Darktrace LON:DARK, the artificial-intelligence cyber-security firm, has had a rollercoaster year. While it attempts to ward off the long shadow cast by fraud litigation at Autonomy, a company previously run by Darktrace’s co-founder Mike Lynch, Darktrace has faced increased analyst scrutiny, a short-seller attack and a terminated takeover offer from US-based Thoma Bravo.
Although headline stories continue to surround Darktrace, the business continues to deliver. In its 1Q23 trading update, published on 12th October, Darktrace grew its customer base by 320 net new customers to 7,757 accounts, resulting in a constant currency annual recurring revenue (ARR) of USD511.5m (GBP453.8m) as at 30th September 2022 and growth of 40.5%. Booked revenue for the first quarter period also grew by 37% to USD126.3m.
While Darktrace’s business momentum and top-line growth continues to be strong, the company did advise caution with regards to foreign-exchange rates. The company reports its results in US dollars. However, it earns a significant amount of revenue outside the US in the EMEA and Asia Pacific regions. The relentless strength of the US dollar has resulted in a headwind in translating ARR into booked revenue for 2023. Despite this, Darktrace maintained its revenue outlook for 2023 at expectations for 30% to 33% growth.
Performance underpinned by momentum
In its most recent trading update, Darktrace announced that key metrics such as gross margin, customer churn and customer retention rates remained within the expected ranges set out in earlier reporting periods. In its full year 2022 results, Darktrace noted churn rates – the number of customers not renewing contracts – reduced compared to the prior year and now sits at 6.5%. Net retention rates, measured in dollar amounts, have grown to 105.5%, as more customers increase order values year-over-year. A continuation of positive momentum in these two metrics, as of 1Q23, shows that customer satisfaction continues to defy sceptics; albeit retention levels have some way to go to match top performing US cyber-security peers such as Zscaler and Crowdstrike, which both boast net retention rates in excess of 120%.
Source: Darktrace Investor Presentation
Despite relatively robust performance, Darktrace remains on the back foot, with its shares down 70% from the highs seen in 2021 and 47% lower than levels seen during Darktrace’s bid speculation from Thoma Bravo. Much of the damage to Darktrace’s reputation was inflicted by its tenuous link to Mike Lynch, Darktrace’s co-founder, who held a directorship position at the company until 2021.
Lynch currently faces extradition to the US, where he is accused of manipulating ex co-founded Autonomy’s accounts, leading Hewlitt Packard to overpay by USD5bn for the company when it bought it in 2011.
Speaking at the Bloomberg Technology Conference in September, Darktrace’s chief executive, Poppy Gustafsson attempted to rebut the sceptical narrative that market participants have cast over Darktrace’s business and proprietary technology, which has been a source of frustration for the FTSE 250 CEO since listing the business in 2021.
“The thing that I always come back to is that we have 7,400 customers. That means 7,400 CSOs and CIOs that thought, ‘I want to see Darktrace working in our business’. That’s the key indicator for me.” – Poppy Gustafsson, CEO
Despite the pessimism, Gustafsson has won some notable fans in the investment community. Keith Ashworth-Lord of the Sanford De Land Buffettology Fund backed the company at IPO in 2021 and has been a notable defender of Darktrace’s business during recent market turmoil. Speaking in September, Ashworth-Lord noted the following regarding Thoma Bravo’s bid for Darktrace.
“It would be a great shame if one of the UK’s few tech champions were to leave the market so quickly.” – Keith Ashworth-Lord, Sanford De Land Buffettology Fund
Darktrace growth prospects
Investors prepared to look past the current scepticism might see some interesting developments occurring operationally for Darktrace. In July 2022, the company launched its latest software product PREVENT, which was developed through internal research and development at the company’s Cambridge research facility. The company has also gained operational capabilities through its recent acquisition of Cybersprint. PREVENT looks to model potential attacker pathways and attempts to gain access to organisational technology. It can then provide companies with their areas of weakness, enabling their IT departments to bolster their security.“We’ve closed a number of PREVENT deals already, even though it’s only been available for the last month or so. I’ve personally never seen as many jaw drop moments in my career in so few meetings, as I’ve seen with PREVENT,” said Maximilian Heinemeyer, Darktrace’s chief product officer.
In addition to the PREVENT software launch, Darktrace has been driving another growth initiative named Darktrace Federal, a specific business unit to serve the US Department of Defence. So far, the company has set up the infrastructure and passed the necessary approvals required of cybersecurity vendors within the space. Darktrace doesn’t anticipate any impact from the federal business in 2023 due to long sales cycles. However, this could be a significant opportunity for the company going forward.
Darktrace outlook and valuation
Looking past the troubles Darktrace has faced over the last year, the company seems to have a bright future, with new technology developments boosting the company’s prospects and a continued retention of over 7,000 customers, showcasing the value Darktrace’s products continue to offer organisations.
With Darktrace’s latest update guiding to revenue growth of 30% to 33%, the company is set to deliver revenues of approximately GBP550m in 2023. This puts Darktrace on an enterprise value-to-sales of 3x forecast sales in 2023, which is still a far cry away from Darktrace’s peers in the US.
Are you bullish or bearish on Darktrace shares over the next 12 months? #DARK #darktrace #CyberSecurity #cybercrime #AI
— The Armchair Trader (@armchairtweets) October 17, 2022
