Darktrace progress overshadowed by collapsed deal

Darktrace (DARK) published a solid set of annual results. However, this will be overshadowed by the fact that US private equity group Thoma Bravo has pulled out of a potential deal for the cyber security company. The market will be waiting for more details about the reasons for the abandoned deal before the share price shows signs of recovery.

Ignoring the speculation around the deal, the results were promising. Constant currency annual recurring revenue (ARR) increased 42.6 per cent to $514mn (£448mn). There were more customers, and they were willing to pay more, with the number growing by 32.1 per cent to 7,437, while average contract ARR was up 7.9 per cent.

The one-year gross churn rate dropped one percentage point to 6.5 per cent. This shows the stickiness of the software is improving. Between 5 and 7 per cent is about average for software churn rates.

Lower costs because of travel restrictions during the pandemic and timely payments from customers helped boost free cash flow by 290 per cent to $99.5mn. The company admits that free cash flow as a percentage of adjusted Ebitda - currently 108.9 per cent - can swing by as much as 15 percentage points, depending on the timing of collections from customers.

Next year, due to the return of travel and cash payments for employer taxes related to vesting grants made at the IPO, management expects cash conversion to fall to around 65 per cent. The typical range should be between 75 per cent and 105 per cent.

Broker Peel Hunt expects cash profit (Ebitda) of $87.1mn in 2024, up 75 per cent from the $49.5mn in 2022. But the broker considers the cancelled Thoma Bravo offer as an important factor in its valuation of Darktrace, saying “we await further clarification on what led to the deal not materialising”.

From the outside at least, Darktrace has undoubtedly become a lot better value this year. It is now trading on a price to ARR of around 5.7 times, which isn’t absurd for a recurring revenue software business. We remain wary given the potential news to come, but the company is creeping towards a reasonable-looking entry point. Hold.  

Last IC View: Hold, 530p, 3 Mar 2022