David's 6 Biggest Stock Pick Losers, No. 2: FireEye

It's tough to pick a set of stocks that will beat the market. David Gardner's Rule Breakers and Stock Advisor portfolios, however, have done so consistently.

But nobody's perfect, and as he has often said, every portfolio is going to have losers. Here at the Fool, we're serious about the need to acknowledge them and learn from them. So, in this week's Rule Breaker Investing podcast, David will break down his biggest losers of 2015, 2016, and 2017 -- with some help from a few Foolish guests to take some of the sting out of it.

In this segment, he's joined by analyst Abi Malin to talk about FireEye (MNDT), which looked to be an up-and-coming cybersecurity company when he picked it in February 2015 and again in June 2015. They discuss why it has performed so poorly since then and what investors can find hopeful about its future.

A full transcript follows the video.

This video was recorded on Jan. 10, 2018.

David Gardner: David's Biggest Losers Nos. 2 and 3: The worst stock I've picked in the last three years. I'm not just going to say No. 2 because it's No. 2 and No. 3 and thereby hangs the tail. We might get into that. For this I'd like to introduce my friend and Fool fellow analyst Abi Malin. Abi, welcome!

Abi Malin: Thanks for having me!

Gardner: Abi, how many years have you been at The Fool?

Malin: Almost three, now.

Gardner: Excellent. Where did you come to The Fool from?

Malin: I came out of our internship program, but before that I went to Tulane University down in New Orleans.

Gardner: Excellent. A shout-out to Tulane.

Malin: Yeah!

Gardner: Which has a very good investing curriculum.

Malin: We do. We have a Burkenroad program, so we do like full-scale research reports on small-cap equities.

Gardner: And you were doing that as an undergrad.

Malin: I was.

Gardner: And we're lucky to have you here at The Fool. Abi, here you are and here we are, and we're going to talk about [FEYE]. Now this is a return appearance for this stock, because we did talk about this a year ago, which is a reminder that this will be the last year we talk about this stock, because I made these picks [two of them in February and June of 2015]. We went over how bad FireEye, [FEYE] had been last year, but it's still going, and it's back. And Abi, you're here to talk about FireEye. Thank you very much!

First of all, in a couple of sentences, what does this company do?

Malin: On a very high level, the company's technology, intelligence, and expertise helps to prevent, detect, and resolve cyberthreats. But more specifically for FireEye, they actually use a virtual machine technology called Multi-Vector Virtual Execution, or MVX Engine for short.

Gardner: Nice. Bringing the acronyms with you.

Malin: Definitely. They protect their customers' networks against external threats by simulating an operating system to get malicious code to activate within the virtual machine rather than in the customer's actual network.

Gardner: Very well explained. Yes, indeed. And in addition, they had acquired Mandiant Corporation, and today the CEO, who is not the CEO when we first picked it three years ago; today Kevin Mandia is the CEO of FireEye. So good, a little bit of background, then, on what the company does.

And at the time I was thinking [and I still think this today] that this is an industry that is going to be around for the rest of our lives. As long as there's an internet -- as long as there's technology -- we're going to need cybersecurity. It's going to grow [that's what I was thinking], and at the time FireEye was an up-and-coming player. I liked it. More of a local angle, here, and a smaller-cap company. You're right. It's a big world out there. Abi, what is thing that went wrong No. 1, here, with this company and this pick?

Malin: I think the first thing is when we first looked at it, we liked what they call "sandbox strategy" of having this virtual machine, and in our original rec we actually referenced that 95% of customer trials that test FireEye actually find a malicious threat missed by a customer's existing security infrastructure. And so, there is a superiority to this platform, but just in this highly fragmented market that constantly evolves, you have a lot of big players like Cisco (NASDAQ: CSCO), Juniper Networks, Intel, IBM, Palo Alto Networks and a variety of other smaller players.

This sandbox strategy is seen as more of an add-on than necessarily a primary security measure, and so general consensus seems to be that the FireEye product is superior. It's still priced at a premium, and many customers may opt for a more comprehensive solution from one of those other existing players rather than adding this on at such a premium.

Gardner: So, I guess the thing that went wrong No. 1 is something along the lines of I picked this stock that is a company. That is a small company in a huge and growing industry that has constant innovation. And, as it turns out, its application isn't considered core or seminal [as] some other stocks. And I'm happy to see at least a few other stock picks of ours in there. You mentioned Palo Alto Networks. That is a Rule Breaker and a bigger and clearly superior company. I understand. What's thing that went wrong No. 2, here?

Malin: So, we've seen the company shift from product sales to subscription revenues, but now we're seeing another transition, and this is to shorter contracts. In the most recent quarter, their average contract length was about 25 months as opposed to 27 months a year ago, and management projects that this can come down as low as between 20-24 [months] in 2018. Analysts have a little bit of concerns regarding their customers committing to FireEye's products for the long term.

Gardner: Now for those of us who may still own FireEye, and I include myself among them. I personally own these shares that are well down from where I paid. By the way, I should mention that I picked FireEye at $46.17 back on February 20, 2015 and then four months later, as it had moved from $46 up to over $53, I recommended it again, liking to add to my winners, as I do. And that position is now down 73%. So, those two positions down 73% and 68%. For those of us who are in this boat -- sitting in the FireEye boat -- wondering what we should be looking for, what's something that's maybe a note of hope, or not, for us going forward?

Malin: I think one thing that can provide a little bit of hope for the future is that they are following this typical, strategic growth path for a security firm, so they entered the market with a really strong initial product that was very specific, and now they're building out an ecosystem of traditional products around it.

They also have this competitive advantage in the quality and recency of the cyber intelligence threat data that they collect. If they can harness both of those advantages to build out a suite of products, and maintain that high quality that they've already been known for and have built their brand around, I think this could still be a turnaround.

Gardner: Well, I appreciate you saying that. I remember. Part of our thesis three years ago was we were all hearing at the time about cyber break-ins and this or that. Large retailer giving away millions of email and other information. Database break-ins. And this company would be hired in as the forensic guys who would come in and let you know afterward what had happened. I loved this idea of this cyber SWAT team coming in and fixing things, or figuring out what happened.

It still feels like a big industry and a relevant business. This is a company [and we may draw some lessons at the very end of this podcast], but this is another company that changed its CEO in just a few years since I picked it. So, a little pattern recognition, there, perhaps as well. Abi Malin, thank you very much for helping us to learn more about FireEye!

Malin: Thanks for having me!