Is Micro Focus's decade-long winning streak over?

Buying Hewlett Packard Enterprises' (HPE) software business for $8.8 billion (£6.8 billion) was meant to make developer Micro Focus the UK's next tech giant, and keep its share price on a relentless bull run.

It certainly had analysts at Deutsche Bank excited, as the broker initiated coverage on the stock a couple of weeks ago, tipping the shares up to £29.

But investors – and analysts – were given a reality check Tuesday when Micro Focus announced HPE Software's revenues were down 10% year-on-year in the quarter ended 30 April 2017, sending the shares tumbling 13% at the opening bell.

Having made a new record at 2,675p only the previous morning, Micro Focus slipped to 2,292p, a five-week low. However, traders smelled a bargain, and by lunchtime they were down just 5% at £25.

Micro Focus says the decline in revenue at HPE was driven principally by a loss of licence fee sales and a decline in the professional services division. Support and software-as-a-Service (SAAS) were "broadly flat".

Executive chairman Kevin Loosemore described the decline as "disappointing", but "not unusual given the level of change being undertaken". And he's "encouraged by the early progress that HPE Software's management are making on implementing operational efficiencies and the speed of change in the business".

It also confirmed regulatory approval to complete the deal and that it's secured new debt facilities needed to finalise. Expect it to go through by 1 September.

Weakness at HPE is clearly a setback, and full-year sales at Micro are expected to be within the range of previous guidance of flat to down 2%. It's share price has rocketed 1,930% since floating at 130p back in May 2005 and today's dive is its largest one-day decline in six years.

Investors will now be asking themselves whether the shares – the third best-performing FTSE All-Share company over the past decade according to data provider Sharepad – have peaked.

The chart above suggests there's a bottom, at least, with prior resistance at 2,283p now acting as technical support. And Deutsche is optimistic.

Having done the sums, it notes that management is adept at making acquisitions work, among them the significant purchases of Attachmate and Serena Software for $1.2 billion and $540 million respectively.

The former deal tripled Micro Focus's revenues and HPE Software will do something similar, taking forecast sales from $1.4 billion in 2017 to $4.5 billion in 2018. In just three years, the company would have increased revenue tenfold.

Deutsche analyst Steven Goulden reckoned a share price of 2,551p "applies a conservative discount to the proposed synergies from the HP Software deal and forecast a 13% earnings per share (EPS) compound annual growth rate (CAGR) FY17-20, normalising to 6% thereafter, supported by a low-mid single digit dividend yield".

His £29 target price is based on an average of an enterprise value/cash profit-based sum of the parts (SOTP) of 10 times and post-HP synergies full-year 2020 price/earnings (PE) of 16 times versus MSCI Software on 21 times.

In fact, Goulden's 'blue-sky' scenario, predicated on higher multiples, yields a target price of £33. True, that looks a stretch just now, but management has proven ability to generate long-term value and integrate acquisitions. This one, however, will be their biggest challenge yet.

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.