- a
mention
- in Gartner’s Enterprise Firewall Magic Quadrant. This should be concerning to FIRE investors because industry pundits believe that next-generation firewall technology, which combines the features of both traditional firewalls and IPS systems, will subsume 50% of IPS deployments by 2015. Admittedly, some customers may continue to prefer a multi-layer approach as opposed to all-in-one NGFWs, but the threat to standalone IPS will only grow in time. Even after launching its own version of an NGFW in Q4 2011, Sourcefire’s founder, Marty Roesch, admits that FIRE still approaches customers with an IPS-first mindset, “
I think the way people are approaching is that we typically interact with, you see them starting up with IPS deployments and then turning on license keys to bring the additional functionality to bear where necessary” (FIRE Q3 2012
Call).
- While this strategy plays to FIRE’s strengths, and allows them to avoid head-to-head competition with Palo Alto (
PANW
- ), Check Point, Fortinet, and other NGFW leaders, it could be a losing strategy over the long term.
- Slowing New Customer Adds and Saturation of the Upsell Opportunity will make Growth More Challenging in 2013. Sourcefire has attempted to mitigate the threat from competitive NGFW systems by launching two new products, a Sourcefire-branded NGFW and theFireAMP Anti-Malware tool. After paying the upfront hardware, subscription, and maintenance costs associated with a Sourcefire IPS, customers can add NGFW and Anti-Malware software for a combined 30% price increase. The addition of these tools to FIRE’s portfolio in late 2011/early 2012 allowed Sourcefire to grow quarterly revenue by an impressive 51% (year-over-year) in Q1 2012. Since then, however, upsell opportunities appear increasingly sparse, as YoY revenue growth slowed to 27% in Q4 2012. Many have overlooked this slowing quarterly growth, instead citing FIRE’s 35% revenue growth in 2012. Yet recent data in FIRE’s 10-K reveals that Sourcefire only added 452 new customers in 2012, which is precisely the same amount of customers adds as in 2011. This may indicate that 2012’s growth reacceleration was the result of one-off upsell opportunities, not increased customer wins.
- A Management-case DCF Model Yields a Fair Value of FIRE of $17 – $26, a 60% Decrease from the Current Share Price. Since GAAP profitability continues to shrink, Sourcefire utilized a February 25th InvestorPresentation to remind shareholders of its long-term margin goals. FIRE argues that, as the business expands, it can materially decrease R&D, selling & marketing, and G&A expense as a percentage of revenue. This long-term plan would theoretically add around 1000bps to FIRE’s 2012 operating margin. While these long-term goals are praiseworthy, in practice they could be difficult to achieve. Given the more than dozen competitors in both IPS and Firewall, FIRE must perpetually invest in new research just to stay competitive. As for the selling & marketing expense, Sourcefire’s shift towards adding channel partners should pressure margins during the transition period, as shown by the 200bps increase in S&M expense between 2010 and 2012. But even if we overlook these challenges and assume that FIRE’s EBIT margins consistently expand, reaching management’s long-term goals by 2017, a discounted cash flow analysis yields a fair value of only $20/share. This analysis uses a 10% cost of capital and a 3% long-term growth rate, both reasonable assumptions given FIRE’s share price volatility and the growing threat from NGFW. Further sensitizing this range to a 9% – 11% WACC and a 2% – 4% long-term growth rate produces a fair value range of $17 – $26/share, or about 60% below FIRE’s current share price of $51.04.
- Recent CEO Appointment and Industry Precedent Suggest that Sourcefire is not a Near-Term Acquisition Target. When traditional valuation metrics fail, analysts have turned to valuing Sourcefire as a buyout target. For example, last year’s initiating coverage report from FBN Securities (1/12/12) assigns a
