Darktrace Stock: No Bids and Oblique Earnings Outlook (OTCMKTS: DRKTF)
UK-listed cybersecurity firm Darktrace (OTCPK:DRKTF) saw its share drop recently after a putative bidder pulled out of the business. I remain optimistic about the company’s prospects, but will not add the company to my portfolio. Here’s why.
The possible bid does not materialize
Last month, the company told the market that it had received a number of unsolicited, preliminary and conditional proposals from Canadian private equity firm Thoma Bravo. However, Darktrace updated the market this month to say that Thoma Brave had no intention of bidding for Darktrace and that talks between the two companies were over.
Under UK takeover rules, this effectively bars Thoma Bravo from making a bid within the next six months.
On the one hand, the fact that Thoma Bravo considered the company as a possible takeover target to begin with can be seen as a positive. This could be taken as suggesting that there is some value in Darktrace, perhaps more than had been reflected in the stock price up to the date of the first announcement.
What about the failure of an offer to materialize, however? Here we don’t know the specifics, not indeed what Thoma Bravo was looking for from an acquisition (but can speculate) or what prompted him to end talks.
All in all, I’d say at this point talking about an offer is best seen as a distraction now in the rearview mirror. This drove up the price of Darktrace shares and they fell accordingly when an offer failed to materialize. So, as investors, we came back to where we were a few months ago, asking ourselves: what could be a fair valuation of Darktrace on its fundamentals?
Valuing Darktrace is a challenge
For this, the most useful starting point is the annual results, which were published this month.
Overall revenue growth was strong, with the company increasing revenue by nearly half.
There has also been an impressive increase in free cash flow.
In terms of profits, the company went from a loss of $146 million to a net profit of $1 million. It’s not much, but the direction of travel is in the right direction. I consider it positive that Darktrace has become a beneficiary. Considered alongside the free cash flow number, the earnings number, while low, is a positive sign that the company is moving towards its long-term potential.
Meanwhile, Darktrace has a market cap of over £2 billion. So while the move to profitability is welcome, the valuation still looks extremely expensive on a P/E basis.
That said, given the company’s stage of growth, it seems reasonable to expect earnings to grow strongly in the coming years, which means the forward-looking P/E ratio could be more reasonable.
Looking at the convoluted language in the “outlook” section of the company’s annual report already raises a little red flag for me as an investor. It’s unnecessarily complicated and dwells at length on things like exchange rates, which, while certainly relevant, I regard as simply part of the course of business for a London-listed multinational reporting in US dollars, at a time when the pound is weakening and the dollar strengthening, both in general and relative to each other.
In fact, the outlook is full of what I consider undesirable measures, such as an “adjusted EBITDA margin” which, as an investor, gives me no useful information because it contains so much leeway from an accounting point of view.
So what might fiscal 2023 revenue look like? Here is what Darktrace guides:
At constant exchange rates, the Group confirms its annual growth forecasts for the 2023 financial year of between 31% and 34%. Measured against its rebased TAR for FY2022, this implies year-over-year growth in constant currency net added TAR between 4% and 14%.
What is “ARR”? You have to refer to the “Alternative definitions of performance measures” of the announcement (uh oh!). There, ARR turns out to represent annual recurring revenue. So those revenues that come in every year (and how would a company know what will happen in the years to come?) Not so fast. ARR is defined as:
The sum of all ARRs, at the constant exchange rate for the period, for customers on the measurement date. The ARR for each customer is the committed annual subscription value of each recorded order for which they will be entitled to recognize revenue. In the small number of cases where a customer has an opt-out within six months of entering into a contract, Darktrace only recognizes ARR on that contract after that opt-out period has expired. out.
Clear the smoke and mirrors of cybersecurity: Darktrace is a B2B services company, which has been around for decades. So, as a private investor with limited time or interest in exploring the intricacies of a company’s account before potentially helping to capitalize it with my hard-earned money, the overworked language here seems more obscure than explanatory.
What we know from last year’s results is that Darktrace has seen rapid growth in sales and I expect that to continue. Last year, its customer base grew by 32% year-on-year to 7,437. I expect further growth in the customer base, but also an increase in the average value of each customer, in line with the “Average ARR of contracts” of 8% last year. But the growth rate remains uncertain for me when it comes to what to expect next. The earnings outlook is even less clear.
I don’t buy
I love Darktrace’s line of business and think their revenue growth has been impressive. I expect him to continue to grow his customer base and revenue. Hopefully, this should also trend towards long-term earnings growth.
However, I don’t think current earnings warrant the valuation and the outlook for future earnings is so skewed at this point that I’m not confident enough with the investment case to add the company to my portfolio. Darkrace shares have lost 65% of their value over the past year but, given the lack of earnings visibility, I remain bearish.