At the time, estimates for the third quarter had been 11 cents, so a beat of 5 cents once you close your eyes and pretend certain expenses don't count. (as we do with all companies)

Breakdown of revenue
  • Achieved 80% of 3Q09 revenues through partners, compared with 71% in the year-ago period.
  • Increased 3Q09 international revenues to $6.1 million, up 57% over the year-ago level.  (about 22% of all sales were international, and growing faster than the company as a whole)
  • Increased 3Q09 U.S. commercial revenues to $13.3 million, up 50% over the year-ago level.

  • Based on information as of October 29, 2009, Sourcefire expects revenue for 4Q09 in the range of $31.5 million to $33.0 million, net income per share in the range of $0.11 to $0.14 and, on an adjusted basis, net income per share in the range of $0.17 to $0.20. Sourcefire’s expectation of adjusted net income per share excludes stock-based compensation expense for the fourth quarter in the expected range of $1.6 million to $1.8 million.
  • For fiscal year 2009 Sourcefire expects revenue in the range of $99.7 million to $101.2 million, net income per share in the range of $0.19 to $0.22 and adjusted net income per share in the range of $0.41 to $0.44. Sourcefire’s expectation of full year 2009 adjusted net income per share excludes stock-based compensation expense in the expected range of $6.0 million to $6.2 million.  (once, more that $6-$6.2M we hand out to executives does not count in American stock market accounting, therefor instead of making 19-22 cents we will make 41-44 cents - I am not picking on FIRE, every company does this now) :)

I would consider Sourcefire to be a very expensive valuation at 60x forward estimates for year end 2009, and 50ish forward for 2010.  But valuation seems to matter little in a Ben Bernanke liquidity party, so those who try old fashioned concepts of value are left in the dust as the punch bowl is circulated without relent.  As I look around at companies shrinking valued at 30, 40x earnings I suppose a 25% grower can be valued at 50-60x with no problem.  Until the chart says otherwise, we stand by the emergency exit sign and wave our party favors.
Long Sourcefire in fund; no personal position

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