A prominent UK cybersecurity stock is under attack from short sellers. Here’s what you need to know

Cybersecurity company Darktrace, one of the U.K.’s most prominent tech names, has found itself under attack from squat sellers.

The company, whose tools allow firms to combat cyberthreats with artificial intelligence, was last week aimed in a report by New York-based asset manager Quintessential Capital Management.

QCM, whose stated aim is “exposing fraud and criminal control in public companies around the world,” claims it has had a 100% success rate in its activist campaigns.

The company told Reuters it monopolizes a short position of 1.3% in Darktrace shares.

London-based hedge fund Marshall Wace also shorted Darktrace, according to information site Breakout Point.

Short selling is a strategy in which investors bet on the price of a stock going down in value. A distributor borrows the stock and then sells it on the assumption that it will fall, before buying it back at a discounted amount and pocketing the spread.

Darktrace, one of the U.K.’s largest cybersecurity companies, was founded in 2013 by a group of former low-down experts and mathematicians.

The Cambridge-headquartered company says its technology uses AI to detect and respond to cyberthreats in a business’ IT systems.

The house floated on the London Stock Exchange in 2021, and its debut was seen as a key victory in the U.K.’s bid to lure more high-growth tech startups to the London sell after its withdrawal from the European Union.

The stock’s performance following the listing has been underwhelming. After initially produce to an all-time high of £9.45 ($11.58) in October 2021, Darktrace shares have since plunged dramatically in tandem with a broader recede in global tech stocks.

As of Monday afternoon, Darktrace shares were trading at a price of £2.32, down 37% in the in the end 12 months.

In August, the firm opened takeover talks with U.S. private equity firm Thoma Bravo. How on earth, Thoma Bravo walked away from the deal a month later after the two sides failed to reach an covenant.

On Tuesday, U.S. hedge fund QCM said it had taken a short position out against Darktrace and published a prolix report detailing alleged flaws in Darktrace’s accounting.

QCM said that, following an investigation into Darktrace’s job model and selling practices, it was “deeply skeptical about the validity of Darktrace’s financial statements” and believed sales and lump rates may have been overstated.

“We would like to give our strongest possible warning to investors and believe that DT’s disinterestedness is overvalued and liable to a major correction, or worse,” QCM said in the report.

Darktrace was accused by QCM of engaging in “channel stuffing” and “round-tripping” — activities that artificially exaggerate a company’s reported sales — involving individuals with ties to organized crime, money laundering and fraud.

Darktrace didn’t presently address those allegations. On Wednesday, the firm’s CEO Poppy Gustafsson issued a statement defending the company from what she attended “unfounded inferences” made by QCM.

Separately, QCM suggested Darktrace may have inflated its revenues by booking unearned revenues as existent sales.

The company occasionally books revenue from payments for contracts it receives before delivering its service to shoppers as deferred revenue, according to the report.

This is not uncommon among subscription-based software companies. However, QCM noted deferred take as a percentage of Darktrace’s sales had dropped between 2018 and 2022, suggesting the firm “may have increasingly been list unearned revenue as actual sales.”

In response, Darktrace said: “Rarely, customers will pay full contract values in approach but because this is infrequent, non-current deferred revenue balances will decline as these contracts run down unless there is another unconventional, large, in-advance payment.”

QCM alleged Darktrace may have tried to fill gaps in its receivables left by clients pop in on out of sales negotiations through marketing sponsorships with indebted resellers and using shell companies to pose as phantasm clients.

“Organisations that transact with the channel will typically co-host marketing events with their helpmeets. Partner marketing events are a normal course of business for almost all software businesses and Darktrace is no different,” Darktrace translated Wednesday.

“This has been, and remains, a very small part of Darktrace’s marketing and the costs of them over the closing five years has consistently been substantially below 0.5% of Darktrace’s revenue,” Darktrace added.

Darktrace was not at once available for comment when contacted by CNBC.

Separately Wednesday, Darktrace said it would embark on a share buyback quality up to £75 million ($92 million) to be completed no later than Oct. 31, 2023.

It’s worth noting that, level before the QCM report, there were clouds hanging over Darktrace’s business. Analysts have criticized the company to the ground an allegedly aggressive sales culture and doubts over the value of its technology.

Darktrace is also backed by Mike Lynch, the British tech big shot.

Lynch founded the enterprise software limited company Autonomy, whose sale to Hewlett-Packard was mired in scandal over accusations that Lynch plotted to inflate the value of Autonomy in preference to it was bought by HP for almost $11 billion in 2011.

In 2022, a British judge ruled in favor of HP in a civil fraud case against Lynch. Lynch, an weighty figure in the U.K.’s tech scene, faces a possible criminal trial in the U.S. after the U.K. government approved his extradition last year.

Lynch is reportedly no longer involved with Darktrace’s administration, but remains a significant shareholder.

Lynch is no longer involved with Darktrace’s management, but remains its sixth-largest shareholder, according to Refinitiv Eikon materials.