Sourcefire, Inc. (NASDAQ:FIRE): Short-Lived Upsell Opportunity has Concealed Decelerating Growth, Slowing Customer Adds, and the Market’s Shift Away from IPS
Disclosure: Kerrisdale Capital are short shares of FIRE. Please review the full disclosures at the end of of the report.
Kerrisdale Capital believes that shares of Sourcefire Inc. (FIRE) are highly overvalued.
Note that Sourcefire, Inc. (NASDAQ:FIRE) reports earnings on April 30th, and if it beats analyst estimates, the stock could rise. We’re short regardless, given that we think there’s a decent chance they could miss estimates or give disappointing forward guidance.
Following a 55% rally since the start of 2012, FIRE shares now imply a 5.4x 2013E revenue multiple and a 204x 2013E GAAP P/E. With valuation multiples as rich as these, it might sound strange to hear that Sourcefire added only 452 new customers in 2012, the exact same amount they added in 2011. Yet FIRE’s revenue growth expanded from 27% to 35% in 2012, masking the slowing momentum in new customer adds. We can attribute this mismatch to the introduction of two new software products, a next-generation firewall and an anti-malware tool, in Q4 2011 and Q1 2012, respectively. These upsell tools allow FIRE to achieve a combined pricing uplift of 30%, providing a one-time growth boost for new and existing customers. Comments from management indicate that this was a defensive measure taken to protect Sourcefire’s core Intrusion Prevention System (“IPS”) business from obsolescence as recently introduced next-generation firewalls now incorporate many features of standalone IPS. Gartner believes these NGFW systems could subsume 50% of new IPS deployments by 2015. While a bullish Wall Street continues to brush aside these issues, our research indicates that Sourcefire, Inc. (NASDAQ:FIRE)’s upsell opportunity is becoming saturated, new product introductions will increase competitive pressure, and FIRE’s GAAP earnings are actually shrinking on a year-over-year basis (2012 10-K, Q3 2012 10-Q).
Sourcefire, Inc. (NASDAQ:FIRE), a 12-year old network security business, is a leading provider of Intrusion Prevention Systems (“IPS”). Modern IPS tools use rule-based systems to identify suspicious packet traffic, alert the IT administrator, shut down attempted malware attacks, and block host, service, or application access as needed. Every network is different, but a firewall is typically used on the perimeter of the network as a first-line defense, where line speeds are the greatest, while IPS sits inside the firewall to provide a second layer of protection. According to Gartner, the $4.9bn firewall market is believed to be four times larger than the $1.2bn IPS market. Some of the largest end-markets for IPS are security-sensitive industries with large information flows, such as governments, financial institutions, and telecommunications networks.
Prior to the introduction of next-generation firewall (“NGFW”), the firewall and IPS systems were purchased separately, creating the need to manage two different security platforms. But Gartner and other industry experts now believe the firewall market is shifting towards NGFW adoption, allowing users to integrate firewall and IPS features into a