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== Valuation == JP Morgan initiates coverage on Darktrace with a Dec-23 price target of 400p. JP Morgan's price target is based on 5.5x ’23E EV/sales (calendarized), ~35% discount to the peer group median (comprising a targeted list of product-led threat detection and response and cyber exposure management/user behavior analytics vendors). Darktrace is likely to report healthy near-term momentum – a function of strong demand for AI-led threat detection and response solutions, brand awareness (driven by its high marketing spend), investments in adding salesforce capacity and roll-out of the new ‘Prevent’ product suite. However, the stickiness of Darktrace’s customer base may be challenged by commoditization of offerings targeting similar security use-cases, low switching costs and as enterprise awareness of competing vendor offerings increases. This could eventually translate to higher customer churn, in JP Morgan's view. With ARR growth tied to new customer acquisition, JP Morgan believes that higher customer acquisition costs and lower customer retention are likely to challenge the company’s ability to deliver profitable growth. This is likely to reflect in Darktrace’s valuation compared to its peer group, in JP Morgan's view. Rather than looking at a blanket list of all listed cybersecurity companies, JP Morgan includes a targeted list of product-led detection and response, threat/user-behavior analytics and cyber exposure/vulnerability management vendors as part of Darktrace’s peer group. JP Morgan excludes from JP Morgan's peer group services-led companies such as Mandiant and SecureWorks, network equipment companies such as Arista and Cisco and managed security service providers (see Table 3 for details). JP Morgan takes the following points into consideration while benchmarking Darktrace’s multiple vs. its peer group: * Darktrace currently leads the network detection and response (NDR) market; however, this segment is characterized by relatively low barriers to entry and high competition. Providers of network security, Endpoint Detection and Response (EDR) and SIEM/SOAR systems are entering the NDR market, as part of their eXtended Detection and Response (XDR) strategy – this will further increase the competitive intensity for Darktrace, in JP Morgan's view (note that Darktrace does not have a strong standalone EDR, SIEM or network security offering and works as a complement to these point security tools). In addition, there is potential risk from public cloud vendors such as Microsoft, Google and Amazon making a big push in the areas of cloud traffic monitoring and email security, in JP Morgan's view. Darktrace has seen good early success with its products, but with growing enterprise awareness of different vendors addressing similar use-cases and low customer stickiness, JP Morgan believes that customer acquisition and retention is likely to get tougher for Darktrace, going forward. * A significant portion of Darktrace’s total addressable market opportunity depends on the company’s ability to grow its ARR independent of new customer acquisition. Despite reporting higher platform adoption stats in the last couple of years, the company has not reported any meaningful uptick in average contract ARR (Dec-21 level approx. flat vs. Jun-19). This is partly explained by Darktrace’s focus on acquiring new customers, SMB/mid-market skew in customer base (and relatively higher churn as a result) and impact from new product launches. It remains to be seen whether Darktrace can decouple ARR growth from new customer acquisition, which will only get tougher with high competition and growing enterprise awareness of competing vendors. For sustainable profitable growth longer term, high customer retention will be key, in JP Morgan's view. * Early success in the AI-driven threat detection and response market and investment in marketing has helped Darktrace scale rapidly, delivering above- average growth (52% 2018-21 revenue CAGR); however, the eventual success will be determined based on how the company balances growth and profitability. Assessing this development through the lens of ‘Rule of 40’ (revenue growth + FCF margin) is a good indicator of the progress the company is making to sustain profitable growth. JP Morgan expects the sum of revenue growth and FCF margin to dip and remain below 40% over the next couple of years. Eventually, this is likely to reflect in Darktrace’s valuation compared to other cybersecurity peers that consistently beat this 40% benchmark. Darktrace made its market debut in Apr-21 at 9x 1-yr forward EV/sales (calendarized). The stock has de-rated since then and currently trades at 6x ’23E EV/sales (calendarized) compared to the peer group median at 9x. JP Morgan believes the multiple de-rating reflects increased awareness of the highly competitive nature of the market Darktrace operates in. In the near term, JP Morgan expects demand for AI-led detection and response solutions to remain high – this coupled with Darktrace’s brand awareness (a function of its high marketing spend), investment in additional salesforce hiring and the roll-out of the new ‘Prevent’ product offering will likely translate to healthy new customer acquisition and thus ARR growth. However, the stickiness of Darktrace’s customer base is likely to be challenged by commoditization of offerings targeting similar security use-cases and as enterprise awareness of competing vendor offerings increases. This could eventually translate to higher customer churn, in JP Morgan's view. With ARR growth tied to new customer acquisition, JP Morgan believes that higher customer acquisition costs and lower customer retention are likely to challenge the company’s ability to deliver profitable growth. This will likely reflect in Darktrace’s valuation compared to its peer group. JP Morgan acknowledges that this may take some time to play out, especially in the current environment, where demand for proactive security solutions is likely to remain high. JP Morgan does not see Darktrace’s discount to its peer group narrowing unless the company is able to demonstrate a sustained decoupling between ARR growth and new customer acquisition (which will be a function of a sustained increase in average contract ARR per customer, lower churn and continued improvement in net ARR retention rate). Accordingly, JP Morgan initiates coverage on the stock with a set JP Morgan's Dec-23 price target at 400p, based on 5.5x ’23E EV/sales (calendarized), ~35% discount to its peer group median (vs. YTD average of ~25% discount). JP Morgan's choice of a higher discount vs. peer median reflects JP Morgan's view of increased competition and limited visibility on the path to achieve sustained profitable growth. On a relative basis, JP Morgan believes that there are better opportunities elsewhere to play the proactive cybersecurity theme – such as CrowdStrike (leading disruptor in endpoint security), CyberArk (Privileged Access Management leader), Tenable (leader in vulnerability management) and Varonis (user and entity behaviour analytics). '''Figure 1: 1-yr forward EV/sales (calendarized): Darktrace vs. peer group median: 2017-present<ref name=":1">Source: Bloomberg Finance L.P.</ref>'''[[File:20220407 JP Morgan DARK-LN Darktrace- Path to sustainable profitable growth unclear Page 10 Image 0002.png]] '''Figure 2: 1-yr forward EV/sales (calendarized): Darktrace vs. peer group median: Jul-21-present<ref name=":1" />'''[[File:20220407 JP Morgan DARK-LN Darktrace- Path to sustainable profitable growth unclear Page 10 Image 0003.png]] {| class="wikitable" |+Table 3: Darktrace: Peer valuation comparison<ref>Source: Bloomberg Finance L.P., J.P. Morgan; calendarized data presented; priced intraday as of 4th April.</ref> ! !Price !Mkt. cap. !EV !EV/sales ! ! colspan="2" |FCF margin (%) ! colspan="3" |Revenue growth (%) Rule of 40* |- ! !LC !$, m !$, m !2022E !2023E !2022E !2023E !2022E ! colspan="2" |2023E |- |Darktrace |451.0 |4,133.6 |3,805.1 |7.9 |6.1 |11% |13% |38% |30% |43% |- |Check Point Software |140.9 |18,716.3 |14,932.9 |6.5 |6.2 |51% |51% |6% |5% |56% |- |CrowdStrike |228.3 |52,675.1 |51,465.0 |24.6 |18.1 |29% |31% |50% |36% |67% |- |Fortinet |344.7 |55,437.9 |53,958.1 |12.6 |10.4 |35% |38% |28% |20% |58% |- |Palo Alto Networks |625.9 |61,645.5 |62,261.5 |10.5 |8.6 |34% |35% |25% |22% |57% |- |Qualys |144.3 |5,631.4 |5,274.6 |10.9 |9.3 |36% |34% |18% |17% |51% |- |Rapid7 |114.2 |6,631.4 |7,320.5 |10.7 |8.7 |6% |10% |28% |22% |32% |- |SentinelOne |41.3 |11,018.1 |9,377.5 |26.4 |16.2 |<nowiki>-42%</nowiki> |<nowiki>-6%</nowiki> |82% |62% |57% |- |Splunk |147.2 |23,660.7 |25,353.0 |7.9 |6.4 |11% |14% |23% |23% |37% |- |Tenable |59.8 |6,566.0 |6,475.8 |9.7 |8.1 |15% |17% |23% |20% |37% |- |Varonis |49.4 |5,306.9 |4,803.6 |9.8 |8.1 |3% |6% |25% |22% |28% |- |Median | | | |10.6 |8.7 |22% |24% |25% |22% |54% |} {| class="wikitable" |+Table 4: Darktrace: Fair value per share (GBp) - sensitivity to discount vs. peer group median<ref>Source: J.P. Morgan.</ref> |Discount to peer median (%) |0% |5% |10% |15% |20% |25% |30% |35% |40% |- |Fair value per share (GBp) |605 |576 |548 |519 |490 |462 |433 |404 |375 |} '''Figure 3: Valuation comparison: Darktrace vs. peer group: 2023 revenue growth + FCF margin vs. 2023 EV/sales (calendarized)'''<ref>Source: Bloomberg Finance L.P.; priced intraday as of 4th April.</ref>[[File:20220407 JP Morgan DARK-LN Darktrace- Path to sustainable profitable growth unclear Page 11 Image 0002.png]]
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