Micro Focus encourages bulls

Micro Focus has impressed the market, again. Granted, it's not shot the lights out, but results have certainly whet investors' appetite for the software group's shares. They're not far off all-time highs now and strong cash generation could line up shareholders for a small windfall, too. Tempting.

Following a strong finish to the financial year, revenue for the 12 months to 30 April was likely $1.25 billion (£856 million) at constant currency, in line with forecasts for a 2-4% unwind from last year's $1.27 billion. Despite major foreign exchange swings over the last six months, underlying cash profit should jump 9% to $530 million.

Against strong 2015 comparatives, management had been cautious not to get too carried away with final-quarter forecasts, but broker Numis is impressed.

We have to wait until July for fine details, but Numis analyst David Toms doubts performance is being driven by its SUSE subscription-based portfolio - the business that came with the 2014 acquisition of software shop Attachmate - "suggesting the performance is largely attributable to the non-SUSE portfolio".

Micro Focus's $540 million acquisition of Serena Software went through earlier this month, which would have increased adjusted cash profit to at least $605 million. With pro-forma net debt jumping to $1.6 billion, its net debt/adjusted facility cash profit ratio now stands at 2.54 times - the facility figure excludes the amortisation of capitalised development costs.

Before the sale went through, net debt slipped to $1.1 billion thanks to the proceeds of March's $223 million share placing at 1,455p. Without this fundraise, net debt of $1.3 billion was better than expected thanks to strong cash collection at the end of the year. Cash conversion reached 90%, which allows scope for management to return an extra $220 million - $1 a share - says Toms.

Leaping 2.5% to 1,619p straight out of the blocks, Micro Focus tested resistance at £16 before slipping back to 1,597p. This is the third time the software group has tried to break through this significant level in five months, and the wedge formation on the chart makes the shares worth watching over the next few months.

The City is on the bullish side, with Panmure Gordon upgrading its target price to 2,034p and Numis valuing the shares at a more conservative 1,850p - that's still 16% upside.

"We continue to see good catalysts for strong share price performance including operating outperformance, ongoing cash returns and further Mergers and Acquisitions activity," explains Toms.

"On 14x CY2017 [enterprise value divided by net operating profit after tax (NOPAT)] and a 7.4% [free cash flow] yield (rising to 8.9% in CY2018 as the headwind of acquired working capital unwind abates) the shares remain undervalued in our view."

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