Micro Focus (MCRO) has today announced a merger with The Attachmate Group, Inc. which technically for the purposes of the Listing Rules amounts to a reverse takeover by Micro focus given the size of the deal. They are paying a total enterprise value of US$2349.8 million for a Company which In the year ended 31 March 2014 generated revenues of $956.8 million and Underlying Adjusted EBITDA of $312.8 million. So it seems like a reasonable 7.5x EV/EBITDA multiple and the company say that they expect it to be significantly earnings enhancing in the current financial year ending 30 April 2015 and thereafter, with scope for further benefits as operational improvements are realised across the combined entity.
I would take this to mean 10% plus and it seems the market likes it as the shares have been marked up by nearly 10% first thing this morning. You can read the full announcement at the link above, but otherwise the Company summarised some more of the benefits for the merger as follows:
- The Micro Focus Board believes that the proposed Merger presents a rare opportunity to achieve a significant increase in the scale and breadth of Micro Focus, through a merger with a business operating in market segments adjacent and complementary to Micro Focus and sharing the same characteristics of high recurring revenues, high operating margins and strong cash conversion; and with the potential to deliver Total Shareholder Returns ("TSRs") that are superior to those likely to be achieved on an organic basis.
- Creation of an enlarged global infrastructure software company with a top three global market position in a number of key segments, including off-mainframe COBOL, mainframe modernisation, host connectivity and Linux.
- The Enlarged Group's combined annual revenues amount to approximately $1.4 billion, with combined Underlying Adjusted EBITDA and cash generated from operations each amounting to approximately $0.5 billion p.a.
While they explained the rationale under the following headings:
Strategic rationale and operational benefits
The Board believes that the proposed Merger presents a rare opportunity to achieve a significant increase in the scale and breadth of Micro Focus, with the potential to deliver TSRs that are superior to those likely to be achieved on an organic basis.
The Directors consider that the businesses of Micro Focus and the Attachmate Group share a number of important attributes:
§ both are well established enterprise software vendors operating at a global scale with a presence in all significant international markets;
§ both are characterised by high Underlying Adjusted EBITDA margins (Micro Focus 45.4 per cent., Attachmate Group 32.7 per cent.)(3) and high recurring revenues (Micro Focus 66.3 per cent., Attachmate Group 71.3 per cent.);
§ both hold a portfolio of software solutions organised into different product groups which address specific aspects of the infrastructure software requirements of a substantial installed base of large enterprise customers, with no material customer concentration; and
§ both the Attachmate Group's and Micro Focus's respective product groups are (with exceptions) predominantly mature solution sets which are embedded within the IT infrastructures of large corporate customers.
§ The Board believes that the principal benefits of the Merger will arise mainly from the delivery, over the medium term, of operational improvements across the Enlarged Group.
§ Given the scale of the Enlarged Group, the Board believes that the operational efficiencies will be achieved in the medium term, primarily through reducing duplicated central costs and combining corporate support functions where appropriate. The Board will also seek to reduce or reverse areas of revenue decline, accelerate revenue growth where achievable, and enhance operating margins.
The financial effects, over and above the earnings enhancement are on the balance sheet and the level of debt. They state that this will take the combined net debt up to 3.3x the combined EBITDA which is above their previous 2.5x upper target / limit. They say they will look to get the debt back down to those kind of levels in the next two years from cash flows. On the back of this they say they are suspending further returns of value and share buy backs, although the recently proposed 60 pence return is still scheduled to go ahead and they are talking about a progressive dividend policy going forward.
Summary & Conclusion:
Seems like a sensible deal which is not only enhances earnings but also takes them into new products and markets related to their existing activities. However, they are buying off of VC's and the financial risks are increased given the size of the deal, integration risks and the levels of debt being taken on as a result. So this gives some pause for thought, but on balance it looks like a deal worth backing.