London-listed IT company Darktrace PLC (LSE:DARK) has become the target of a short-selling campaign from US hedge fund Quintessential Capital Markets (QCM).
The New York firm appears sceptical of the validity of Darktrace’s financial statements due to suspected overstated sales, margins, and growth rates, with evidence laid out in a 70-page document titled Autonomy 2.0? The Dark side of Darktrace.
QCM purports that Darktrace is engaging in similar behaviour to Autonomy, the software company established by Mike Lynch in 1996 and subsequently sold to Hewlett Packard for US$11.7bn.
Hewlett Packard wrote off 75% of the acquisition less than a year later, citing “accounting improprieties, misrepresentations, and disclosure failures to inflate the underlying financial metrics” of Autonomy.
According to QCM, Darktrace “appears to be profoundly linked to Autonomy through common leadership, key investors, offices and… alleged business practices” such as “channel stuffing” whereby revenues are inflated immediately prior to earnings calls, and “fabricated sales”.
Darktrace claps back
Darktrace responded, saying it has “full confidence” in its accounting practices and financial reporting.
Poppy Gustafsson, chief executive of Darktrace said: "We embrace the scrutiny of the public markets. However, it is also important to refute any unfounded inferences about the listed business we are today and push back in the strongest terms on any suggestions that this is a business that is not being run with the greatest integrity…I stand by my team and the business I represent.
On the issue of inflated revenues, Darktrace said: “As Darktrace recognises revenue on a straight-line basis from the first day of the contract to the last, for any contract that does have an opt out, Darktrace recognises only the pro rata portion of the revenue related to the service period actually provided.
“To reiterate, Darktrace only recognises revenue on fully contracted transactions and only the portion of a transaction that is fully committed is included within backlog.”
On the issue of fabricated sales, Darktrace rebutted: “Where Darktrace sells a hardware appliance, Darktrace recognises all of the revenue and the costs up front on the appliance portion of the contract only, in line with the required accounting treatment.”
Darktrace offered further rebuttal on the issues of partner channel controls and marketing costs.
Darktrace’s buyback offer
Darktrace responded, saying it has “full confidence” in its accounting practices and financial reporting. The group also initiated a £75mln share buyback plan representing nearly 13% of its free float.
Darktrace shares initially plummeted to a record low of 198p after the report dropped, but recovered to 220.9p on Wednesday, February 1 after the buyback announcement.
QCM’s executive summary signed off its scathing report with with a warning: “Given the above, we would like to give our strongest possible warning to investors and believe that DT’s equity is overvalued and liable to a major correction, or worse.”
QCM stated it “has an economic interest in the price movement” of Darktrace securities, which Reuters reported as a 1.3% stake in the company.