Darktrace: what's happening to the British cybersecurity multinational

Darktrace: what's happening to the British cybersecurity multinational


Since last September the shares of Darktrace, a British cybersecurity multinational, have taken the downward path. First, US investment fund Thoma Bravo withdrew from an offer to take over the group, dropping the stock by 35% in one day. Then, after a slight recovery, Darktrace itself in January trimmed its forecast for 2023 on annual recurring revenue, i.e. the money it collects from contracts for cybersecurity services.

Finally, on January 31, the last tile. Quintessential capital management, a New York-based fund, issues a report questioning “the validity of the financial records” of Darktrace, listed on the London Stock Exchange, and expresses fears that “sales, margins and growth rates could be overestimated and close to a sharp correction ”. All allegations that the company rejected to the sender.

What's happening:

The attack on Darktrace The protagonists of the story Sales in the crosshairs Budget advances The Italian cases The other disputes What happens Now?

The attack on Darktrace

Quintessential's torpedo hit Darktrace stock, which fell from £220 at the opening to just over £199 on the morning of 31 January, only to recover during the day . The New York-based fund has an interest in the shares falling because it has taken a short position. Also known as short selling: you sell an asset you don't own by betting that its price will fall.

There are three main lines of accusation by Quintessential, founded by Gabriele Grego in 2013. The first concerns what the fund believes are fictitious and simulated sales schemes implemented by Darktrace, including through shell companies. The second trend concerns the fact of charging what are instead agreements for hardware devices to the balance sheet as software sales with three-year contracts, which for Quintessential would cause an impact on the company's financial metrics. Finally, the fund's attention was focused on the presence on the upper floors of Darktrace of former managers of Autonomy, a software house that ended up at the center of a civil case in the United Kingdom for accounting discrepancies and a criminal investigation by the Department of Justice of the United States.

The English company first responded to the report's allegations with a statement, in which it claims it has never been contacted by Quintessential and that, “as a listed English company, our team of managers and the board take their fiduciary responsibilities very seriously and have full knowledge of our accounting practices and the integrity of our financial statements, independently assessed. We have stringent controls across our businesses to ensure we fully comply with international auditing standards (Ifrs).” Since the first comment, Darktrace has provided some more direct responses to the complaints. Chief Executive Poppy Gustafsson, who spearheaded the listing in 2021, said: 'We welcome scrutiny from public markets. However, it is equally important to refute any unfounded interference” and “strongly reject any insinuation that this company is not guided by the highest integrity”. sportsgaming.win wrote to the company for further clarification, with no response, and has analyzed the study of the fund, the Darktrace data and contacted companies and industrial partners to narrow down the situation.

The protagonists of the story

Let's start with the two protagonists of the story. is Darktrace. Founded in 2013 in Cambridge, United Kingdom, the company has developed an artificial intelligence and machine learning system to identify potential cyber threats and activate forms of network protection. The group declares around 8,100 customers in 110 countries, two thousand employees and 125 between registered patents and sent requests.Its logo has been around the world: it stands out on the rear wing of the McLaren Formula 1 gui given by Daniel Ricciardo and Lando Norris in the 2022 championship.

According to the financial statements for the 2022 fiscal year, which closed in June, the multinational recorded a turnover of 415 million pounds, an increase compared to 285 million in the previous year, and a profit of 7.6 million (against the 34 million loss recorded twelve months earlier). At the top are Chairman Gordon Hurst, on the board since 2019, and CEO Gustafsson, who led the listing in 2021. “ We are a fast growing and cash generating company. Our technology is world-class, created in the UK by some of the brightest minds, and addresses one of society's most pressing challenges – the dire costs of cyber attacks,” said the CEO.

The group is also present in Italy. Two offices, both housed in spaces managed by real estate and coworking developers. In Rome, Darktrace has a home in Piazza del Popolo, in a business center of the brick giant Regus. While in Milan it is located in via Tortona, in one of the coworking spaces of the Copernico group. In Italy, the Cambridge multinational has done discounting in the IT sector, enlisting a series of partners to resell its solutions.

Across the ring is the Quintessential fund. An old acquaintance for Italy, given that in 2019 one of his reports overwhelmed Bio-on, the former Bolognese unicorn from bioplastics, which then went bankrupt and is now awaiting the conclusion of the process to entrust it to a new owner. It was founded by Gabriele Grego, already in the Israeli consultancy firm Sfk and founder of Zanshin Capital. Quintessential is an activist fund, which investigates the companies it targets and goes public by taking short positions.

In the past he denounced the affairs of the Greek companies Folli Follie, in the distribution of jewels, and Globo, a software developer (the first in liquidation and with the top management on trial, the second ceased), the Canadian Aphria , cannabis (board executives cleared), Israel's Ability and Aac Holding. Among the most recent operations: in 2020 a report against the US Penumbra, whose medical devices were withdrawn from the market, and in 2022 one on the Texan biotech group Cassava Sciences, which later ended up under investigation.

Targeted sales

The analysis conducted by Quintessential accuses some of the sales practices adopted by Darktrace . The English group sells cybersecurity services based on artificial intelligence. “ He deals with network protection, a very important element ”, explains to sportsgaming.win Simone Frison, sole director of Ipway, the Vicenza-based reseller of the Cambridge multinational, which, it should be noted, is not accused of any type of suspicious operation. “ Their tool - continues Frison - allows you to manage complex networks with fewer people and with forms of automatic response in reaction to anomalous activity in seconds” .

Darktrace not only provides software, but also a hardware component to be integrated into the network. “ The artificial intelligence platform must analyze all the traffic - explains Frison -. If it detects potential threats, it blocks the connection session.” Typically companies sign three-year contracts with Darktrace. For this reason, the company insists on recurring revenue in its financial communications: in fact, it collects a piece of the deal every year. expecting those revenues to decrease, as communicated in January, expectations for the group worsen because it means that some contracts have not been renewed or not enough have been signed to compensate for the exits.Also, according to Darktrace's sales patterns, the hardware is assigned on loan for use. At the end of the contract, he must return home.

Quintessential has analyzed some operations conducted by Darktrace before the listing, which took place in 2021, and believes it has identified some patterns used by the management to " inflate revenues, profit margins and growth rates". According to the fund, the company "frequently interfered to accelerate its pr ofits expected to meet analyst forecasts” or asked its resellers to buy the service Darktrace intended to provide to a potential customer in order to cash out first. In essence, Quintessential accuses the group of having "inflated the accounts" with the effect of "moving future revenues into current accounts". A practice, it insists, "which is both illegal and unsustainable". 

In its public response, Gustafsson claims that Darktrace and its independent consultants monitor “all partners and contracts through robust processes put in place in the run-up to listing”. their customers must be ”consecutive". In other words, explains the manager, “they must have the same start and end dates and all other material terms of the contract must be aligned ” and “ Darktrace only recognizes agreements that meet these criteria ” Ahead of the listing the firm says it has seen its portfolio of deals as well as control procedures and that a small number of contracts have not been validated as a result of these analyses. .

Budget advances

Quintessential points the finger at a system of advance sales and purchases. Basically, in some cases Darktrace would have had the collection of the contract anticipated by the retailer in a still negotiating phase. And if that didn't go through, to balance position with the reseller, the cybersecurity firm would use several schemes: fund partner events; use shell companies to compensate for the failed agreement instruct its sales force to find sufficient orders to pay off the debt position.

Finally until 2020 (year in which the practice would have stopped) Darktrace in some cases would have sold its hardware instead of giving it on loan for use. In this case, according to Quintessential, the group should have indicated the transfer in the financial statements differently. “If the device is sold and not loaned to the customer, Darktrace should charge the full cost immediately as cost of sale and not amortize it over five years as a fixed asset,” writes Quintessential. Profit margins and EBITDA before tax may appear inflated as a result.” It also allegedly misrepresented the practice in the listing documents.

Again, Darktrace provided its location. With regards to the hardware, he states that in the majority of contracts he does not sell it. The company says it develops its technology on a device it owns or virtually in the cloud, depending on customer needs. “Darktrace owns the hardware devices as assets and depreciates them over five years,” the response reads. And he specifies: “There are exceptions, for example when a customer needs to own the entire infrastructure in its own data center, usually because it is a government or regulated entity”. In 99.5% of cases, the company says its revenue is based on subscriptions.

The CEO adds that sponsored events are an industry business practice and represent a small portion of the company's marketing costs. Darktrace: Under 0.5% of revenues over the past five years. “A preliminary review of Darktrace events in the areas highlighted in Quintessential's original report [including Italy] showed no sign of unusual practices,” the company writes. Darktrace notes that some historic contracts have exit options or cancellation rights, while the $1 billion bond is fully covered. The company states that it does not advance costs, but only recognizes the date of the reference period in the financial statements.

Italian cases

In the report, Quintessential mentions some transactions involving Italian companies . It should be noted that the fund disputes the actions of Darktrace and does not assign any liability to the companies mentioned. Again, the fund does not dispute that a reseller can advance a sum that it will collect from one of its partners, but that Darktrace was able to enter these revenues ahead of time and, if the contract did not materialize, had to run for cover to make ends meet . A practice that sends the ad back to the sender.

An operation concerns a contract anticipated in 2020 by a dealer to place the software package with Maserati, which in the end decides not to sign the contract. According to the fund, the retailer found himself with the match in his hand and only after a year and a half of discussions would he get the money back from Darktrace. sportsgaming.win asked Maserati for confirmation of the fact, to which no charge has been disputed, without obtaining an answer.

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