We are going to have to wait an awful long time to discover whether Micro Focus International’s $8.8 billion purchase of Hewlett Packard’s software business is indeed a transformational deal or the overambitious culmination of a long run of successful acquisitions. The deal is not due to close until the third quarter of next year, so the first indications of success or otherwise will not be manifest until 2018.
In the meantime we will just have to make do with the deals Micro Focus has done so far, such as the $540 million purchase of Serena Software in May and other, smaller ones — the company’s belief is that as software products mature and growth slows, they are better aggregated under one roof, where savings can be made.
Micro Focus’s argument is that such deals are automatically accretive to margins, which in the first half to the end of October did indeed grow from 44.5 per cent to 46.8 per cent.
Theoretically, revenues of those legacy products should be in decline, countered by new additions. In fact, Micro Focus actually beat its own forecasts for the full year. The numbers are confused by Serena and the others, but on a pro forma, constant currency basis revenues were up by 1.2 per cent, against a management forecast of flat to down 2 per cent for the year. Not too much should be read into this outperformance, and Micro Focus reckons that earlier figure will be the outcome for the year. Those enhanced margins sent earnings ahead, though, by 7.8 per cent to $332.5 million.
The dividend is up an eye-catching 75.5 per cent, though, in line with the policy of having it twice covered by earnings. Shareholders will also get, under the complicated terms of the Hewlett Packard deal, another $400 million back when it completes.
The argument for the deal is that the older assets being bought, about 80 per cent of revenues, see margins of about 21 per cent and this should go up to the company’s usual level. This would be a staggering return, while it is hard to argue with the progress for the shares already, adding another 89p to £22.19 yesterday. They sell on 16.6 times earnings. This is a tricky one for investors. The nervous should take profits. Those prepared to bet on the deal working should hold on.
My advice Buy
Why There are any number of risks in the Hewlett Packard deal but if it succeeds the rewards are enormous and would justify a brave stance
Burford Capital
There cannot be too many markets where the top player can agree to merge with the second biggest without a peep from any competition regulator. Burford Capital is a £1 billion company that is among the lowest profile of any of that size. It invests in litigation finance for those thinking of bringing legal actions in return for a fee and a cut of any resulting proceeds.
It is buying Chicago-based Gerchen Keller Capital for $160 million and another $15 million deferred according to future performance. The two clearly know each other and the deal will complete shortly. There are a number of advantages to the deal. Burford is acquiring a trained team of lawyers and their contacts.
Gerchen Keller is owned mainly by private equity, which can continue to invest in the merged group, while Burford gets its capital from the public markets. Plainly this increases the sources of funds available. There is also the chance, as litigation finance becomes more accepted, to expand into other global markets.
This column has recommended Burford before. The shares have risen sharply over the past couple of years and gained another 77¼p to 562p yesterday. Part of the problem with investor acceptance of Burford is the lack of comparators — the shares fit vaguely into the other financials sector. The deal can only be beneficial; there are tough earn-out targets set for the founders before they see any further payout and the market will continue to grow. On 16 times earnings, the shares look a good long-term bet.
My advice Buy
Why Burford is a key player in a growing market
John Wood Group
The recovery in the share price of John Wood this year has been truly extraordinary, despite the company’s heavy exposure to the oil and gas industry. The shares, 550p in January, lost 2p to 866½p on a trading update that at least confirmed the outcome for the year would be in line with forecasts.
Wood has cut costs by $220 million over the past two years. It has spent $280 million on strategic purchases, including two American companies for about $200 million. Given a strong balance sheet and a dividend payout ratio that was probably below par, the company has encouraged investors with dividends up by 10 per cent or more each year, a pledge repeated in yesterday’s update even if it can hardly be justified by an expected fall of a fifth in this year’s profits.
Though the North Sea remains depressed, there are signs of recovery elsewhere. The US onshore rig count has been climbing, though this has yet to feed into new business as Wood only comes in later. The shares sell on almost 17 times earnings — full enough unless you take a very rosy view on the future price of oil.
My advice Avoid
Why The shares look fairly priced for now
And finally . . .
Also not terribly well followed in the past, along with Burford Capital, is IQE, the Welsh technology business. This makes gallium arsenide wafers that go into semiconductors and has seen its shares hit a five-year high on the basis of an upbeat trading statement that promised, unusually for the sector, rather better than expected results for the current year. Revenues should be up by more than 10 per cent year on year. Some wonder if IQE will be the next tech company to attract the interest of an overseas buyer.
