McAfee Corp (NASDAQ:MCFE) returned to the NASDAQ markets on Oct. 22 and it is fair to say that things have not gone according to plan. MCFE has had a tumultuous history and has only begun to put to bed its troubles in the last few years. Between 2010 and 2016, MCFE operated under Intel (NASDAQ:INTC). The marriage was ill-thought-out and in that time, MCFE stopped being a leader and innovator in the cybersecurity landscape and bled talent who went on to found more innovative businesses, including George Kurtz who left to found CrowdStrike. As innovation stalled, so too did earnings.
MCFE listed with an anticipated price range of $19-22, and eventually priced its shares at $20 per share. Since the IPO, the stock price has not traded above $20, sliding down to below $17.
MCFE has attempted to shift its business model toward one focused on the consumers rather than enterprises and this has lifted margins, improved revenues, and reduced operating costs.
Nevertheless, MCFE is still pretty much where it was when Intel bought it a decade ago, which says a lot about the intervening period.
The question investors have to face when deciding whether or not to buy MCFE is, has MCFE shaken off the cobwebs or is the company still a long way away from being a market leader.
Valuation
Some context is important here. In August 2010, DeWalt sold McAfee to Intel (NASDAQ:INTC) for $7.68 billion in an all-cash deal, paying a 60% premium for what at the time was a leading cybersecurity firm with a strong brand that along with Symantec (NASDAQ:NLOK) was seen as the best in the business.
Yet, by 2017, INTC had sold 51% of the business private-equity firm TPG Capital for $3.1 billion, in a deal that valued MCFE at $4.2 billion. This represents a degradation in the value of $3.48 billion since it was acquired. Thoma Bravo bought a minority stake from TPG Capital the following year. This background helps us value MCFE and also suggests that the debt burden MCFE has taken on is obscenely high. The company has $4.66 billion in debt, which is higher than the value of the company just four years ago. The company estimates that that debt will go down to $4.15 billion, but that hardly moves the needle. Whether you believe MCFE’s valuation, by which I mean enterprise value, is close to its 2017 valuation or whether you are guided by its market capitalization, it is clear a big chunk of MCFE’s valuation is debt-related.
A base case for valuation would be the $4.2-$7.68 billion valuations between 2010 and 2017. |This gives us a base scenario of $9.70-16 per share, which, at the upper end, is close to where MCFE is trading now, and at the lower end, suggests even greater declines ahead.
Since 2017, revenues have grown from $1.49 billion to $2.64 billion in 2019, for a 3-year CAGR of 21%. To put that into context, only 3.9% of firms over the last 70 years have been able to attain those levels of growth. To put this into even sharper relief, 2011 revenues for MCFE were $1.9 billion in 2011. The near-term picture looks rosy but set against the last decade, revenue growth has not moved much. The year before it was acquired, it reported just over $2 billion in revenue and four years later, Intel's Software and Services Group reported $2.216 billion in revenue. The past decade has been awful for MCFE. It missed the growth of its addressable market and lost its lead in cybersecurity.
There are positives. MCFE’s ability to make money has grown, as seen by a gross profitability for 2018 of 0.27 and of 0.31 for 2019. Gross profitability of 0.33 generally is the benchmark high-quality firms attain. Operational income is up from a loss of $406 million in 2017 to a profit of $126 million in 2019. 2020 will likely see even higher operating income numbers. Presently, operational income for the TTM period at $291 million.
However, there is a $22 million restructuring charge plus a $222 million amortization charge that weighs on the company. The amortization charge is thanks to write-downs of capitalized research expenses, so is secular in nature.
The company has improved from 2017. Freed from its bad marriage to Intel, it has been able to get its house in order to formulate a good strategy and execute it. This is a testament to TPG’s fantastic tutelage. Though the company’s past is pretty awful, the TPG era leads one to suggest that MCFE is on the right track. Nevertheless, the company seems overvalued still, with a combination of high debt levels, a trailing PE of 42.10 and a less favorable competitive landscape than it faced in the past. Competitive Landscape is Unfavourable
MCFE addressable market, if we take on faith the numbers it gives, paints an exciting picture. The consumer and enterprise security market’s size is said to reach $30.4 billion in 2020, with a four-year CAGR of 7.9% and reach $41.2 billion in 2024. Though MCFE missed the growth of the last decade, recent history shows a company that is growing and growing fast.
However, gravity should bring its growth in line with the market’s at some point, but even in this scenario, growth would be good. This is a testament to the shift to consumer security but this shift has massive vulnerabilities. There are no barriers to entry that prevent a rival such as Crowdstrike, Palo Alto Networks (NYSE:PANW), Carbon Black and others, who are more innovative than MCFE, from using their enterprise security solutions to compete with MCFE in the consumer security market. MCFE’s debt burden does not give it a lot of room to fight off an assault by a potential rival. Debt-fueled growth in a vulnerable market leaves the company exposed to attack. Given that the company cannot in such a scenario to defend its profitability and growth, it is highly risky to invest here. One would rather make land investments than buy into MCFE.
Conclusion
Overall, despite improvements in the last 3 years, the valuation is not attractive enough and the competitive position of MCFE is fragile. The business remains unattractive at present. The lurking threat of rivals such as Crowdstrike (NASDAQ:CRWD) adds an element of danger that is hard to overcome.