Darktrace – Dirty traces

IPO now may not be such a good idea.

• The spectre of Autonomy hangs over the Darktrace IPO partly due to its relationship with ex-Autonomy executives but also because it has made a mess of its communications.
• The last thing the LSE needs is another failed IPO as many leading prospective UK technology companies are already questioning the wisdom of a London listing.
• Consequently, I think that waiting until the Autonomy overhang is dealt with might be a good move as it is not as if the company needs to raise money right now.
• Darktrace is a cybersecurity company that uses pattern recognition (AI) to detect cyber threats which to date has been very successful but is not without risk.
• On its website, the company states that it can mimic human intuition through its ability to automate 90% of the task of threat detection and mitigation.
• While this sounds great, the reality is that it is the 10% where all the difference is made and it is new, never before seen threats that always cause the most damage.
• AI by its very nature is backwards-looking (as it learns from the past to predict the future) and so when human intuition comes up with a new way of breaching cyber defences, this system is unlikely to detect it without human help.
• Darktrace effectively admits this in the risk warnings in its listing documents (see here (pages 5 and 6))
• That does not mean that Darktrace is not a good company as its 38% YoY growth is a testament that the solution that it offers is very valuable to its clients.
• The big problem with this IPO is that Mike Lynch and Sushovan Hussain (ex CEO and CFO) of autonomy have been involved with the company and are still shareholders.
• Sushovan Hussain has been convicted on 14 counts of wire fraud in the USA and his appeal in August last year failed on all counts.
• Mike Lynch is also currently fighting extradition to the US to face similar charges while at the same time fighting a civil suit brought by HP related to its acquisition of Autonomy in 2011 for $10bn.
• 14 months after the acquisition, HP wrote down over 80% of the goodwill from this acquisition and claimed that had been the victim of fraud.
• I have long contended (see here) and still contend today that the main reason for this write-down was HP’s gross incompetence in the conduct of the due diligence related to the acquisition.
• This is because it was well known in the public markets (where I was working at the time) that Autonomy played fast and loose with the accounting rules which is why we used to spend hours matching up revenues to cash flow at the end of every year (see here).
• HP decided to ignore these warning signs and pressed ahead with the acquisition, a mistake for which it paid dearly.
• There is also considerable doubt with regard to the degree to which the 14 counts of wire fraud impacted the size of the write-down raising the possibility that HP has used these convictions to hide the degree of its incompetence when it came to the due diligence.
• This is further evidenced by the fact that this write-down was followed by a shake-up of both management and HP’s board.
• This reputational problem for Darktrace has been compounded by the company contradicting itself with regards to its relationship with Mike Lynch.
• In 2018 it stated that he had left the advisory council in 2017 but then made the mistake of stating that he remained on the council until March 2021 in its listing documents.
• This is clearly a genuine error, but it leaves a bad taste in the mouth of any prospective investor.
• If the company made such a simple error on such a sensitive issue, one immediately begins to wonder what other errors has the company made in the listing documents.
• This is all anyone is talking about when it comes to this IPO and the merits of the company, which are many, are being largely ignored.
• This is why I think that the company, the investors and the LSE will be better off putting this whole thing on ice until the dust has settled with regards to Mike Lynch’s legal fights and his relationship with the company.
• Another strike against the LSE could irretrievably damage its already tattered reputation as a good place to list a technology company.