Shares in Darktrace (LSE: DARK) have done well recently, buoyed by impressive-looking results. The Darktrace share price rallied as the artificial intelligence (AI) cybersecurity group lifted its expectations for FY22, thanks to high demand.
In its results for the year ending June, the group said it now expects year-on-year revenue growth of 35%–37%. Its previous guidance was for 29%–32%. In its first results since listing earlier in the year, the company said revenues surged 41.3%, to $281.3m, as customer numbers rose from 3,858 to 5,605.
However, Darktrace is still loss-making – something that will put many investors off. All the more so given it can make significant revenues and is relatively well established – so why such large losses?
The reasons for being loss-making
Darktrace’s results noted one-off costs associated with the company’s initial public listing. The group incurred $15.3m of non-recurring professional fees relating to the preparation and listing, which happened in May.
Quite a lot of the increasing losses was down to research and development, which could be seen as investment in the future of the business. Research and development expenses in FY21 were $18.6m, up from $7.5m the previous year. If Darktrace can maintain a strong position in a competitive market and keep investors onside with strong revenue and customer growth then this may well be justified in the end. It’s a well-worn path in technology to invest to take market share. Think of Amazon as a famous example of this. But it could spend all this money and not get the expected pay off. Of course that’s a risk.
Also, the company spent less on travel and events over the period than in previous years — otherwise losses would have been even greater. It’s unclear if these costs will increase substantially in the coming years.
Could the Darktrace share price do well?
Customer churn increased 0.8% over the last year, which is not a trend anyone would like to see continued. Why are 7.7% of customers leaving every year, when cybsersecurity products such as this ought to keep customers year after year? The company blamed it mostly on pandemic-induced client budget cuts, which may be right, but it’s worth keeping an eye on, in my view.
There does seem to be significant cash in the business, which lessens the risks that come with it being a loss-making business currently. Without cash, a company can’t keep going. In my view, though, Darktrace has significantly improved its cash flow and will one day likely be profitable.
I also think investors over the next few years are going to value AI more and more and appreciate its application in cybersecurity. Darktrace has a lead here and continues to invest heavily, including with an R&D centre in Cambridge. This could be a positive for the share price in the future. I believe investors will pay a premium for AI companies, much like the premium that 2020 investors paid for e-commerce companies, which generally provided very strong returns. AI will have its day in the sun.
I think Darktrace shares could keep doing well, especially if its R&D investments mean it captures more market share. If losses narrow and revenue growth remains strong, I think the Darktrace share price could do very well in the rest of 2021 and beyond. I am considering buying the shares for my portfolio.
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Andy Ross owns no share mentioned. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Amazon. The Motley Fool UK has recommended the following options: long January 2022 $1,920 calls on Amazon and short January 2022 $1,940 calls on Amazon. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.