Micro Focus rockets on HPE surprise

It's taken some time for the market to digest Micro Focus's purchase of Hewlett Packard Enterprise's (HPE) software business. In fact, many analysts still appear to struggle getting to grips with HPE's figures, principally volatility of licence revenues and execution unknowns relating to the $8.8 million (£6.75 million) deal, which completed on 1 September.

Shares in Micro Focus, now one of the world's largest pure play software companies, have been weak ever since a May trading update suggested HPE's second-quarter revenue would be down by 10% - it was actually 11%. Worse, at June's Q2 results, we heard that licence revenue sank 29%. In the two months to July, its shares fell by a quarter to a July nadir of 1,993p.

Barclays' predicted late July similarly poor third-quarter results. Best hope was for a "material improvement" in licence revenues, claiming "anything better than -15% would arguably be an OK result". "If licences were to be better than 10% it should be seen as a positive result."

Actual results, published Wednesday, showed reported revenue down 2% on an organic basis year-on-year, but licence "surprisingly strong" at plus-5%. Margin was strong, too, improving 710 basis point to 24.9%. It's "a strong result", say Barclays analysts, "and could suggest that the prior quarter was impacted by some slippage".

No surprise, then, that Micro Focus is the best performer on the FTSE All-Share, up over 10% at one stage to a 10-week high.

HPE did caution that one quarter does not make a trend, though, "and this result should be seen in the context of balancing the weak last quarter". It expects a decline in licence revenues of between 4% and 12% in the fourth quarter versus a tough comparison in 2016.

In fairness, Barclays has been calling Micro Focus up to £26 for a while, and re-iterates its target price. Shares are currently trading at 10.5 times forward earnings on Barclays' pro-forma estimates.

Kudos, too, to Ryan Paterson, research analyst at Thesis Asset Management, who highlighted Micro Focus as an undervalued stock three weeks ago when trading at around 2,140p. That's a 12% profit in the bag!

He told us that the HPE deal makes complete "strategic sense" and he expects Micro Focus to continue to do what it does best, which is "drive operational efficiencies and relentlessly focus on delivering sustainably high free cash flows".

Micro Focus chairman Kevin Loosemore has profited, too. We noted in July he'd backed his chief executive Chris Hsu by shelling out £1 million on 49,000 shares at 2,170p. At one point Wednesday, he was sitting on a paper profit of over £130,000.

One sour note was continued decline at the professional services division, where revenues fell 22% in Q3. Barclays expects Micro Focus to reduce this exposure, though, as the firm aims to put "more emphasis on higher margin product". It's "a good thing and profit positive".

Guidance for the full-year to October 2017 should see HPE's overall revenue come in between $2.89 billion and $2.96 billion, implying a full-year decline of 7-9%.

Still, only two months of this will be included in Micro Focus's results for the six months ending 31 October 2017, due in December.

Micro Focus hosts a capital markets day for analysts Thursday, which it says will be focused on a deep-dive on the product offerings rather than the integration strategy.

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