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Jen Ross via Wikimedia Commons

Darktrace brings in EY to counter short-seller claims

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UK cybersecurity specialists Darktrace has commissioned an independent review of its finances by EY following criticism of the company’s financial statements from a short-seller.

21st Feb 2023
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In a statement released to the stock market, Darktrace said it had appointed the Big Four auditor to “provide an additional independent third-party review of its key financial processes and controls”.

Commenting on the appointment, Darktrace Chair Gordon Hurst said the board “believes fully in the robustness of Darktrace's financial processes and controls,” with the EY review a sign of this confidence. 

The independent review comes in response to a 70-page critique of the company’s financial statements from activist short-seller Quintessential Capital Management (QCM), issued at the end of January this year.

The report, entitled Autonomy 2.0? The dark side of Darktrace, QCM stated it was “deeply sceptical” about the validity of Darktrace’s financial statements, and believes the cybersecurity firm’s sales margins and growth rates may be overstated.

The accusations are primarily based on the short-seller’s analysis of transactions during the period leading to Darktrace’s stock market floatation in 2021, which QCM states may be “simulated or anticipated sales to phantom end-users through a network of willing resellers”.

Darktrace fired back with a lengthy rebuttal the following day, which refuted QCM’s allegations. CEO and chartered accountant Poppy Gustafsson said the company would “push back in the strongest terms on any suggestions that this is a business that is not being run with the greatest integrity”. Darktrace has also announced a £75m share buyback in a bid to reassure investors.

Formed in 2013, Cambridge-based Darktrace offers a range of AI and machine-learning cybersecurity solutions to more than 8,0000 mainly medium and enterprise-level businesses around the world. 

Darktrace floated on the London Stock Exchange in April 2021, but its stock has fallen in value over the past year, with the most recent drop following the breakdown of acquisition talks with US private equity house Thoma Bravo in September.

 

The Autonomy connection

The title of the QCM report refers to business data analysis tool Autonomy – a name sure to prick up the ears of those with an interest in the UK tech market. 

Darktrace co-founder and shareholder Mike Lynch is currently resisting extradition to the US for his part in what Hewlett-Packard Enterprise (HPE) claims were fraudulent efforts to inflate the market value of Autonomy – where Lynch was CEO. 

HP acquired Autonomy for £7.1bn in 2011 but a year later wrote down 75% of the company’s value citing accounting irregularities which artificially inflated Autonomy's reported revenues, revenue growth and gross margins.

Lynch denies the claims, stating that HP was “trying to make him a scapegoat for their failures”. While Lynch remains an investor in Darktrace, the company has stated has no operational role.

The QCM report accuses Darktrace of adopting similar tactics to Autonomy, highlighting several instances where “at least until 2020, DT [Darktrace] may have sold, not lent, its appliances to end-users while probably keeping the devices on its books as assets”. The report also highlights that the two companies share many of the same leadership team, although it stresses that this alone is not evidence of any wrongdoing.

In its rebuttal to the QCM report, Darktrace stated that in the “vast majority” of contracts, the company does not sell appliances to customers, instead deploying its technology on an appliance that it owns or virtually as a cloud deployment, based on the customer's needs.

“Over 99.5% of Darktrace's revenue is subscription based, namely a single unit of accounting, meaning there are a limited number of customers who buy hardware appliances from Darktrace,” said the statement.

QCM welcomed Darktrace’s decision to initiate the independent review of its finances. A statement posted on the firm’s Twitter account said: “We hope that such review will be of sufficient granularity, scepticism and impartiality to provide insights about the dubious transactions we flagged in our report.

“Detecting any irregularities in Darktrace's independent audit could be a great way for EY to restore its reputation tarnished by events at Wirecard, Bio-on and others,” continued the statement.

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By Hugo Fair
21st Feb 2023 19:48

Interesting - but for a company who say "Quintessential is a New York-based asset management firm aiming for exceptional returns through the application of value investing, shareholder activism and deep due diligence" ... they appear remarkably shy when it comes to providing info about themselves.

https://www.qcmfunds.com/ tells you almost nothing that "deep due diligence" might reveal.

But they obviously enjoy tweaking the tiger's tail. They entertain with 2 for the price of 1 when their 'welcoming' of the review includes the barb directed at EY:
“Detecting any irregularities in Darktrace's independent audit could be a great way for EY to restore its reputation tarnished by events at Wirecard, Bio-on and others.”
Ouch!

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