It’s been a difficult few months for the Darktrace (LSE: DARK) share price. Since September, the stock has fallen by a huge 58%, although it’s still up 25%+ on its April float price. It’s been a volatile period for the share since the IPO.
However, I view the prospects for Darktrace favourably. The company provides artificial intelligence-based cybersecurity software. This sector is going to be in high demand going forward, in my view. Not only this, but the company has an impressive list of customers, which suggests its products are high quality.
I’m not buying the shares just yet though, and here’s why.
The bull case
It’s useful to review the key bull points for Darktrace. The first being the sector that the company operates in. Demand for cybersecurity is only going to grow from here. The expanding metaverse, e-commerce and online banking will all require enhanced levels of security to protect against cybercriminals. Darktrace’s security services boast some impressive statistics too, such as being able to respond to ransomware in 10 seconds.
As mentioned, Darktrace has an impressive customer list that extends to over 5,500 organisations. For example, the Enterprise Immune System product is used by Vodafone and KPMG, two large companies that trust the capabilities of Darktrace’s cybersecurity software.
City analysts are also expecting revenue to grow 38% next year, and by a further 32% in 2023. This is attractive growth and something I like to see as a potential investor.
Risks to consider
I was strongly considering buying Darktrace shares, writing in November that I was placing it high on my watchlist.
However, I do question the company’s recent announcement of a share buyback. This is a way for management to return excess cash to shareholders. It’s generally preferred over a cash dividend when the shares are undervalued.
The problem as I see it is that the company only recently issued new shares in April at a price of 250p, raising £165.1m. Now, the decision has been to buy back shares up to a value of £30m, but at a far higher share price today. As an example, the most recent transaction saw Darktrace reacquire 73,038 shares at a price of almost 418p. I question why management has decided to buy back Darktrace shares at the now higher price, and not invest the £30m into the company’s growth.
The company is also no longer a member of the prestigious FTSE 100 after the share price crash. This means that the market value is now under £3bn. I’d have to expect further volatility if I was to buy the shares.
Where will the Darktrace share price go from here?
Taking everything into account, I do think there’s upside in the Darktrace share price. It’s growing in an exciting sector, and has an impressive list of customers.
Nevertheless, I’m going to sit on the sidelines for a little while longer. I recognise that the recent share buyback of £30m is small relative to the company’s almost £3bn in market value. But I want to see further evidence of effective capital allocation decisions from management before I buy the shares.
