Why UK cybersecurity firm Darktrace is under attack from short sellers

Cybersecurity firm Darktrace, one of many U.Okay.’s most outstanding tech names, has discovered itself under attack from short sellers.

The corporate, whose instruments permit companies to fight cyberthreats with synthetic intelligence, was final week focused in a report by New York-based asset supervisor Quintessential Capital Administration.

QCM, whose said purpose is “exposing fraud and criminal conduct in public companies around the world,” claims it has had a 100% success charge in its activist campaigns.

The corporate advised Reuters it holds a short place of 1.3% in Darktrace shares.

London-based hedge fund Marshall Wace additionally shorted Darktrace, in line with knowledge web site Breakout Level.

Short promoting is a technique through which buyers guess on the worth of a inventory taking place in worth. A dealer borrows the inventory after which sells it on the belief that it’ll fall, earlier than shopping for it again at a reduced value and pocketing the unfold.

What is Darktrace?

Darktrace, one of many U.Okay.’s largest cybersecurity corporations, was based in 2013 by a gaggle of former intelligence specialists and mathematicians.

The Cambridge-headquartered firm says its expertise makes use of AI to detect and reply to cyberthreats in a enterprise’ IT programs.

The corporate floated on the London Stock Exchange in 2021, and its debut was seen as a key victory in the U.K.’s bid to lure more high-growth tech startups to the London market after its withdrawal from the European Union.

The stock’s performance following the listing has been underwhelming. After initially rising to an all-time high of £9.45 ($11.58) in October 2021, Darktrace shares have since plunged dramatically in tandem with a broader slump in global tech stocks.

As of Monday afternoon, Darktrace shares were trading at a price of £2.32, down 37% in the last 12 months.

In August, the firm opened takeover talks with U.S. private equity firm Thoma Bravo. However, Thoma Bravo walked away from the deal a month later after the 2 sides failed to succeed in an settlement.

Why is it under attack?

On Tuesday, U.S. hedge fund QCM mentioned it had taken a short place out towards Darktrace and printed a lengthy report detailing alleged flaws in Darktrace’s accounting.

QCM mentioned that, following an investigation into Darktrace’s enterprise mannequin and promoting practices, it was “deeply skeptical about the validity of Darktrace’s financial statements” and believed gross sales and progress charges might have been overstated.

“We would like to give our strongest possible warning to investors and believe that DT’s equity is overvalued and liable to a major correction, or worse,” QCM mentioned within the report.

Darktrace was accused by QCM of partaking in “channel stuffing” and “round-tripping” — actions that artificially inflate an organization’s reported gross sales — involving people with ties to organized crime, cash laundering and fraud.

Darktrace did not immediately tackle these allegations. On Wednesday, the firm’s CEO Poppy Gustafsson issued an announcement defending the corporate from what she referred to as “unfounded inferences” made by QCM.

Individually, QCM prompt Darktrace might have inflated its revenues by reserving unearned revenues as precise gross sales.

The corporate sometimes books income from funds for contracts it receives earlier than delivering its service to purchasers as deferred income, in line with the report.

This is not unusual amongst subscription-based software program corporations. Nonetheless, QCM famous deferred income as a proportion of Darktrace’s gross sales had dropped between 2018 and 2022, suggesting the firm “may have increasingly been booking unearned revenue as actual sales.”

In response, Darktrace mentioned: “Rarely, customers will pay full contract values in advance but because this is infrequent, non-current deferred revenue balances will decline as these contracts run down unless there is another unusual, large, in-advance payment.”

QCM alleged Darktrace might have tried to fill gaps in its receivables left by purchasers dropping out of gross sales negotiations by means of advertising and marketing sponsorships with indebted resellers and utilizing shell corporations to pose as phantom purchasers.

“Organisations that transact with the channel will typically co-host marketing events with their partners. Partner marketing events are a normal course of business for almost all software businesses and Darktrace is no different,” Darktrace mentioned Wednesday.

“This has been, and remains, a very small part of Darktrace’s marketing and the costs of them over the last five years has consistently been substantially below 0.5% of Darktrace’s revenue,” Darktrace added.

Darktrace was not instantly obtainable for remark when contacted by CNBC.

Individually Wednesday, Darktrace mentioned it will embark on a share buyback price as much as £75 million ($92 million) to be accomplished no later than Oct. 31, 2023.

The Lynch connection

It is price noting that, even earlier than the QCM report, there have been clouds hanging over Darktrace’s enterprise. Analysts have criticized the corporate over an allegedly aggressive sales culture and doubts over the worth of its expertise.

Darktrace is additionally backed by Mike Lynch, the British tech tycoon.

Lynch based the enterprise software program firm Autonomy, whose sale to Hewlett-Packard was mired in scandal over accusations that Lynch plotted to inflate the worth of Autonomy earlier than it was purchased by HP for nearly $11 billion in 2011.

In 2022, a British choose dominated in favor of HP in a civil fraud case towards Lynch. Lynch, an influential determine within the U.Okay.’s tech scene, faces a attainable prison trial within the U.S. after the U.Okay. authorities authorised his extradition final yr.

He has repeatedly denied the allegations.

A number of executives at Darktrace, together with Gustafsson and Chief Technique Officer Nicole Eagan, beforehand labored for Autonomy.

The QCM report additionally raised issues over the connections between Darktrace and Autonomy.

“Darktrace has been led or strongly influenced by many of the very same individuals that participated in the Autonomy debacle,” QCM mentioned in its report.

“If our allegations are confirmed, we expect Darktrace to follow the same tragic destiny of its predecessor, Autonomy,” QCM mentioned.

Lynch is reportedly no longer involved with Darktrace’s management, however stays a major shareholder.

Lynch is no longer involved with Darktrace’s management, however stays its sixth-largest shareholder, in line with Refinitiv Eikon knowledge.

In the meantime, Darktrace is additionally struggling from uncertainty associated to the broader macroeconomic surroundings. The corporate lowered its forecast for annual recurring income progress for the yr ending June 2023 to between 29% and 31.5%, down from an earlier forecast of 31% to 34%, citing weaker buyer progress.

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