A prominent UK cybersecurity stock is under attack from short sellers. Here’s what you need to know
Darktrace, one of the U.K.’s largest cybersecurity companies, was founded in 2013 by a group of former intelligence experts and mathematicians.
Omar Marques | SOPA Images | LightRocket via Getty Images
Cybersecurity company Darktrace, one of the U.K.’s most prominent tech names, has found itself under attack from short sellers.
The company, whose tools allow firms to combat cyberthreats with artificial intelligence, was last week targeted in a report by New York-based asset manager Quintessential Capital Management.
QCM, whose stated aim is “exposing fraud and criminal conduct in public companies around the world,” claims it has had a 100% success rate in its activist campaigns.
The company told Reuters it holds a short position of 1.3% in Darktrace shares.
London-based hedge fund Marshall Wace also shorted Darktrace, according to data site Breakout Point.
Short selling is a strategy in which investors bet on the price of a stock going down in value. A trader borrows the stock and then sells it on the assumption that it will fall, before buying it back at a discounted price and pocketing the spread.
What is Darktrace?
Darktrace, one of the U.K.’s largest cybersecurity companies, was founded in 2013 by a group of former intelligence experts and mathematicians.
The Cambridge-headquartered company says its technology uses AI to detect and respond to cyberthreats in a business’ IT systems.
The company floated on the London Stock Exchange in 2021, and its debut was seen as a key victory in the U.K.’s bid to lure more high-growth tech startups to the London market after its withdrawal from the European Union.
The stock’s performance following the listing has been underwhelming. After initially rising to an all-time high of £9.45 ($11.58) in October 2021, Darktrace shares have since plunged dramatically in tandem with a broader slump in global tech stocks.
As of Monday afternoon, Darktrace shares were trading at a price of £2.32, down 37% in the last 12 months.
Darktrace share price performance in the last 12 months.
In August, the firm opened takeover talks with U.S. private equity firm Thoma Bravo. However, Thoma Bravo walked away from the deal a month later after the two sides failed to reach an agreement.
Why is it under attack?
On Tuesday, U.S. hedge fund QCM said it had taken a short position out against Darktrace and published a lengthy report detailing alleged flaws in Darktrace’s accounting.
QCM said that, following an investigation into Darktrace’s business model and selling practices, it was “deeply skeptical about the validity of Darktrace’s financial statements” and believed sales and growth rates may have been overstated.
“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 said in the report.
Darktrace was accused by QCM of engaging in “channel stuffing” and “round-tripping” — activities that artificially inflate a company’s reported sales — involving individuals with ties to organized crime, money laundering and fraud.
Darktrace didn’t directly address those allegations. On Wednesday, the firm’s CEO Poppy Gustafsson issued a statement defending the company from what she called “unfounded inferences” made by QCM.
Separately, QCM suggested Darktrace may have inflated its revenues by booking unearned revenues as actual sales.
The company occasionally books revenue from payments for contracts it receives before delivering its service to clients as deferred revenue, according to the report.
This is not uncommon among subscription-based software companies. However, QCM noted deferred revenue as a percentage of Darktrace’s sales had dropped between 2018 and 2022, suggesting the firm “may have increasingly been booking unearned revenue as actual sales.”
In response, Darktrace said: “Rarely, customers will pay full contract values in advance but because this is infrequent, non-current deferred revenue balances will decline as these contracts run down unless there is another unusual, large, in-advance payment.”
QCM alleged Darktrace may have tried to fill gaps in its receivables left by clients dropping out of sales negotiations through marketing sponsorships with indebted resellers and using shell companies to pose as phantom clients.
“Organisations that transact with the channel will typically co-host marketing events with their partners. Partner marketing events are a normal course of business for almost all software businesses and Darktrace is no different,” Darktrace said Wednesday.
“This has been, and remains, a very small part of Darktrace’s marketing and the costs of them over the last five years has consistently been substantially below 0.5% of Darktrace’s revenue,” Darktrace added.
Darktrace was not immediately available for comment when contacted by CNBC.
Separately Wednesday, Darktrace said it would embark on a share buyback worth up to £75 million ($92 million) to be completed no later than Oct. 31, 2023.
The Lynch connection
It’s worth noting that, even before the QCM report, there were clouds hanging over Darktrace’s business. Analysts have criticized the company over an allegedly aggressive sales culture and doubts over the value of its technology.
Darktrace is also backed by Mike Lynch, the British tech tycoon.
Mike Lynch, former CEO of Autonomy.
Hollie Adams | Bloomberg via Getty Images
Lynch founded the enterprise software firm Autonomy, whose sale to Hewlett-Packard was mired in scandal over accusations that Lynch plotted to inflate the value of Autonomy before it was bought by HP for almost $11 billion in 2011.
In 2022, a British judge ruled in favor of HP in a civil fraud case against Lynch. Lynch, an influential figure in the U.K.’s tech scene, faces a possible criminal trial in the U.S. after the U.K. government approved his extradition last year.
He has repeatedly denied the allegations.
Several executives at Darktrace, including Gustafsson and Chief Strategy Officer Nicole Eagan, previously worked for Autonomy.
The QCM report also raised concerns over the connections between Darktrace and Autonomy.
“Darktrace has been led or strongly influenced by many of the very same individuals that participated in the Autonomy debacle,” QCM said in its report.
“If our allegations are confirmed, we expect Darktrace to follow the same tragic destiny of its predecessor, Autonomy,” QCM said.
Lynch is reportedly no longer involved with Darktrace’s management, but remains a significant shareholder.
Lynch is no longer involved with Darktrace’s management, but remains its sixth-largest shareholder, according to Refinitiv Eikon data.
Meanwhile, Darktrace is also suffering from uncertainty related to the wider macroeconomic environment. The company lowered its forecast for annual recurring revenue growth for the year ending June 2023 to between 29% and 31.5%, down from an earlier forecast of 31% to 34%, citing weaker customer growth.
CEO of Nvidia, Jensen Huang, speaks during the launch of the supercomputer Gefion, where the new AI supercomputer has been established in collaboration with EIFO and NVIDIA at Vilhelm Lauritzen Terminal in Kastrup, Denmark October 23, 2024.
Ritzau Scanpix | Mads Claus Rasmussen | Via Reuters
Nvidia is replacing rival chipmaker Intel in the Dow Jones Industrial Average, a shakeup to the blue-chip index that reflects the boom in artificial intelligence and a major shift in the semiconductor industry.
Intel shares were down 1% in extended trading on Friday. Nvidia shares rose 1%.
The switch will take place on Nov. 8. Also, Sherwin Williams will replace Dow Inc. in the index, S&P Dow Jones said in a statement.
Nvidia shares have climbed over 170% so far in 2024 after jumping roughly 240% last year, as investors have rushed to get a piece of the AI chipmaker. Nvidia’s market cap has swelled to $3.3 trillion, second only to Apple among publicly traded companies.
Companies including Microsoft, Meta, Google and Amazon are purchasing Nvidia’s graphics processing units (GPUs), such as the H100, in massive quantities to build clusters of computers for their AI work. Nvidia’s revenue has more than doubled in each of the past five quarters, and has at least tripled in three of them. The company has sginaled that demand for its next-generation AI GPU called Blackwell is “insane.”
With the addition of Nvidia, four of the six trillion-dollar tech companies are now in the index. The two not in the Dow are Alphabet and Meta.
While Nvidia has been soaring, Intel has been slumping. Long the dominant maker of PC chips, Intel has lost market share to Advanced Micro Devices and has made very little headway in AI. Intel shares have fallen by more than half this year as the company struggles with manufacturing challenges and new competition for its central processors.
Intel said in a filing this week that the board’s audit and finance committee approved cost and capital reduction activities, including lowering head count by 16,500 employees and reducing its real estate footprint. The job cuts were originally announced in August.
The Dow contains 30 components and is weighted by the share price of the individual stocks instead of total market value. Nvidia put itself in better position to join the index in May, when the company announced a 10-for-1 stock split. While doing nothing to its market cap, the move slashed the price of each share by 90%, allowing the company to become a part of the Dow without having too heavy a weighting.
The switch is the first change to the index since February, when Amazon replaced Walgreens Boots Alliance. Over the years, the Dow has been playing catchup in gaining exposure to the largest technology companies. The stocks in the index are chosen by a committee from S&P Dow Jones Indices.
Charles Liang, chief executive officer of Super Micro Computer Inc., during the Computex conference in Taipei, Taiwan, on Wednesday, June 5, 2024. The trade show runs through June 7.
Annabelle Chih | Bloomberg | Getty Images
Super Micro investors continued to rush the exits on Friday, pushing the stock down another 9% and bringing this week’s selloff to 44%, after the data center company lost its second auditor in less than two years.
The company’s shares fell as low as $26.23, wiping out all of the gains for 2024. Shares had peaked at $118.81 in March, at which point they were up more than fourfold for the year. Earlier that month, S&P Dow Jones added the stock to the S&P 500, and Wall Street was rallying around the company’s growth, driven by sales of servers packed with Nvidia’s artificial intelligence processors.
Super Micro’s spectacular collapse since March has wiped out roughly $55 billion in market cap and left the company at risk of being delisted from the Nasdaq. On Wednesday, as the stock was in the midst of its second-worst day ever, Super Micro said it will provide a “business update” regarding its latest quarter on Tuesday, which is Election Day in the U.S.
The company’s recent challenges date back to August, when Super Micro said it would not file its annual report on time with the SEC. Noted short seller Hindenburg Research then disclosed a short position in the company and wrote in a report that it identified “fresh evidence of accounting manipulation.” The Wall Street Journal later reported that the Department of Justice was in the early stages of a probe into the company.
Super Micro disclosed on Wednesday that Ernst & Young had resigned as its accounting firm just 17 months after taking over from Deloitte & Touche. The auditor said it was “unwilling to be associated with the financial statements prepared by management.”
A Super Micro spokesperson told CNBC that the company “disagrees with E&Y’s decision to resign, and we are working diligently to select new auditors.” Super Micro does not expect matters raised by Ernst & Young to “result in any restatements of its quarterly financial results for the fiscal year ended June 30, 2024, or for prior fiscal years,” the representative said.
Analysts at Argus Research on Thursday downgraded the stock in the intermediate term to a hold, citing the Hindenburg note, reports of the Justice Department investigation and the departure of Super Micro’s accounting firm, which the analysts called a “serious matter.” Argus’ fears go beyond accounting irregularities, with the firm suggesting that the company may be doing business with problematic entities.
“The DoJ’s concerns, in our view, may be mainly about related-party transactions and about SMCI products ending up in the hands of sanctioned Russian companies,” the analysts wrote.
In September, the month after announcing its filing delay, Super Micro said it had received a notification from the Nasdaq indicating that its late status meant the company wasn’t in compliance with the exchange’s listing rules. Super Micro said the Nasdaq’s rules allowed the company 60 days to file its report or submit a plan to regain compliance. Based on that timeframe, the deadline would be mid-November.
Though Super Micro hasn’t filed financials with the SEC since May, the company said in an August earnings presentation that revenue more than doubled for a third straight quarter. Analysts expect that, for the fiscal first quarter ended September, revenue jumped more than 200% to $6.45 billion, according to LSEG. That’s up from $2.1 billion a year earlier and $1.9 billion in the same fiscal quarter of 2023.
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