Conventional wisdom has it that when a company doles out a large bundle of cash to investors, it either is feeling generous, is rewarding shareholders for possibly overtaxing their patience or has simply run out of ideas about better ways to spend the money.
In the case of Micro Focus, which bumped up its stock buyback programme last week by $110 million to $510 million, shareholders may be hoping that it is a bit of all three, particularly if the better idea might have been to embark on another massively ambitious takeover.
Micro Focus was founded in 1976 and was listed on the stock market in 2005. It specialises in helping companies to get the best out of their legacy software systems, employing about 14,000 staff with about 40,000 customers in 43 countries. It makes its revenues in four ways: software licence payments, maintenance contracts, consultancy services and packages containing all three.
Operating in what ultimately is a market in slow structural decline as outdated programmes disappear, Micro Focus has grown steadily through acquisitions and it has about 300 separate software products in its portfolio.
Life was running fairly smoothly for the group until late 2016 and its decision to spend $8.8 billion buying the software business of Hewlett Packard Enterprise, which brought with it some of the former Autonomy business sold to Hewlett Packard in 2011 in a process that subsequently descended into bitter acrimony and legal dispute. The HPE acquisition was its biggest takeover so far, doubling the size of its business, although the logic was sound because the two companies were broadly comparable and the opportunities available to strip out unnecessary costs significant.
It didn’t quite work out that way and last March Micro Focus issued an unexpected revenue alert for the year after it suffered a spate of staff defections, encountered hiccups implementing a new IT system and revenues slowed down by more than it had expected. Chris Hsu stepped down as chief executive and was replaced by Stephen Murdoch. Mr Hsu had been in charge of the HPE business, becoming the group boss once the takeover had gone through. It could be argued that he would have been more reticent about working his way through some of the grittiness associated with takeovers — losing underperforming sales staff, cutting costs — because of his links with the company. Mr Murdoch has taken a more aggressive approach to integrating HPE in a process that appears to be working.
The annual results last week were complicated. The company changed its financial year-end and reported figures for the 18 months to the end of October, but also pro forma figures for the 12 months to that date.
What’s important, though, is that while annual revenues declined, by 5.3 per cent, that was better than the previous guidance of between 6 per cent and 9 per cent. While further integration costs led Micro Focus to a pre-tax loss, pre-exceptional operating profits almost doubled. Its guidance of a drop in revenues for this year of between 4 per cent and 6 per cent was also better than expected and helps to explain why the shares have risen since by just under 16 per cent. Nevertheless, an expected fall in revenues is still a fall.
Micro Focus’s shares, up 68½p, or 4 per cent, at £17.48½ yesterday, are cheap, changing hands for about 7.4 times Barclays’ forecast earnings and for a dividend yield of 4.9 per cent. As well as the buyback programme, investors can look forward to a slice of the $2 billion in proceeds from the sale of its Suse business.
While Micro Focus seems to be emerging from its problems, unless investors have a keen appetite for risk, its shares are probably best avoided.
ADVICE Avoid
WHY It’s all too easy to make slip-ups in this complex and highly competitive market
Vesuvius
Vesuvius is one of those instinctively likeable businesses that actually make something. It is at the heavy end of engineering, serving the steel and foundry industries with the tubes, stoppers, coatings and mouldings that help them to control the flow of molten metals at unimaginably high temperatures.
Mind you, its shares could do with a bit of heat protection themselves. They have been hit by the gyrations of cyclical worries about the health of car manufacturing, construction and the general engineers whose demand for steel has a bearing on the need for its own products.
The company was founded in 1916 as the Vesuvius Crucible Company in Pittsburgh, Pennsylvania, and used to be part of Cookson until it split in two in 2012. It is now a constituent of the FTSE 250 and employs just over 11,000 people, with its biggest markets in Europe, Asia and the Americas.
The company operates a steel and a foundry division, plus a far smaller unit that provides specialist technical services, and in its most recent financial year it made a pre-tax profit of £97.1 million on revenues of just under £1.7 billion. Vesuvius has a track record of delivering positive surprises, not only because of the long-term increase in demand for steel but also its ability to strip out costs and improve margins. It is targeting a 12.5 per cent return on sales in 2020.
The company said in November that trading in the third quarter had been healthy and, in spite of currency movements, that it was on course to make the £195 million in trading profit that was being estimated by analysts for the full year. There are concerns, however — among them, slowing underlying growth in steel production, the outlooks for the automotive and construction industries and China. The backdrop of higher trade tariffs is unsettling, although it does not yet seem to have interfered with Vesuvius’s business.
The shares, which rose by 13p, or 2.2 per cent, to 608p yesterday, trade on 12.6 times Berenberg’s forecast earnings, for a yield of 3.1 per cent. This is perfectly respectable, but the uncertainties mean that it doesn’t feel compelling.
ADVICE Avoid
WHY A quality performer but the backdrop is uncertain
