Member Info for Lending

‘Think of the poor shareholders who sold as a result of QCM's scaremongering. “

Think also of the brave PIs who bought at low prices due to QCM’s scaremongering. For some it could be seen as a positive -and I hope it is for them.

P69 - Thanks for posting - a real eye opener. I wonder whether this is where some of the cheaper - or maybe most of the - trading platforms make their money. How much risk are we taking using them?

I think DT has a good chance of winning the battle on this one with their short term buy-back strategy, but I remain unconvinced that they will win the longer term war. Unless they do more to assuage the concerns in the market about governance and business control issues, the SP will remain volatile and management will continue to be distracted - and business will suffer.

I think Stifel’s analysts (as reported in the FT) are spot on when they say that unaddressed concerns emanating from the market will keep making Darktrace “an easy target for shorts”. And that DT needs to prove to the market what they said in their response - words saying we have confidence………..…are not enough. What actions are they going to take? Stifle made some suggestions.

I agree 100% regarding the necessity of BOD changes, and that another external audit is needed to quell suspicions. GH as chairman of the BOD was always seemingly too cosy with the management team, so having only 2 true ly independent no-Execs is disgraceful - and not in line best practice - from my point of view as a shareholder.

To quote from the FT article:

“‘But absent a new defence strategy, will the company find any lasting relief? Not according to the Stifel analysts, who say “quirkiness” will keep making Darktrace “an easy target for shorts”

“[W]e believe the company has failed since its IPO to alleviate concerns emanating from the market. While we believed time and strong operational results would help heal the company’s wounds, we are now of the view that the company, its Board and its management need to take more proactive and tangible measures. Among others, these could potentially include: 1) replacing part of the management and middle-management teams, 2) electing more independent Board members, 3) electing a new Chairman of the Board (current Chairman Gordon Hurst, while independent, is also Chairman of the Board of another company backed by Mike Lynch’s VC fund), 4) implementing an auditor rotation, and 5) launching a forensic audit run by another audit firm. Until material measures are taken, we believe more unpredictable hits are likely to affect the company’s share price in the future.”

I think we’ll all are prey to Motivation Reasoning and Confirmation Bias and don’t like contrary views so become aggressive. Just look at how Cassandra was set upon when she (?) gave an opinion that differed from the prevailing views. Right or wrong the views expressed on this bb are mostly just opinions.

Personally I welcome alternative views because it challenges my own motivation reasoning and confirmation bias. To attack those with opposing views is not a heathy approach IMVHO.

As others have said attack the argument/reasoning not the person, Or use the ignore button. And as Sheltie said “play nice”.

Yes a good article but:-

They are using adjusted EBIT and cash flow figures to explain how well DT is doing. That’s fine for the company’s books as printing share certificates is “free” to pay for SBC, but from a shareholder’s perspective they are paying for it through share dilution. As complex situation and the practice much castigated by Buffett, Terry Smith and others.

Response from one:

“Whilst you hold your share through Interactive Investor, these will be held via a Custodian but you will not lose any of you beneficial rights to the security and they will not be used for
security lending.”

P69 your questions have raised so many other questions concerning the 3 online brokers I use. I’ve taken a look at the T&C of them all but cannot see any reference to their being allowed to lend out shares. But they do use nominee accounts and my share shares are bundled together with others unless a heavy fee is paid to ring fence them. So I do wonder. I have written to all 3 to seek clarification.

Thanks for raising it as potential issue. What a can of worms!

I suspect IIs lend out the shares out though a broker at a high cost to make some extra money. Risky if the borrowers go belly up so the risk premium will be high.

p 69. I think it depends who the registered owner is of the shares being borrowed is. If the broker is not the owner, or does not have the explicit permission of the owner, to allow the shares to be borrowed and sold, I would have thought this was a question of theft or fraud.

P69 - good question. My thoughts.

If, say, you thought Mr Market was overpricing a share so you borrowed shares from somebody, and sold them with the hope of buying them back later at a lower price, this to my mind is quite legal and ethical. It is speculating though, and not investing. Not too far away from “long” trading in my view.

However, if you do this,m and then issue reports that are designed to cast doubt on the reputation and integrity of a business in order to drive the price down, that is pure supposition, then to me it is unethical ( shady practice) but not necessarily illegal - Caveat Emptor and all that. If a report, however, accuses a company of doing bad things that are untrue, this is both unethical and slander to my mind so illegal. QCM is walking on a time rope in my opinion.

In my view reputation is vital to any company and huge sums are spent on reputation and brand management and client communications. Darktrace has identified harm to its reputation - technical or otherwise - as one of its major risks. For my sins, I once was for chairman of the tender board of our company and we did not award, and occasion did not renew, supply contracts on the basis of perceived concerns about the ethical values of our suppliers even though their products and services otherwise fully met our requirements.

Apple does a brilliant job in managing and honing its reputation and 3 vice presidents are involved in different ways of “shaping and sharing Apple’s story of innovation and strong values”

The old dictum in reputation management is that “perception = reality”.

My main concern is that the brand and reputation of DT will be negatively impacted in the eyes of DT’s customers - and potential customers - no matter the rights and wrongs of the matter, and that the business will be affected through lower sales. The report attacked the technology, its delivery and the integrity of management and the business controls. The RNS is directed at the financial community. How are they going to address any concerns or perceptions customers may have have as a result?

They identified this risk:

“The Group's brand and reputation relies on a variety of factors including … if its external associations expose it to real or perceived factors beyond its control, its business and operating results could be negatively impacted.”

Sometimes it is necessary to go on the offensive highlighting positives rather than just defending against negatives.

Where does the 75m share figure come from? I read 35m shares to be bought back for cancellation and a maximum 10m shares to be bought back and eventually to handed to employees as compensation. Shares in issue will therefore be concentrated by 5% and only just cancelling out the dilution since IPO of shares issued to pay for the SBC.
A good move all the same but is it enough of a response?

JC - yes you are right on FCF margins for companies on who get costomers to pay upfront and sometimes years in advance. This creates a situation where the change in working capital is negative boosting the FCF figures as long as the company keeps growing, but is a serious problem if growth goes negative. Amazon has used this to great advantage and now the contribution of negative working capital is in the multiple billions leading to a fantastic FCF.

Given the SP turmoil, I took another look at the FY22 accounts in an attempt to answer the question: “what sort of growth rate and free cash flow margin is needed in the next 10 years to justify a SP of 250p?”

Reported Revenue FY 22 was $415m having grown by 45% in the year, but with an expectation that it will slow to ca 30% FY23.
Free cash Flow (FCF) was reported to be $99m but this includes the Share Based Compensation (SBC) cost of $45.7m which was paid for by diluting the shares in issue, so it shouldn’t be part of the FCF for evaluation purposes. The reported FCF also includes a contribution of $65.6m in changes to then deferred revenue for which the delivery service is still to be provided. So at least the Cost of Sales (COS) should be subtracted in my view, and then tax of 25% paid on the balance as EBIT is already positive. This leaves a FCF of $32.1m, or a FCF margin on revenue of 7.7%.

So if we make some assumptions regarding the future revenue and FCF margin growth over a 10yr period and assume a value for DT at the end of that period, and discount those figures at say 10% we can get an idea of what growth rates and FCF margins would be needed to justify a SP of 250p. The 10% discount rate is the sort of yield I would want to get on my investment.

My assumed projections are:
Revenue growth rate in years one to ten from the $415m current revenue: 30:25:20:15:10:5:5:5:5:5% and then 2% thereafter (an assumed GDP growth rate) to perpetuity to value the company after the 10 year evaluation period (one of the standard approaches to do this),
FCF margin on revenue years one to ten: 8.5:9.0:9.5:10.0:10.5:11.0:11.5:12.0:12.5:13.0% and then 13%: thereafter to perpetuity.
The sum of the discounted values comes to $1774m. To this enterprise value I added the $390m cash on the balance sheet to give an equity or intrinsic value of $2164m (£1803m). Per share this is 250p. At an 8% discount rate this would be 320p and at a 12% rate it would be 207p.

If DT cannot exceed the above assumed growth rates and FCF margins by a considerable extent I would have got my assessment of the company horribly wrong; so I remain a holder for now.
I just hope the accusations of fraud made today are not systematic – if they are my faith in the accountancy world would take another beating.

If anyone is interested in DCF analysis there are some excellent videos out there that take you through the process step-by-step in a very illustrative way. It is the approach used by analysts.

MaryBr raises an interesting matter that has been on my mind regarding the technology of DT.

To use an older military analogy of the defence of a castle, my understanding that competitor technologies mostly strengthen the castle walls to prevent breaches while DT’s technology analyses what is going on inside the castle walls to ascertain whether any breach has occurred - and then to take remedial action immediately and automatically on detection.

It would therefore seem to me that DT’s technology is much more intrusive on an organisation’s IT infrastructure and would require a much more persuasive effort on the part of DT, and take longer, to demonstrate the capability and implement . Could this be a weakness in their approach, I wonder, at the present difficult time, that puts some potential customer’s off? So when times are hard, and when there are huge pressures on organisations as there are now, they would rather take an easier and less intrusive option albeit, and perhaps, not as good.

Just a thought, and perhaps I have described DT’s technology too simplistically.

I always take shorting activity seriously asking myself always “what do they know that I don’t?”.

Quintessential seems to focus on fraudulent activity, but, apart from a mistake in reporting revenues in the correct period I have seen no sign of this. But if well hidden we wouldn’t. And some of the tell tale signs like not generating sufficient cash are just not plain to see - the contrary in fact.

Or perhaps they see something wrong with the business model, but apart from what I consider to be poor practice in making shareholders pay for SBC costs and excluding these costs in parallel accounts, and changing some compensation rules after the event, , I don’t see anything fundamentally wrong. The market for cybersecurity is still there and seemingly they have a novel product.

Or perhaps it is that their competitors are out competing them and that they are not demonstrating that they have long term competitive advantage. This is indeed a niggling concern but it is still early days.

Or are Quintessential just using their “name” to force prices down to make a buck or two?

Who knows at present? Whichever, to neglect these signals out of hand like some do on this bb is not the approach I would want to take. I remain even more vigilant as more and more questions are being brought to the front. I still hold for now, but my patience is being tested.

As I, and others , have alluded to in the past, the fall of the SP is not specific to DT and the SP of all the cybersecurity companies have been hammered to a similar extent. Even Fortinet, a much more established company, has not been immune.

DT is still growing, but, in common with others, not as fast as before, and has plenty of cash., partly because we, the owners, have been paying for their share based compensation by dilution of the shares. But it is yet to show signs of outperforming the opposition.

What I was hoping when I initially invested at IPO (or close to IPO)) was that DT’s technology was superior to that of the opposition, and that this would be recognised by the customers and the market. Unfortunately there is no sign yet that this is the case as DT is not outperforming the opposition on revenue growth. Holding its own, perhaps, but not outperforming.

Unfortunately the best technology does not always win. Betamax, Sony’s video tape, was the best in the market by far, bur VHS took them to the cleaners in the 80s because they had a superior marketing strategy.

Come on DT, you can do it - but will you is the lingering question.

Oldgold - good that you mention Adam Seessel. I havn’t read his book but have seen him interviewed and he explains concepts well in my opinion. Very much in the Buffett school of thought but ties it all together nicely and with an updated slant. Focus on the business not the SP, ensure it can have long term competitive advantage and indeed “Follow the Money”.