Shares of British cybersecurity company Darktrace tumble as short sellers circle | Business

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Darktrace’s value has plummeted to a record low after two new short sellers have emerged betting against its business, as the British cybersecurity company has been hit with a fresh wave of criticism for its sales, marketing and accounting practices.

The company, which warned earlier this month of a slowdown in the numbers of new clients signing up for its AI-based security products, has attracted the attention of Quintessential Capital Management (QCM) and London-based Marshall Wace, one of the world’s largest hedge firms. In the world. $60bn (£49bn) in client assets.

Darktrace has been under fire and is battling to escape the specter of its controversial founder Mike Lynch, a British billionaire fighting extradition to the US over fraud charges related to the $11 billion sale of his software company Autonomy to Hewlett-Packard in 2011. Lynch denies all charges.

US hedge fund QCM backed up its short stance, publishing a 69-page document on Tuesday critical of Darktrace’s management and operations.

The company alleges that questionable and aggressive marketing, sales and accounting practices were used by Darktrace to raise the value of the company before its multi-billion pound float in London nearly two years ago.

“After careful analysis, we strongly question the validity of Darktrace’s financial statements and fear that sales, margins and growth rates are overstated and approaching a sharp correction,” QCM said. “We would like to provide the strongest possible warning to investors and we believe Darktrace stock [is] Overrated and subject to major correction, or worse.”

Shares in Darktrace fell more than 7% to a record low of 198p on Tuesday after short sellers’ positions were announced on Monday, well below the 250p at its April 2021 initial public offering, and a far cry from the lofty heights. Approximately £10.00 arrived in the months following its listing in London.

QCM claims questionable practices to ensure vital revenue growth rates, such as so-called “channel stuffing,” were employed to maintain a glowing image of high client sales to investors.

Issues noted also include a significant increase in revenue from multi-year contracts being booked in the first year of a deal, which inflates revenue, growth and ultimately profits in the short term.

While this is not an uncommon practice in many industries, and certainly not illegal, QCM claims that the amount of deferred revenue as a percentage of sales decreased significantly between 2018 and 2022.

As other skeptics have noted, QCM notes that Darktrace has an extremely high level of spending on marketing expenses compared to its budget for research and development of its products.

The New York-based company believes that Darktrace’s sales-heavy marketing approach, previously likened by some customers interviewed by a Peel Hunt analyst to “snake oil,” may lead to customers failing to renew after the first three years. shrinkage.

“We suspect that a large portion of the legitimate sales were obtained through a very aggressive sales force,” she said. “Sales momentum may be about to decline as contracts signed before Darktrace’s IPO expire without renewal by frustrated customers increase.”

Earlier this month, Darktrace reported that it registered a quarter fewer new customers in the last three months of 2022 than in the previous year.

The company lowered guidance for the full year for growth in annual recurring revenue, regular spend by existing customers, and total revenue.

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Despite questions about the fundamental viability of Darktrace’s business model, the slowdown is reflected in many of the largest players in the cybersecurity space as macroeconomic conditions worsen.

Shares of US-based market leader CrowdStrike and rival Sentinel One are down 43% and 67% over the past 12 months, respectively.

The company said it was focused on attracting larger customers and increasing sales to existing customers, resulting in new customer account revenue increasing 17% on average over those recorded in 2021 and contract renewals increasing 12%.

Darktrace is led by Bobby Gustafson, who co-founded it in 2013 at the age of 30 and is one of dozens of former Autonomy employees.

“We would like to provide the strongest possible warning to Darktrace investors and urge them to read our report carefully,” said Gabriel Grego, founder of QCM, which holds a 0.86% position in Darktrace.

Marshall Wace, which holds a 0.9% position in Darktrace and is also shorting stocks including Burberry, The Hut Group and owner of British Airways, declined to comment.

A Darktrace spokesperson said: “As a UK listed company, our management team and Board of Directors take our fiduciary responsibilities very seriously and have full confidence in our accounting practices and the integrity of our independently audited financial statements.

“We have strict controls in place throughout our business to ensure we are in full compliance with International Accounting Standards for Financial Reporting. We are proud of the business we have built, which today helps protect more than 8,100 customers around the world from cyber disturbances.”

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