Shares in FTSE 100 software firm Micro Focus (MCRO) shot up more than 12% in early trading as investors swarmed to buy stock after the announcement of a $40m mega licensing contract.

The share price had calmed down a bit by mid-morning but it is still roughly 9% up at £13.815.

Micro Focus was the UK’s largest software company by market value until very recently. It helps organisations from around the globe drag their legacy systems into the 21st Century digital age. Think banks, for example, which simply cannot rip out old IT systems and start again.

WHY $40M CONTRACT IS NOT THE BEST NEWS

Today’s news is a positive, no doubt. But let’s put this contract into context.

For a start, the agreement did not come out of the blue. It was signed-off a bit earlier than expected, which means it will fall just the right side of the company’s 30 April half year end. That in turn means previous guidance for first half revenue declines of between 9% and 12% are now likely to come in the range of 6% to 9%. Still down, but not as much as previously flagged.

It is also ‘still a far cry from original guidance for 2% to 4% declines,’ according to Indraneel Arampatta, analyst at IT consultancy Megabuyte.

Consider also that Micro Focus is forecast to generate revenues in excess of $3.9bn this full year to 31 October 2018. This shows the relative drop in the income ocean today’s agreement is.

Investors might ponder whether that justifies a near £500m increase in the company’s value today.

DIGGING DEEPER

There are other more important data points in today’s announcement that may well justify this renewed spell of confidence in the investment story.

Making ‘encouraging progress on improving both the discipline and speed of execution within the business,’ is the sort of commentary investors wold have been hoping for after the integration problems and profit warning in March.

‘We think that, whilst there still remains much to do, manual workarounds are alleviating systems issues and the focus is shifting to clearing the backlog as well as improving automation,’ says Numis Securities analyst David Toms today.

MARGINS AND DEBT

It’s also worth noting that margins appear to be stable, anticipated at around 37% on an earnings before interest, tax, depreciation and amortisation (EBITDA) basis.

Unchanged guidance on net debt is encouraging too, pitched at $4.2bn by year end. That should further ease concerns over banking covenants. ‘We reiterate our view that there is no problem with debt,’ states Numis’ Toms.

The Numis number cruncher calculates full year valuation metrics of seven-times enterprise value to EBITDA, a nine-times PE and 12% free cash flow.

That makes the stock ‘look materially too cheap,’ says Toms, and ‘highly attractive.'


Issue Date: 16 May 2018