Cyber security firm Darktrace (LSE: DARK) has seen its share price climb 30% since its London flotation on 30 April. I reckon the company — which is now valued at £2.2bn — could be the hottest tech IPO in the UK this year.
Darktrace uses artificial intelligence to secure all of a company’s digital operations, including cloud, network, email, and industrial control systems. I think demand for cyber security services is likely to grow for the foreseeable future. So should I buy Darktrace for my portfolio?
Why I might buy
I can see a lot to like about Darktrace. The company says it uses artificial intelligence to learn about a company’s IT operations. It can then detect unusual activity that might be a threat and neutralise it, even if it’s not been seen before.
This is different to traditional cyber security systems, which tend to set up a perimeter and watch out for known threats.
Darktrace’s software is also very quick to deploy. The company offers a 30-day free trial and says its system can be up and running within an hour.
In financial terms, I think Darktrace’s subscription model could help it deliver strong share price growth over time. As an online service, the cost of adding new customers is relatively low. Successful subscription businesses can become very profitable, with a high level of repeat revenue each year.
Progress so far looks promising. Since its foundation in 2013, Darktrace has grown to serve 4,700 customers in 100 countries. The employee count looks a bit high to me, at 1,500, but my understanding is that many of these are in sales. This approach seems to have worked — revenue rose by 45% to $199m during the 12 months to 30 June 2020.
Things I don’t like
I believe Darktrace could become very profitable. But right now, this business is still losing money. Last year’s accounts show an operating loss of $24.9m.
I don’t know how long it’ll be until Darktrace becomes profitable, assuming it does. For now, I’d suggest a market-cap of £2.2bn means Darktrace’s share price already reflects continued strong growth. Any disappointment could see the stock slip.
One other risk I should mention is Darktrace’s connection to UK tech billionaire Mike Lynch, whose company Invoke Capital was an early investor. Lynch is currently fighting extradition to the US on fraud charges. He denies the charges, but Darktrace does warn in its prospectus that “there remains a risk that the Group could be charged with offences” arising from these allegations. I don’t know how likely this is, but it’s out there.
Darktrace share price: my decision
Is Darktrace’s technology as revolutionary as it seems? I’m not an expert on cyber security, but the firm’s approach does seem to be different to traditional security software. However, I’d imagine that, over time, established competitors will adopt some of Darktrace’s techniques to improve their services.
Darktrace floated at a share price of 250p, but the stock has already risen to 325p. That prices this loss-making business on 13 times sales. On a long-term view, I think this could be a fair price.
However, I’d like to learn a little more about how Darktrace performs before I decide whether to buy. For now, I’m going to stay on the sidelines.
