Convincing corporate c-suites of its skill in defending against “novel attacks” is a crucial part of Darktrace delivering on its growth ambitions. More recently, the cybersecurity group has faced external threats of its own.
Annual figures do not offer a definitive riposte to the doubters. A change in the way commission is paid to salespeople will hit free cashflow and margins this year, causing management to lower guidance for the margin it generates on adjusted earnings before interest, taxes and other charges to 17-19 per cent. The impact should be a one-off.
A slowdown in annualised recurring revenue (ARR) growth, a measure of contracted revenues, is more telling of a challenging trading environment. ARR rose just under 30 per cent last year, lower than the 42 per cent last year. This year that metric is to fall to 21-23 per cent at constant currency rates.
Companies are becoming more reluctant to take up a trial of Darktrace’s products, which it seeks to differentiate from those of other providers through its use of artificial intelligence. For now, tighter IT budgets have trumped the AI buzz that has grown louder over the past 12 months. Darktrace is also gaining new customers at a slower rate. Almost $144 million in net new contracted revenue was added last year, 0.4 per cent lower than the year before. There was also a slight uptick in the client churn rate to 6.8 per cent, from 6.6 per cent.
Squeezing more out of its existing customers provided some offset against weaker client wins. But this year, management thinks the value of the contracted revenue being added could fall by up to 8 per cent, and at best, be 1 per cent higher.
Contract pricing has held up “pretty well”, according to Poppy Gustafsson, the Darktrace chief, but the extent to which there is an inflation link built into the life of the average three-year contract varies.
Investors have tempered their growth expectations. An enterprise value equivalent to 3.8 times forward sales is down from a multiple of five this time last year. Its earnings multiple has fallen by an even greater degree, to about 17 forecast earnings before interest, taxes and other charges. Still, Darktrace remains one of the few of the crop of 2021 whose shares are above the IPO price, just.
Darktrace is not relying on the macro picture improving to meet its annual ARR guidance for 21-23 per cent growth. But it is banking on the second half of this financial year doing more of the heavy lifting than usual, which should put investors on higher alert. That rests on the launch of its new Prevent and Heal products gaining traction with customers, as well as heavy investment in its sales and marketing teams paying off.
Sales and marketing is a chunky cost for Darktrace, equating to more than half of revenue generated last year. It puts more onus on the group to maintain a healthy pace of revenue growth if it is to hit a target of achieving an operating margin in the mid-20s, or else rein in its costs. True, revenue growth meant the margin improved last year, but at 15.1 per cent it is some way off its target.
An EY audit of Darktrace’s accounting practices helped reassure investors this year after a second short-seller attack on the company. But sizeable stakes still held by Mike Lynch, the tech entrepreneur who is facing fraud charges in the US relating to the 2011 sale of a previous company, Autonomy, along with his wife, Angela Bacares, is an unhelpful overhang to the shares. Lynch denies all the charges.
Showing that it can push revenue forward at a faster pace than costs this year and move closer towards its margin target, will help vindicate Darktrace in the eyes of the market.
ADVICE
Hold
WHY
The shares trade at a discount to their historical average but it is justified by lower sales growth
Ashmore
Ashmore is powerless against a stuttering Chinese economy and the rapid tightening in US monetary policy that has seen investors pull cash out of emerging markets.
Net outflows totalled $11.5 billion last year for the EM specialist, which pushed assets under management down another 13 per cent to $55.9 billion at the end of June. Costs declined by a much lower degree, which eroded the profit margin.
A bias towards fixed-income strategies, which accounted for 86 per cent of assets at the end of September, has made Ashmore more vulnerable to investors seeking seemingly less risky assets such as US Treasuries or similar investments offering reasonable yields.
There are signs that the stream of cash flowing out is starting to slow. Net outflows were heavily weighted towards the first six months of the year, with only a third being pulled in the second half. Forecasts on when Ashmore may return to positive inflows vary. The brokerage Panmure Gordon thinks it may come in the second half of this financial year but bearish analysts at Numis anticipate net outflows until at least 2025.
Looking ahead, there are some encouraging signs for Ashmore. US inflation is cooling and some developing nations are starting to cut interest rates. But the worsening health of the Chinese economy is the biggest shadow looming over any potential improvement in sentiment towards emerging markets.
Ashmore is focused on self-help, including attempts to diversify further into equities and alternatives.
Equities are just $6.2 billion, or 11 per cent, but its finance chief Tom Shippey thinks an increase to $20 billion or 20 to 25 per cent of assets under management is feasible. There would be a clear margin benefit to adding more flavour to the asset mix — alternatives carry a management fee margin of 140 basis points, more than three times the 30 to 45 basis points Ashmore earns on fixed income.
When flows turn, the improvement in the margin should be speedy, but timing remains uncertain. That is not risk reflected in a forward earnings ratio of 15, bang in line with the ten years since the last taper tantrum.
ADVICE
Avoid
WHY
Shares not cheap enough to compensate for risk of more heavy outflows
