August 22, 2011 8:01 pm

Micro Focus takeover talks prove abortive

Micro Focus’s business model is set to come under renewed scrutiny, after the software company reported a fruitless end to four months of takeover talks with several private equity suitors.

Its shares fell 12.5 per cent after the announcement on Monday, as analysts said a buy-out of the company – a subject of market speculation for most of the last year – was now off the agenda for the foreseeable future.

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Micro Focus’s core business – selling and maintaining software based on Cobol, a mature and increasingly unfashionable programming language – is in a slow but inexorable slide, says Milan Radia, an analyst at Jefferies.

“Ultimately Cobol is a declining end-market. The reality is that enterprises are not building new applications on Cobol; wherever possible they’re discontinuing them,” he says. An attempt to diversify by moving into the software testing market has left Micro Focus struggling to compete with bigger companies such as IBM and HP.

In a conference call on Monday morning, Kevin Loosemore, executive chairman, denied that the breakdown of talks reflected any underlying problems at the company. Micro Focus had distributable reserves of about $112m (£68m), he said, and planned to buy back as many as 12.3m shares – worth £31.2m ($51.4m) at Monday’s closing price.

The company had received preliminary offers ranging from 415p to 450p a share, Mr Loosemore added, and a more detailed proposal valuing the company at more than 400p a share, or £791m. However, it called time on discussions after a deadline last Friday passed without a formal offer.

Micro Focus had decided to let its suitors peruse a trading statement for the three months to July, published on August 10, before bringing talks to a close.

“The cynics among us could say they were hoping [the performance was] going to be weaker to enable them to lower any price expectations,” Mr Loosemore said. “By that time there was a degree of market turmoil ... we didn’t believe that was any reason why a price should be lower than the value of the company.”

The market turbulence had also made it harder for the interested parties to raise financing for a takeover, Mr Loosemore said.

His explanation was supported by Advent International, one of the bidders, which attributed its decision to pull out to market volatility. Advent said it remained a great admirer of Micro Focus, its management and employees, adding that it reserved the right to make another offer within the next six months under certain conditions.

However, Jonathan Imlah, at Collins Stewart Hawkpoint, said the talks’ failure could not be blamed only on choppy markets. Bain Capital, another private equity firm that expressed an interest in Micro Focus, last week paid A$1.2bn (£760m, $1.3bn) for MYOB, the Australian software company, he pointed out. Meanwhile, HP last week announced the proposed takeover of Autonomy, Britain’s biggest software developer, for $11bn.

“I think it’s a convenient excuse, frankly,” he said, pointing to a “lack of obvious growth prospects” that would complicate a private equity buyer’s eventual exit from the investment.

The market for Cobol software remains huge – 1.5m lines of code are written every day, Mr Loosemore claims – and most analysts say that cash flow of $182m in the year to April makes Micro Focus look cheap at about 8.5 times 2012 earnings. Improvements at middle management level and a greater focus on sales to medium-sized businesses could help to cushion long-term pressure on revenue.

But a further round of bids looks unlikely, analysts say.

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