Another Milestone In Micro Focus’ History
Summary The acquisition of @Hewlett PE’ software business make sense in a matured market. There is still time to buy MPGP at a fair price. Executive Chairman, Kevin Loosemore, has built a reputation for buying unloved assets and extracting value from them, quadrupling market value over 5 years. The Deal On Sept. 1, HPE completed the spin-off and merger of its software business with @MicroFocus International (MFGP). The organization of the merge was in form of a Reverse Morris Trust, free of taxes. Seattle @SpinCo Inc. holds the software business of HPE that was spun off and was merged with a wholly owned subsidiary of Micro Focus. Prior to the merger, Seattle SpinCo made a cash payment of US$2.5 billion. HPE stockholders received 0.13732611 American Depositary Shares of Micro Focus for each share of HPE common stock. After the merger, HPE shareholders owned 50.1% of Micro Focus’s ordinary shares. The logic behind this acquisition is consolidation in an infrastructure software market that has matured. Both Micro Focus and HPE Software’s businesses operate at a global scale and hold a portfolio that targets specific software needs of large enterprise customers. Specifically, it would be an opportunity to create a greater scale of product portfolio, add substantial recurring revenue and accelerate operational effectiveness. Pro Forma Analysis To assess the status of the enlarged company, I am going to compute some ratios related to financial strength, profitability and management effectiveness and compare them with the old Micro Focus. ￼ Source: Company prospectus, unaudited pro forma statements As we can see, Micro Focus International benefits most in financial strength when compared to its previous situation. The business software of HP had almost the double of current assets than Micro Focus, and only $515 more in current liabilities. Its margins generally worsened, and the company that was spun off had 1366 basis points less in gross margin, 1169 basis points less in operating margin and 972 basis points less in net profit margin. Furthermore, the pro forma statement notes 61 million $ of the remaining transaction and related costs in connection with the Merger. The last section of the analysis is the most striking. All ratios in management effectiveness decrease to ratios lower than 1%. This is due to the high volume of dollars in net assets of HPE software business and its non-proportional increase in net profits. The main takeaway of these ratios is that the enlarged company is highly increasing its resources, not as much as worsening its actual position in profitability and returns for its shareholders. The enlarged company, in its press release from Sept. 1, 2017, said that Micro Focus would be the seventh largest pure-play enterprise software company in the world, measured by annual publicly reported revenue. It makes sense to find these other six companies and rank them to estimate a valuation for MFGP. ￼ Advertisement ￼ Source: CA Inc., Cisco Systems Inc., Citrix Systems, Inc., IBM Corp., Microsoft Corp, Open Text Corp., Oracle Corp. and SAP SE are competitors directly named in the Company’s Prospectus and the rest from other sources. ￼ Source: Self-elaboration ￼ Source: Self-elaboration Although I don’t have the exact list of the company for which it ranks using revenue, I have developed another list quite accurate. From a valuation standpoint, Micro Focus International is situated 8th in revenue and 3rd less expensive ranking by Price to Sales ratio, being the mean 6.54 and Std. Dev 3,96. Taking a look at the histogram and diagram chart, I would say that it does make sense that this ratio could expand more, hopefully via an increase in market price and revenue. Post-acquisition operations to achieve success This acquisition, like Micro Focus’ Attachmate Group and Serena, are part of the Company’s strategy of delivering Total Shareholder Returns in excess of Micro Focus’ risk-adjusted cost of capital, from 15 to 20% per annum. So far, this objective has been exceeded via a combination of increasing earnings per share, financial performance and returning cash. Things to watch: Executive chairman Kevin Loosemore plans to double HPE Software’s Underlying Adjusted EBITDA margin of 20.6 percent to near Micro Focus’s level by April 2021. Although he has a proven record of doubling operating profits over the past four years, there might be three impediments that prevent it from happening. First, the continuing declining of licensing and consulting sales at the HPE unit. It seems that HPE’s management hasn’t been able to stop this decline and will continue for some time until Mr. Loosemore takes control. Second, the Autonomy segment. It was previously acquired by HP and management had to write off almost the entire value of the UK company, issuing legal proceeding against former Autonomy manager due to allegations of financial impropriety. There is a risk that Mr. Loosemore had underestimated the holes of this segment. Third, and final, are the opposing approaches hold by the new CEO, Mr. Hsu, and Mr. Loosemore. The former wants to improve margin dollars from revenue growth, while the second wants to look after its existing customers. At the current value, it’s a buy. If these three threats are treated with discipline over time, Micro Focus will secure its dominance in the market. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.