The Darktrace (LSE: DARK) share price has exceeded expectations since its IPO, rising over 100%. Such an incredible post-IPO performance always piques my interest, especially in fairly recent start-up companies. So, what is behind this incredible rise, and should I be buying this stock for my portfolio?
The business
Darktrace is a cyber-security firm that uses artificial intelligence to help detect and deal with any cyber threats. As stated by the firm itself, this is a “fundamentally different approach” to cyber-defence. It is also hoped that the use of artificial intelligence will be able to thwart cyber-attacks that would have gone undetected by humans.
I find this business model promising. Firstly, it is clearly unique, and this helps distinguish it from other competitors. Secondly, due to increases in cyber-crime over the past few years, there is room for expansion in this area. These two factors offer a partial explanation for the rise in the Darktrace share price.
Such a unique business model has also attracted numerous different customers. In fact, Darktrace currently has over 5,000 customers, based in over 100 different countries. The represents growth of 42% over the last year.
Other factors to consider
Growth prospects for the company are also strong. In fact, the company expects FY 2021 revenue growth of 40%, to at least $278m. During the current financial year, management also expects revenue growth of 29%-32%, up from a previous estimate of 27%-30%. This highlights the excellent potential of this UK share, a factor that will hopefully cause the Darktrace share price to rise further.
Even so, there are risks, including the firm’s unprofitability. Since its inception, the firm has incurred losses each year. Most recently, during the year to June 2020, it announced an operating loss of $25m. It is not expected to reach profitability over the next few years. Although unprofitability is common among tech stocks, it still means that outside funding is necessary, and this may include issuing more shares. This would likely have a negative effect on the Darktrace share price, due to share dilution.
Further, the company does have a high market capitalisation of around £5bn. Comparing this to expected revenues of $278m gives the company a price-to-sales ratio of around 26. This can be compared to other cyber-security firms, like Palo Alto, which has a lower price-to-sales ratio of around 10. This means that if Darktrace cannot maintain its strong revenue growth, investor sentiment could be dampened considerably.
The final risk is the potential conviction of Mike Lynch, who currently faces 17 counts of fraud and conspiracy in the US. Lynch owns 4.5% of Darktrace, and he would be forced to sell this stake if he was convicted. This potential controversy is an unwanted distraction for the company, and could also damage Darktrace’s reputation.
Has the Darktrace share price got upside potential?
Overall, I am extremely impressed with Darktrace. It has a unique business model, in a high-growth area, and its current growth is excellent. As such, I feel that there is long-term upside potential. Despite this, I am also concerned by its current valuation and think that investors may use the recent rise in the Darktrace share price to bank profits, especially due to the Lynch controversy. This would lead to downward pressure on the share price and is the reason I’m staying away for now.
