Can Darktrace’s share price outshine negative press?

Darktrace’s share price rebounded last week as investors shrugged off a co-founder’s legal headaches and an underwhelming analyst price target. The cyber-security firm has been boosted by solid revenue growth. But the stock is volatile, having come under attack from short sellers earlier this year.

•  Darktrace’s co-founder and former adviser Mike Lynch sells $50m shares to make bail in a fraud case.
•  Investors shrug off Merrill Lynch’s 240p price target on Darktrace stock.
• Darktrace’s share price is up over 12% in 2023; revenue this year could top guidance.

Darktrace’s [DARK.L] share price shone last week, posting a 10.9% gain to close Friday, 2 June, at 291.1p as investors shrugged off a double blow of negative news.  

First, there was a stinging investor note from Bank of America Merrill Lynch (BofA), with the bank’s analysts slapping a bearish price target on Darktrace’s stock. Then news broke that co-founder Mike Lynch was selling shares to raise bail money as he fights fraud charges in the US.

Darktrace has struggled to escape the shadow cast by Lynch, who was extradited to the US earlier this year. He faces allegations that he misled Hewlett Packard [HPE] into overpaying for software company Autonomy. To make bail Lynch sold around $50m worth of Darktrace shares. Lynch has denied all charges and entered a not-guilty plea.

Darktrace’s share price appeared resilient to the news. Lynch had already resigned from his role as an adviser to the cyber-security company in February. But can the stock outshine much more negative press?

BofA puts 240p target on Darktrace stock

BofA slapped Darktrace with an ‘underperform’ rating and a price target of 240p on 26 May. The price target is one of the lowest out there and suggests a 17% downside on Friday’s close.

BofA argued that despite strong revenue growth, the Darktrace business was vulnerable as it relies primarily on acquiring new customers. However, that is harder in a weak macroeconomic environment as potential customers tend to “buy additional solutions from existing providers rather than from new ones”.

The bank also noted that Darktrace’s retention rate lagged its peers partly due to “limited upsell potential due to underinvestment”.  

“While revenue growth has been strong historically (48% in FY22) driven partly by its attractive interface, successful marketing and a highly effective salesforce, we expect growth to significantly decelerate,” BofA said in a note.

This chimes with Darktrace chief financial officer Cathy Graham’s own assessment of the headwinds facing the company. In a statement accompanying earnings for the third quarter (Q3) of 2023, Graham said that the current environment “poses challenges to winning new customers, as requirements to hold or cut spend have made prospects more reluctant to run product trials”.

What’s happening with Darktrace’s share price?

Darktrace’s share price is no stranger to the effects of controversy. At the end of January, short seller Quintessential Capital Management published a report claiming Darktrace’s “financial statements may not be relied upon as the company looks like a sophisticated replica of the Autonomy debacle”. Darktrace countered with a statement refuting the allegations as unfounded.  

The publication of the short seller report sent Darktrace’s share price down to an all-time low of 198p on 31 January. Since that point, Darktrace’s share price has bounced back over 38%, helped by a $75m share buyback scheme.

There are also headwinds that could propel the stock higher. Revenues continue to grow, with Darktrace saying that it expects fiscal year 2023 revenue growth on the higher end of its previous guidance range after a boost in its Q3 revenue. For 2023, Darktrace expects adjusted earning margins of around 19%, above its previous 16% to 18.5% range.

A shake-up in management could also help boost demand. In May, Darktrace announced that Chris Kozup will join the company as chief marketing officer on 6 June. Kozup joins from cloud security firm Zscaler [ZS] and will play a “pivotal role in guiding the brand and driving demand”, according to Darktrace.

Analysts covering the stock have a median 12-month price target of 409.64p. Hitting this would see a 40.7% upside on Friday’s close.