Short seller says Darktrace targets are "a pipe dream"

ShadowFall says Darktrace’s business is driven by “an aggressive, promotional, sales focus” and is unlikely to stand the test of time

British hedge fund ShadowFall has taken a short position against cybersecurity specialist Darktrace, calling its business "watery-thin".

The hedge fund is known in the City as the ‘dark destroyer' for its practices of unpicking corporate reports and devaluing shares. While the fund paints its work as a public service, as a short seller its own business model relies on driving down the prices of companies it bets against.

In Darktrace's case, ShadowFall confirmed to The Telegraph that it took a short position in October, although did not say how much money was invested.

The fund said, ‘We believe that the quality of the Darktrace business is watery-thin, driven by an aggressive, promotional, sales focus, which we doubt will stand the test of time.'

IT leaders who have dealt with Darktrace told a similar story. Speaking to Computing's research arm, Delta, they said the company uses a "very pressured" sales technique that "baffles [potential clients] with algorithms".

Darktrace went public early last year, with its share price hitting a peak in September before crashing back down to almost launch levels in November-December. The price today stands at 424 pence per share, having launched at 330 pence per share (a 28.5 per cent increase).

ShadowFall claims the company, which produces an AI-based cybersecurity product, is taking on new customers at a significant discount, while customer retention is also falling. It says the average value of a contract has fallen by 15 per cent since 2018, and more than a quarter of customers have left the company in the last two years.

Darktrace, which upgraded its sales forecasts this month, has rejected the allegations. A spokesperson said ShadowFall's criticisms were "old and already discredited," based on inaccurate financial information.

That didn't stop ShadowFall - which, again, relies on crashing stock prices - from calling Darktrace's forecasts a ‘pipe dream,' pointing out that its research spending is significantly lower, as a proportion of total spend, than rival security firms'.

Even if Darktrace's spending did match its competitors, ShadowFall believes the company would only reach half of its quoted targets.

Analysing financial filings from before Darktrace went public, the hedge fund found that following an accounting restatement in 2019, Darktrace ‘suddenly' had 181 fewer employees in research and 145 more in sales than it had previously stated: a change not discussed in its listing prospectus.

Darktrace said restatements like this were not uncommon and that old numbers were "irrelevant." A spokesperson said the company "did not need to spend as much on R&D as peers" because it has better technology.

The company said it would publish its latest financial results in the coming weeks, which will "give a truer picture" than ShadowFall's claims.

Darktrace is still haunted by the spectre of Mike Lynch, a shareholder who has previously been accused of massive fraud at his former company Autonomy. Lynch is now fighting extradition to the USA.

‘Dozens' of ex-Autonomy staff, including current CEO Poppy Gustafsson, have worked or still work at Darktrace, says ShadowFall.