Can Darktrace shares recover from the breakdown of takeover talks?

Investors had boosted momentum in the Darktrace share price this August on the back of news that it would be subject of a bid from a private equity firm. Now talks have broken down, the company will be under pressure to retain customers.

US private equity firm Thoma Bravo has walked away from plans to buy Darktrace [DARK.L], sending the cybersecurity company’s share price down by 32% since the announcement on 8 September (through 20 September).

While the stock’s fall is significant, Darktrace has been under pressure ever since its IPO on 30 April last year. Several unsolicited, preliminary offers had been received and it was thought that a formal proposal of 570p-per-share — roughly £4bn — might have been enough to clinch the deal.

News that a bid hadn’t materialised has taken the wind out of Darktrace’s sails. The Darktrace share price had hit a year-to-date high of 560.80p on 19 August, but closed on 20 September at 348.90p with a market cap of £2.5bn.

Goodbody analyst George O’Connor isn’t surprised by Thoma Bravo walking away from the table. “For investors with long memories, this is par for the course – and they will remember that Micro Focus [MCRO.L] had the same thing happen a number of years ago,” he told Bloomberg. “The only rational explanation is that Thoma walked away because they couldn’t get to the price that they wanted.”

CEO confident in Darktrace’s value

According to a fourth-quarter earnings call on 8 September, Darktrace CEO Poppy Gustafsson (pictured) believes that the company still has more to offer by remaining independent. She cited the increasing demand the world faces to ensure systems are secure from outside threats, and reasoned that cybersecurity is an essential component that must be addressed by every company.

On the call, Darktrace reported its first full-year profit of $1.5m, an increase of $147.3m from 2021. Annual revenue increased by 45.7% to $415.5m. This top line growth was driven by constant currency annual recurring revenue (ARR), which increased 42.6% year-over-year to $514.4m. The company added net ARR of $153.7m, up 36.8% from 2021, while there was a marginal 2.5 percentage point increase in the net ARR retention rate to 105.5%. The year-over-year adjusted earnings before interest, taxes, depreciation and amortisation (EBITDA) flew by 173% to land at $91.4m

Gustafsson is confident that the company will continue to go from strength to strength. She reiterated previously issued guidance for fiscal year 2023. Constant currency ARR is forecast to grow between 31% and 34% and the adjusted EBITDA margin is expected to fall between 15% and 18%.

Customer retention set to be in focus

Holding on to customers will be Darktrace’s litmus test. Analysts at Megabyte have concerns with the company’s “reliance on new business to maintain growth and the high levels of customer churn – suggesting the company knows how to win customers but can’t keep them”.

Meanwhile, short-focused hedge fund ShadowFall believes that Darktrace overestimates its potential customer base and growth while underspending on research and development.

ShadowFall declared its short position back in January, saying “the quality of the Darktrace business is watery-thin, driven by an aggressive, promotional, sales focus, which we doubt will stand the test of time”.

Darktrace doesn’t want to sell up, but, ultimately, keeping customers and proving the likes of ShadowFall wrong will be crucial if it wants to fend off potential future bidders. Under London Stock Exchange rules, Thoma Bravo won’t be able to make a play for the company for six months.

Robust profits signal rosy outlook

According to results released by Darktrace earlier this month, there is reason to look on the bright side. An almost doubling of revenue and profit where there was loss for the same period in the previous year paint a hopeful picture. Though its customer base may not yet be what it should, year-over-year growth of 32.1% is still forward momentum in a market that only stands to gain from increased cybersecurity measures.

Despite the sharp pullback in the Darktrace share price recently, Berenberg analysts are optimistic about its future. They initiated coverage with a buy rating and price target of 600p following the earnings report, according to Marketbeat data. This implies an upside of 72% from the most recent closing price.

Of the six analysts who provided ratings to the Financial Times, one recommended to ‘buy’, three rated the stock as an ‘outperform’, one rated to ‘hold’ and one to ‘underperform’. Seven analysts provided 12-month price targets 601.88, not far off from those of MarketWatch.