May 9, 2011 10:42 pm

Bain approach intensifies Micro Focus debate

The recent approach for Micro Focus by Bain Capital, the US private equity group, has intensified the debate about the long-term growth prospects of the British software company.

Bain’s preliminary inquiry over the Easter weekend – a precursor to a possible bid worth up to £890m – followed a turbulent year for Micro Focus. The departure last June of Nick Bray, its well-regarded financial director, worried investors, as did last month’s resignation of Nigel Clifford after only 11 months as chief executive.

The stock suffered a single-day fall of 26 per cent in February after the management said revenue and earnings for the year to April would be about 10 per cent lower than expected – guidance repeated in a trading update on Monday.

Investor concern, analysts said, is founded on the company’s focus on Cobol, one of the oldest programming languages that is increasingly unfashionable.

Companies will look to move their systems away from Cobol, said George O’Connor at Panmure Gordon, due to fears that the number of technicians familiar with the code is declining. “Cobol was the baby boomers’ lingua franca,” he said. “If you’re a young graduate, you won’t want to learn Cobol.”

However, Cobol remains by far the most widespread code, used in all IBM mainframes and relied upon to some extent by most of the world’s biggest companies, including leading banks, utilities and retailers. While its reach is unlikely to expand in the coming years, demand will endure for Micro Focus’ software, which updates Cobol-based systems, said Tintin Stormont at Singer Capital.

“Some of these applications are quite core in some of these big enterprises. [Micro Focus] is extending the life of this software ... the only other option would be to replace it with package [off-the-shelf] software, so any competitive advantage they’ve built into it would be lost,” Ms Stormont said. “You lose all that individual tailoring.”

That suggests a steady stream of cash-generative sales in the long-term future – potentially boosted as companies enlist Micro Focus’s services to help move their data from IBM mainframes to lower-cost servers made by the likes of Dell and Hewlett-Packard.

This strong cash flow makes it attractive fodder for a private equity takeover. Bain is familiar with the software industry: its $65bn (£40bn) portfolio includes enterprise software companies, such as SkillSoft in Ireland and Applied Systems of the US.

In February, the company highlighted its business in automated testing of companies’ computer systems, which accounted for a third of turnover in the first half of the financial year, as a central focus for future growth. Kevin Loosemore, who moved to executive chairman from a non-executive chairman role after Mr Clifford’s resignation, is expected to continue this strategy.

Alexandra Jarvis, analyst at Peel Hunt, said a quarter of the group’s business was in “high-growth testing products” that could begin to reap strong dividends as early as next year.

A Gartner study in January put Micro Focus third in the world by revenues in testing, ahead of Microsoft and Oracle, and behind only IBM and HP. “The company has a solid product line that it has invigorated, [and] it has provided a clear direction for customers,” Gartner said.

Bain is believed to be planning a bid worth up to 450p a share, compared with 338p when it made the approach. However, analysts expect the buy-out firm to wait for Micro Focus’s next trading statement on Thursday before deciding on the quantum of its bid – or whether to pull out altogether.

Micro Focus has forecast sales of $434m-$442m for the year to April, and earnings before interest, tax, depreciation and amortisation of $141m-$153m.

“The update will tell us if they’ve made their numbers or not,” Ms Jarvis said. “If not, it provides strength to the ex-growth theory.”

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