- multiple, make us believe that a near-term takeout is unlikely at the current share price.
- Wall Street Research is Drastically Overstating Sourcefire’s Addressable Market Opportunity. By combining the firewall with the IPS, next-generation firewalls can consolidate hardware and software tools into one platform, eliminating the need to purchase separate IPS and firewall hardware. Since upfront product expenses are typically the lion’s share of a vendor’s income, the cost savings to customers are meaningful. But when viewed from the perspective of the vendors, such as Sourcefire, this innovation might lower the revenue opportunity. This can be demonstrated by Sourcefire’s new sales model, where customers need only pay 30% more to add NGFW and Anti-Malware software to FIRE’s traditional IPS system. And because FIRE is an IPS-first business, we believe Sourcefire’s ability to upsell NGFW and Anti-Malware is primarily limited to existing IPS users. If this is the case, we can calculate FIRE’s addressable market by multiplying the size of the IPS market ($1.2bn) by the incremental upsell opportunity (130%), yielding a TAM of $1.5bn. Since Gartner’s market size data only tracks product revenue, and not service revenue, it makes sense to gross this figure up to $2.5bn (product revenue is 60% of FIRE’s total). Lastly, if we then apply Gartner’s prediction that 50% of standalone IPS will convert to NGFW, then FIRE’s addressable market would be just $1.25bn, or about 25% less than FIRE’s current market capitalization. Comparatively, many analysts mistakenly believe that FIRE’s TAM is between $5 -10bn (Topeka, FBN, Wells Fargo, and others). Without this enormous addressable market opportunity, many of the valuation arguments made to justify FIRE’s 2013 GAAP P/E of 200x+ quickly fall apart.
- FIRE’s Valuation Disconnect can be Partially Attributed to Non-GAAP Earnings, which Overstate GAAP Earnings by 400%. Any investor that takes the time to scrutinize Sourcefire, Inc. (NASDAQ:FIRE)’s 10-K would quickly conclude that not only is Sourcefire, Inc. (NASDAQ:FIRE)’s business barely profitable but its GAAP earnings actually fell in 2012. Diluted earnings per share shrunk from $0.21/share in 2011 to just $0.16/share in 2012. But this is of little concern to Wall Street research analysts, who instead value Sourcefire using “adjusted” earnings. After adjusting for a growing laundry list of expense add-backs, the largest of which is stock-based compensation, Sourcefire’s adjusted earnings per share grew from $0.57 in 2011 to $0.81 in 2012. Realizing that SBC expense seems to be considered free in the research community, Sourcefire’s management appears to be actively shifting cash salaries into equity-linked compensation. Even as revenue grows, SBC as a percentage of revenue has doubled since 2008, growing from 6% in 2008 to 12% in 2012. These adjustments have allowed FIRE to show steady year-over-year adjusted earnings growth when underlying earnings have actually decreased since 2010. This tactic has buttressed FIRE shares over the short-term, but we believe the continued degradation of FIRE’s quality of earnings should be a clear red flag to any potential investor.
Sourcefire April 2013 by ValueWalk.com
