New cybersecurity offering brings hope to Darktrace shares

Darktrace launched to fanfare in 2021, but the UK cybersecurity firm has struggled as anticipated demand failed to come to fruition, and it recently trimmed its forecasts. It’s also been accused of questionable marketing tactics. Darktrace’s new product, Newsroom, part of its AI-driven PREVENT system, might offer the boost it needs.

• Darktrace’s shares spiked on the Newsroom release, but slumped 5% on the day.
• Positive results for cybersecurity stocks in 2023, with sector slated to grow to 2029.
• The Global X Cybersecurity ETF offers exposure to Darktrace.

The share price of cybersecurity company Darktrace [DARK.L] fluctuated when it announced the release of Newsroom, a system that detects threats to businesses' software and customer networks, on 23 February.

The Newsroom system uses artificial intelligence to identify vulnerabilities to cyber-attacks as part of Darktrace’s PREVENT product.

On the day of the news, the Darktrace share price jumped as much as 6.9% during intraday trading, but ultimately closed down 5%.

The Cambridge-based UK start-up is having a difficult year, and has reportedly hired the firm EY to independently review its finances, after New York hedge fund Quintessential Capital Management accused Darktrace of inflating its sales figures.

In January, the stock sank below its 2021 IPO price of 250p after reporting in its first half (H1) of 2023 trading update that customers were cautious about employing its services, and anticipating growth will slow.

Since then, Darktrace’s share price has recovered, and is now up 2.9% year-to-date.

The struggle to win new customers

In its H1 trading update on 11 January, the company cut revenue forecasts for the year to June, predicting constant currency annual recurring revenue (ARR) would rise 29-31.5%, compared to previous forecasts of 31-34%.

Darktrace is set to report H1 2023 earnings on 8 March. Despite lowering its ARR expectations at the trading update, it said “foreign exchange headwinds present early in the financial year” had “largely reversed”, helping them moderate any reductions in revenue.

It added operating efficiencies were slated to continue into H2 2023, and would shore up fiscal year 2023 earnings margin predictions. The company’s adjusted EBITDA margin is expected to be 16-18.5%, a slight improvement on the 15-18% previously forecast.

Darktrace has attracted its share of controversies, not least the recent accusations of questionable marketing, sales and accounting practices, which led to Quintessential taking a well-publicised short position on the firm. Analysts argue Darktrace invests too little in research and development and focuses disproportionately on sales and marketing—the latter department’s £193m 2022 budget jumped 23% from 2021.

As far back as October 2021, Peel Hunt analysts advised investors to sell Darktrace shares, due to “a gap between the promise and reality”, said analyst Oyvind Bjerke at the time.

Cybersecurity theme still slated to grow

Darktrace investors will hope Newsroom renews demand. In February, the cybersecurity firm warned that the average time it takes for companies’ vulnerabilities to be exploited is 15 days. Pieter Jansen, senior vice president of cyber innovation, said the PREVENT dashboard would tackle a threat “of rapidly expanding attack surfaces”, with Newsroom being “a vital component”.

The time might seem ripe to invest in cybersecurity, but some experts are still exercising caution. “Cybersecurity… is more vulnerable than investors perceived six to nine months ago,” wrote Deutsche Bank analyst Brad Zelnick in a report.

Others are more optimistic, including Cowen analyst Shaul Eyal, who said concerns of a sector slowdown had “failed to materialise”.

Cybersecurity peer Fortinet’s [FTNT] Q4 earnings topped estimates in February, as did leading US cybersecurity name Palo Alto Networks [PANW] for its Q2 report, in which it raised its forecasts for the year.

The global cybersecurity market was worth $139.8bn in 2021 and is projected to reach $376.3bn by 2029, growing at a CAGR of 13.4%, according to Fortune Business Insights.

Funds in focus: Global X Cybersecurity ETF

The Global X Cybersecurity ETF [BUG] offers exposure to Darktrace stock. As of 3 March, the company had a 3.41% weighting in the fund with Fortinet, Palo Alto and Okta [OKTA] holding the top three positions in the fund. BUG is up 12.9% year-to-date, but down 21.3% over the past 12 months.

Darktrace has more limited exposure in the First Trust Nasdaq Cybersecurity ETF [CIBR], with a weighting of 1.18% as of 3 March. The top three holdings in the fund are Broadcom [AVGO], Fortinet and Palo Alto Networks. CIBR is up 9.4% year-to-date, but down 14.6% over the past 12 months.