Micro Focus agrees $8.8bn merger with Hewlett Packard software arm

8th Sep 2016 07:37

(ShareCast News) - Micro Focus International has agreed an $8.8bn deal to merge with US giant Hewlett Packard Enterprise's software business, including a $400m return of value to the FTSE 100 company's shareholders.The UK company will issue American Depository Shares (ADSs) to shareholders in Hewlett Packard Enterprise (HPE), which was spun out of its more famous hardware parent in October 2015, so that once the deal is complete, the US corporation's shareholders will own 50.1% of the combined entity.Micro Focus will keep its listing on the London Stock Exchange, however, and management will retain their roles, with a number of the HPE software team joining and HPE appointing half of the non-execs to the enlarged board.Micro Focus, which agreed $5.5bn of new debt with JPMorgan, plans to effect the capital return of roughly $1.68 per share to existing shareholders prior to completion, which it expects in the third quarter of 2017 after shareholder approval and a likely lengthy regulatory approval process.HPE software will have circa $2.6bn of net debt on completion and Micro Focus will have around $1.8bn.Executive chairman Kevin Loosemore said the deal, which is expected to enhance Micro Focus's adjusted earnings per share by the first full financial year after completion, will "create one of the world's largest infrastructure software companies" with combined annual revenues of $4.5bn and earnings before interest, tax, depreciation and amortisation (EBITDA) of $1.35bn.Micro Focus said the rationale of the deal was that it was a "rare opportunity" to make such a significant step-change in growth by combining with a company that has "adjacent and complementary product areas with similar characteristics" as well as offering high level of recurring revenues and strong cash conversion, while seeing potential to bring HPE Software's adjusted EBITDA margin of around 21% up closer to its own equivalent margin of circa 46%."Today's announcement marks another significant milestone for Micro Focus and is wholly consistent with the long-term business strategy we have been pursuing to be the most disciplined global provider of infrastructure software," said Loosemore."The merger will create one of the world's largest infrastructure software companies with leading positions across a number of key products and represents a compelling opportunity to create significant value for both companies' shareholders by applying Micro Focus' proven approach to efficient management of mature software products."AnalysisJasper Lawler, analyst at CMC Markets, heralded the wider significance of the deal: "No sooner has the UK lost a technology giant with ARM selling out to Softbank, it has gained a new one," he said, although he noted that the assets "are not all new to the UK since they were formerly owned by Autonomy before being taken over by HP."House broker Numis calculated that Micro Focus will pay $8.4bn, based on the assumption of $2.6bn of debt and calculating it will issue $5.8bn of equity to HPE shareholders."Our preliminary calculations suggest 26% accretion to FY20 EPS based on what we think are some very cautious modelling assumptions," Numis analyst David Toms said."The greatest opportunity we see is in margin expansion - HPES delivers 23% EBITDA margins at present, and MCRO management indicate that they expect to take these to over 40%. We think HPE's Meg Whitman summed up the deal rationale very clearly on the HPE call - when asked how MCRO would be able to get such margin improvement she responded 'This is what Micro Focus does'."Analysts at Olivetree said the basic jamming together of the two companies suggested a share price of circa 1,950p for new Micro Focus, which "makes no effort to account for the synergy potential between the two" and is based on a multiple of 12.2 times EV/EBITDA."The current shareprice of 2,375p implies an EV/EBITDA metric of circa 14 times, which seems aggressive and requires a decent level of belief in the synergy potential on offer," Olivetree said. "The easy conclusion here is more that the market is immediately pricing NewCo as performing well and executing a large transaction effectively, it wouldn't appear that there are meaningful amounts of value being left on the table this morning."Olivetree noted that the companies will need to work with US tax authorities to ensure that the tax-free nature of HPE's 2015 spin-out is preserved, as there are restrictions on transactions that a spun-subsidiary can perform within a two-year period - though as Baxalta-Shire showed this should not prove an impediment.