FireEye: Unhappy returns
Issuing bonds to help bondholders hedge their positions suggests a lack of options for raising funds
No tech sector is hotter than cyber security. So why is FireEye, a young Silicon Valley cyber security darling, resorting to an unusual debt structure to shore up its balance sheet? The company is burning through cash quickly, as it spends on marketing (95 per cent of revenues) to fuel growth (sales are more than doubling every year). FireEye’s losses are growing nearly as fast as sales: net losses were equal to revenues last year. That is partly because more than half of revenues are from subscriptions and services; multiyear contracts for which the marketing is done up front.
None of this is unusual in Silicon Valley. What is less common is FireEye’s solution for shoring up its balance sheet: a “happy meal” bond offering. The bond deal, which priced last week, will issue $800m of convertible debt to two investors, possibly hedge funds, at “happy” interest rates of 1 per cent and 1.6 per cent. FireEye will then use $150m of the proceeds to sign a prepaid forward contract with a bank to buy back its own shares in 2020 and 2022. Meanwhile the bank buys the shares on the market (in anticipation of the buyback) and can then lend them on to the bondholders to help them hedge their position (for example via a short sale of the stock.)
The essence of the happy meal is that the company issuing the bonds helps the bondholders to hedge their positions. The happy meal structure has an unhappy reputation — often companies use it because they have no other options. Perhaps lenders were unwilling to lend to them at good rates; perhaps there was too much short interest in the stock already, making it difficult for bondholders to hedge. Either way, the use of such sweeteners is concerning when debt is so cheap. The immediate downside for FireEye is that it will be spending $150m on a prepaid forward share buyback — money that would be better invested in the underlying business. A year ago FireEye was doing the opposite: raising equity through a secondary offering.
FireEye says it is in a growth period and will become profitable by 2018. It will need cash to get there: S&P Capital IQ estimates that the company will post a free cash outflow of $157m this year and $63m next, with only a small inflow in 2017. If it is issuing a happy meal convertible now, what will happen if those outflows turn out to be worse than expected?