From shadowy enigma to the full glare of public markets, Darktrace (DARK) has emerged as one of the world’s most innovative cyber security companies. This is a born in Britain technology success story and one that unusually chose to list in the UK rather than the US Nasdaq stock market.

Darktrace’s share price jumped more than 40% on its stock market debut in April 2021, albeit the starting valuation was lowered due to investor concerns about one of the company’s investors facing extradition to the US over fraud charges.

The shares were eventually priced at 250p for a £1.7 billion London listing, but the stock rallied in early trading to hit 355p, well above the 220p to 280p range set by its brokers when its investor roadshow began.

Since then, the share price has more than doubled, helped by substantially lifting guidance for the year to 30 June 2021 and also significantly ratcheting up its 2022 expectations.

USING AI DEFENCE

Darktrace is one of the world’s fastest-growing cyber defence companies and a leader in Enterprise Immune System technology, a new category of cyber solutions based on pioneering Bayesian mathematics developed at the University of Cambridge, a mathematical way of applying probabilities to statistical problems.

The company addresses the challenge of insider threat and advanced cyber-attacks through its unique use of artificial intelligence to detect threats in real-time, as manifested in the emerging behaviours of the network, devices and individuals.

Analysts at Needham Research says: ‘We think Darktrace is delivering the most innovative application of artificial intelligence and security automation in the market today.’

Some of the world’s largest organisations rely on Darktrace’s adaptive, self-learning platform to spot anomalous activity, with clients in sectors including energy and utilities, financial services, telecommunications, retail and transportation. Its customers include property firm British Land (BLND), clothing retailer Brooks Brothers, lender Funding Circle (FCH) and plus approximately 5,000 others from every corner of the globe.

This is a rapidly changing and fast-growing industry. Experts predict that by 2025 cybercrime could cost the global economy $10.5 trillion a year, based on data from digital security firm Specops Software. That’s almost $20 million every minute.

In 2019, UK organisations hit by cyber-attacks faced an average bill of £11.5 million, according to data from consultancy Accenture, although that’s less than half the average cost to enterprise in the US, which was estimated at $27.4 million.

This is not just the direct cost from hackers and the like, but also includes reputational damage, lost business and customers and industry fines, which can be steep, up to £17.5 million or 4% of annual global turnover under UK General Data Protection Regulation, also known as GDPR.

In an age of exponential data growth, digital safety and security has moved beyond the remit of an organisation’s technology chiefs to become a boardroom-level issue.

CONTROVERSIAL BACKING

Founded in 2013 by world-class machine learning specialists and operational government intelligence experts, Darktrace is backed by Invoke Capital, the technology investment company set up by tech entrepreneur Mike Lynch.

He founded UK data firm Autonomy and has been dragged into a long-running £4 billion legal battle after selling that company for $11 billion to US tech giant HP in 2011. A year late HP wrote down the value by $8.8 billion and alleged that Lynch artificially inflated the value of the group before the takeover.

Lynch sits on Darktrace’s science and technology committee and there are several former Autonomy executives on board, including chief executive officer Poppy Gustafsson and chief strategy officer Nicole Eagan.

This association may have put off some investors, but Lynch owns just 4.4% of Darktrace and analysts have now largely dismissed any residual reputational impact from the computer science expert.

What is far more likely to drive the share price moving forward will be Darktrace’s growth trajectory and pathway to profit, and a level of patience will be required on the latter point.

Forecasts currently extend to the June 2023 full year and analysts anticipate net losses all the way despite strong sales growth.

When it joined the stock market in April, Darktrace guided that in the year to June 2021 annual recurring revenue growth would be within a range of 34% to 35.5% and that overall revenue growth would fall between 36% to 38%.

Darktrace actually delivered annual recurring revenue growth of more than 44% and overall revenue growth of more than 40%.

OUTPERFORMANCE IMPLICATIONS

The better-than-expected annual recurring revenue allowed analysts to deduce a couple of important things. First, productive headcount increased at a faster rate than expected, allowing the company to win more clients. Second, the company has been much better at upselling and renewing large clients. ‘This is exactly in line with the company’s stated focus on prioritising client wins,’ says Berenberg.

Based on market forecasts, investors should expect annual recurring revenue growth in the 32% to 34% range this financial year, significantly up on previous 26.5% to 29.5% expectations on around 30% headline revenue growth.

This implies around $45 million to $50 million of net losses in the next two years, by which time analysts and investors should have a much clearer understanding of future profit potential.

Still, a lot could go awry, and we think there is likely to be quite a bit of share price ups and downs over the months ahead as news flow and trading updates emerge.

This possibility of intense share price volatility may leave many investors uncomfortable to back a business currently on a rough £5 billion enterprise value, or nearly 19 times this year’s $367 million (£264 million) of forecast sales.

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