Darktrace’s cut-price IPO still looks risky

Before considering the merits of Darktrace’s business, investors will first need to get comfortable with Lynch

  
A dealer works at his desk whilst screens show market data following a vote on Prime Minister Theresa May's Brexit 'plan B' at CMC Markets in London, Britain, January 30, 2019.

A dealer works at his desk whilst screens show market data following a vote on Prime Minister Theresa May's Brexit 'plan B' at CMC Markets in London, Britain, January 30, 2019.

REUTERS/Dylan Martinez

(The author is a Reuters Breakingviews columnist. The opinions expressed are her own.)

LONDON  - Darktrace’s cut-price initial public offering still leaves investors exposed. The cyber firm is offering shares which value it at up to $2.6 billion. Although that looks cheaper than listed peers, the company is exposed if investor Mike Lynch is extradited and convicted of fraud in the United States. Its loss-making business also warrants a cautious approach.

Before considering the merits of Darktrace’s business, investors will first need to get comfortable with Lynch. The founder of Autonomy, who has been charged by the U.S. government of inflating the British group’s revenue before it was sold to Hewlett-Packard in 2011, invested in the Cambridge-based firm when it was founded in 2013. He and his wife still own 18%. Until last month he was a member of Darktrace’s advisory board, he has now switched to its science and technology council. His investment vehicle Invoke Capital, whose shareholders include Autonomy’s former chief finance officer, currently serving a prison sentence for fraud, provided management advice to Darktrace.

If Lynch is extradited to the United States and found guilty of fraud, he may be forced to hand back any money he earned from the crime. This could lead to a forced sale of his stake. Lynch denies all charges and is contesting the U.S. extradition. Even so, Darktrace admits there is a risk the company and prospective shareholders could face money-laundering charges, although it says the chances are “low”. Still, the dangers were severe enough that UBS dropped out as a bookrunner for the IPO.

Darktrace’s sales prospects also warrant a closer look. The company, which uses machine learning in its software that can detect anomalies in an IT system, earned revenue of $199 million in the year to last June, up 45% from the previous year. But it spent around 80% of revenue on sales and marketing, begging the question of just how loyal Darktrace clients are. Its plan of expanding in the United States faces a stiff challenge from rivals like privately owned Vectra AI.

These risks are baked into Darktrace’s valuation. At the top of the mooted price range its enterprise value is around $2.3 billion after deducting net cash and IPO proceeds. That’s around 10 times its revenue for the 12 months to last December, a steep discount to $49 billion CrowdStrike and $26 billion Zscaler, which are valued at 55 times and 59 times their trailing revenue, respectively. Investors will have to ask whether any discount can compensate them for Darktrace’s risks.

CONTEXT NEWS

- Cybersecurity company Darktrace is targeting a valuation of as much as 1.9 billion pounds ($2.6 billion) in a London initial public offering, according to terms of the deal reported by Bloomberg on April 26.

- Darktrace is marketing shares in the offering at 220 pence to 280 pence each and plans to sell between 51.1 million and 65.1 million new shares. It’s aiming to raise $200 million.

- Management and employees are seeking to sell shares worth about $45 million, with no sales by board members or the company’s top shareholders. Some former holders of Darktrace’s convertible loan notes could consider offering as much as $75 million to enable additional IPO liquidity, subject to price, Bloomberg added.

- The shares are due to start trading on May 5.

(The author is a Reuters Breakingviews columnist. The opinions expressed are her own.)

(SIGN UP FOR BREAKINGVIEWS EMAIL ALERTS http://bit.ly/BVsubscribe | Editing by Peter Thal Larsen and Karen Kwok) ((Aimee.Donnellan@thomsonreuters.com; Reuters Messaging: Aimee.Donnellan.thomsonreuters.com@reuters.net))


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