Darktrace shares fall by 23% despite further growth

After launching its Initial Public Offering on 30 April last year, Darktrace's (LON: DARK) share price was worth 946p as recently as October.

But despite continued and sustainable growth, the AI cybersecurity stock was hit with a toxic combination of headwinds. First was the end of its initial post-IPO lock-up period, which saw insiders flood to take profits.

Then Peel Hunt released a savage investor note on 25 October. Entitled ‘Reality Check,’ the investment bank said Darktrace had a ‘disconnect between the valuation and the ultimate retail opportunity.’

In November, the Omicron variant struck. Then December saw the Bank of England begin raising interest rates. And Darktrace was embarrassingly ejected from the FTSE 100 after just three months.

After releasing a Q3 trading update on 13 April, Darktrace proffered yet more bad news.

Darktrace share price: Q3 FY22 trading update

The second post-IPO lock up on 85.5 million employee-held shares ends on 1 May, and the FTSE 250 company expects ‘no more than 20 million shares’ will be sold.

Insider selling usually has undesirable synergistic effects; it suggests a lack of confidence in the company’s prospects, means millions of shares will be dumped in a short time frame, and creates wider negative investor sentiment.

However, this share sale doesn’t affect the intrinsic value of the company. And the financial updates were solid. Darktrace added 359 net new customers in the quarter, with the customer base now up 37.3% year-over-year to 6,890.

Meanwhile, Q3 Net Annualised Recurring Revenue (ARR) rose by 56.8% year-over-year to $35.4 million, and total revenue was up 50.1% year-over-year to $109.8 million. Moreover, Darktrace now expects FY 2022 year-over-year revenue growth of between 45.5% and 47.0%.

CFO Cathy Graham exhorted ‘we sustained strong growth trends across our customer base, ARR and revenue, as well as maintaining the gains in churn and net ARR retention rates we made in the first half of the financial year.’

However, the company warned ‘its cost structure will increase as a percentage of revenue in 2H FY 2022,’ blaming ‘the return of travel and entertainment, recent and ongoing hiring, facilities for employees returning to offices and, in key locations, the Group moving to larger premises.’ But arguably, these are fair expenses to sustain growth.

Cybersecurity spending: Ukraine war

With monetary policy tightening, the tech stock sell-off is gathering pace. But Darktrace seems unworried, after acquiring Cybersprint for $53.7 million, ‘an attack surface management company that provides continuous, real-time insights from an outside-in perspective to eliminate blind spots and detect risks.’

Darktrace CEO Poppy Gustafsson argues ‘bringing inside-out and outside-in visibility together is critical… ultimately making it much harder for cyber-attackers to carry out successful missions.’ And reinforcing the company’s long-term strategy, ‘Cybersprint's results of operations are not expected to be material to Darktrace's results for the remainder of FY 2022.’

And its long-term strategy is backed up by the data. Astute Analytica analysis shows the cybersecurity sector could be worth £286 billion by 2027. For context, the UK spent £45 billion on defence in 2021, and the US £576 billion.

It’s not hard to see why. Whether the hybridisation of the workplace, increased cryptocurrency adoption, move to cash obsoletion, or even the nascent Metaverse, the rapidly changing global economy continues to create more hacking targets.

Moreover, cybersecurity is becoming an increasingly important national security concern. Deputy Chairman of the State Service of Special Communications, Viktor Zhora, recently revealed Ukraine had been ‘extremely lucky’ in averting a cyber-attack on its power grid which would have caused blackouts for 2 million people. And in Russia, hacking group Anonymous continues to attack infrastructure.

With Germany finally committing 2% of GDP to defence, and Finland and Sweden on the verge of joining NATO, cyber defence spending is set to soar.

And with both customers and revenue growing exponentially, May could just be a buying opportunity.

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