Micro Focus in Buyout Talks Suggesting Software Steal: Real M&A

May 25, 2011, 11:16 AM EDT By Cornelius Rahn and Tara Lachapelle

May 25 (Bloomberg) -- Micro Focus International Plc is luring private-equity buyers with the cheapest valuation for a non-U.S. business software provider even as the 50-year-old computer code it was founded to translate becomes obsolete.

The Newbury, England-based seller of software to update systems running programming languages such as Cobol is trading at 12 times earnings, the lowest for an enterprise software company outside America with a market value of more than $1 billion, according to data compiled by Bloomberg. Potential buyers would gain a company that’s also cheaper relative to its free cash flow than 92 percent of global rivals, the data show.

While earnings and revenue growth are stalling after three chief executives left in five years, Micro Focus still makes almost twice as much profit per dollar of sales as the industry average and has only $73 million in debt. Matrix Corporate Capital LLP’s estimated price tag of $1.5 billion for Micro Focus would make it the cheapest business software takeover relative to earnings, data compiled by Bloomberg show. Bain Capital LLC and Advent International Corp. have made approaches, the company said last week.

“It’s a steal,” said George O’Connor, an analyst at Panmure Gordon & Co. in London who recommends buying the shares. “Considering a premium on the purchase price it would still look cheap. It’s a very well-established company with many customers and really nice products.”

Laura Stiff, a spokeswoman for Micro Focus, and Kelly Rapoport with Advent declined to comment. Alex Stanton, a spokesman for Bain, didn’t respond to a call and e-mail requesting comment.

Preliminary Interest

Micro Focus said on May 20 it had received and will explore “a number of preliminary, non-binding approaches,” including from Boston-based Bain and Advent. The company said there’s no certainty regarding the submission of an offer or the price.

A takeover of Micro Focus at 455 pence ($7.36) a share, as Matrix analyst Rajeev Bahl in London estimated last week, would value the company including net debt at 7.8 times earnings before interest, taxes, depreciation and amortization in the last 12 months. That would be the lowest multiple ever paid in an enterprise software deal of more than $500 million, data compiled by Bloomberg show.

Those terms would represent a 23 percent premium to the stock’s average closing price over the past 20 days, compared with the 38 percent average premium paid historically for deals in the industry, the data show.

Early Computer Code

Micro Focus, which counts Tesco Plc and HSBC Holdings Plc as customers, makes software that allows companies utilizing old programs on leased, power-hungry mainframes to use them on newer computers and devices. Software with programming languages such as Cobol -- the early computer code used to control automatic teller machines, traffic lights and mobile phones -- can then be run more cheaply.

The company, founded in 1976, acquired Austin, Texas-based Borland Software Corp. in 2009 to expand in the software testing business and reduce its reliance on legacy platforms.

“The jury is out on whether there is still growth in the core Cobol business, but in testing, the market is growing fast,” said Alex Jarvis, a technology analyst at Peel Hunt LLP in London with a “hold” recommendation on Micro Focus. By cutting costs, an acquirer could justify a bid of more than 5 pounds a share, Jarvis said.

Free Cash Flow

The software maker trades at 8.91 times free cash flow, less than every company in the industry except for Tokyo-based Nomura Research Institute Ltd. at 8.06 times and CA Inc. of Islandia, New York, at 8.85 times, data compiled by Bloomberg show. Meanwhile, Micro Focus made 23 cents per dollar of revenue in the last 12 months, almost double the industry’s average profit margin of 12.5 percent, the data show.

Vijay Anand, an analyst at Espirito Santo Investment Bank, expects a buyout firm to pay as much as 450 pence a share and boost revenue growth to as high as 10 percent annually.

“The key attractions are the recurring revenue stream, the solid customer base and strong cash flows due to high Ebitda margins,” said London-based Anand. “The issues the company has are fairly fixable. It mostly requires consistency of leadership and better focus on sales execution.”

The Cobol business may lure strategic buyers such as International Business Machines Corp., Hewlett-Packard Co. or Oracle Corp., while professional services and testing may be attractive to IBM or Mumbai-based Tata Consultancy Services Ltd., said Panmure’s O’Connor.

Management Turnover

Ed Barbini, a spokesman for Armonk, New York-based IBM, said the company has a policy of not commenting on rumors or speculation. Deborah Hellinger, a spokeswoman for Oracle of Redwood City, California, declined to comment. HP doesn’t comment on rumor or speculation, the Palo Alto, California-based company said in an e-mail. Mike McCabe, a spokesman for Tata in North America, also declined to comment.

Micro Focus has been plagued by management turnover. Nigel Clifford left the post of CEO on April 15 after less than a year, and just two months after the company said sales and earnings were unlikely to recover by the end of the fiscal year in April.

The shares fell 0.2 percent to 371 pence at 3:51 p.m. in London. Before today, they had slumped 21 percent over 12 months as the FTSE All-Share Software & Computer Service Index climbed 21 percent. The company’s market value had dropped to about 734.8 million pounds ($1.2 billion) as of yesterday.

‘Pedestrian’ Revenue Growth

A bid is not likely to emerge because of the company’s “pedestrian” revenue growth, limited ability to boost margins and the improbability of another public offering as Cobol continues to age, Jonathan Imlah, an analyst with Collins Stewart Plc in London, said in a May 23 report. The shares may fall to 325 pence if a bid doesn’t emerge, a 13 percent drop from yesterday’s closing price.

About 51 percent of $432.6 million in revenue in the year ended April 2010 came from maintenance with 42 percent generated by license fees, data compiled by Bloomberg show. Revenue is projected to remain flat through 2012, according to the average of analysts’ estimates compiled by Bloomberg.

“Half of the revenues are maintenance and that makes them quite cash rich, which is why private-equity firms would be looking at it,” Peel Hunt’s Jarvis said. “The core business has had quite sparse growth.”

Micro Focus, which traded at as much as 21 times its earnings in the past year, is now valued at 12 times, the lowest for an enterprise software company greater than $1 billion outside the U.S., data compiled by Bloomberg show.

“It’s a very cheap share, hence the opportunity,” said Panmure’s O’Connor.

Overall, there have been 9,870 deals announced globally this year, totaling $964.3 billion, a 22 percent increase from the $792.8 billion in the same period in 2010, according to data compiled by Bloomberg.

--With assistance from Michael Tsang in New York. Editors: Sarah Rabil, Daniel Hauck.

To contact the reporters on this story: Cornelius Rahn in Frankfurt at crahn2@bloomberg.net; Tara Lachapelle in New York at tlachapelle@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net; Kenneth Wong at kwong11@bloomberg.net.

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