Mega-deal makes Micro Focus new tech star

UK tech firm Micro Focus, which just replaced fellow techie ARM Holdings in the FTSE 100 index, didn't wait long to show the market it means business. Buying Hewlett Packard Enterprises' software business (HPES), the assets bought from Autonomy five years ago, for $8.8 billion (£6.6 billion) will make it one of Britain's biggest tech businesses and one of the largest pure-play infrastructure software companies in the world.

The best-performing FTSE All-Share stock of the last decade, and up 22% Thursday, Micro Focus is on a roll.

Hewlett Packard's (HP) 50,000 customers around the world will give Micro Focus much-needed scale and provide software for IT operations management, application delivery, enterprise security, information management & governance, and Big Data analytics.

And this deal is just another example of Micro Focus's excellently executed acquisition strategy, which has transformed the small Newbury-based firm into a £5.2 billion giant that doubled sales in 2015.

With combined revenue of $4.5 billion, cash profit of $1.4 billion is expected to surge by over a quarter to $1.8 billion by the turn of the decade, reckons Numis Securities, and earnings per share should jump 26%. But even they admit these forecasts are conservative.

What should really get investors' taste buds tingling, however, is the margin opportunity. HP currently generates 23% cash profit margin, but Micro Focus's equivalent business does 46%, a level which it reckons the HP business can achieve under its wing within three years of completion.

How? "This is what Micro Focus does," HP chief Meg Whitman told analysts Thursday.

Sold through a range of licencing models, HPES generated $3.2 billion revenue in the year to 30 April and $658 million of cash profit. Adjusted for costs that won't be transferred, Micro Focus is acquiring $738 million of earnings before interest, tax, depreciation and amortisation.

Reverse takeover

After completion, shareholders of HPES will own 50.1% of the combined group through the issue of American Depository Shares, in an equity and debt transaction that constitutes a reverse takeover.

HPES will first pay $2.5 billion to its HPE parent through a new debt facility before the deal's completion, after which Micro Focus snaps it up and issues 238 million new shares worth around $6.3 billion. Together with the $2.5 billion of debt funding, the deal is valued at $8.8 billion, 11.4 times adjusted cash profit.

Micro Focus has rocketed nearly 2,000% since 2006, more than any other currently listed companyMicro Focus shareholders could also be in line for a $400 million return of value before the deal closes. Allowing the pre-completion dividend payment and return of value, Micro Focus has set up a $5.5 billion debt facility, which includes a revolving credit facility of $500 million.

Micro Focus could return $400 million to shareholders in 2018, $600 million in 2019 with the cancelling of 23 million shares, and a further $700 million in 2020, cancelling another 23 million shares, says Numis.

There's a lot of work ahead to separate HPE from its parent HP, which explains why the deal is expected to take until the third quarter of 2017 to complete.

Micro Focus has rocketed nearly 2,000% since 2006, more than any other currently listed company, surging just shy of 500% since 2012. Continuing its relentless climb upwards, Thursday's rally saw the shares hit 2,400p.

Micro Focus was promoted to the FTSE 100 last week after ARM Holdings was acquired by Japan's Softbank.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.