2014 has been a great year to be an investor in Micro Focus (LSE: MCRO). Thats because shares in the company have risen by 24% since the turn of the year, which easily surpasses the FTSE 100s 1% gain over the same time period. Indeed, todays news of a merger with Attachmate Group has accounted for the majority of those gains, with shares in Micro Focus being up 14% on the day at the time of writing. Clearly, the market welcomes the deal, but is it good news for long-term investors in Micro Focus?
Classed as a reverse takeover, the merger will see Micro Focus buy Attachmate for $1.2 billion in return for the issue of around 40% of shares in the new company. The deal is seen as a merger of two similar companies, in terms of their high recurring revenues, strong cash flow and impressive operating margins. Furthermore, it is envisaged that the deal will create an enlarged global software company with key positions in areas such as Linux, mainframe modernisation and host connectivity. Due to it being classed as a reverse takeover, Micro Focus shares will be cancelled and an application will be made for a new listing.
Clearly, the market is impressed by the deal and, on the face of it, it seems to make sense. Thats because Micro Focus is currently struggling to grow its bottom line, with earnings forecast to be just 2% higher in the current year and 8% higher next year. Although not a disaster, neither of these numbers are particularly impressive for a software company and do not compare particularly well to key rivals. So, the deal should help to bolster Micro Focus profitability, which is a great thing for investors.
However, the deal also brings to light the issue of financial gearing. Micro Focus currently has debt of $294 million, but after the merger the new company is pencilled in to have around $1.46 billion of debt (as Attachmates debt currently stands at $1.166 billion). Normally, this would be a major cause for concern, since high debt is often associated with high levels of risk. However, in Micro Focus and Attachmates case, they both possess relatively stable earnings profiles, which means that they can stomach a higher level of financial gearing.
So, while increased debt inevitably means more risk, it could also mean higher rewards for investors. Furthermore, the two companies appear capable of living with higher debt moving forward.
Of course, one of the major attractions of Micro Focus is its strong dividend prospects, with shares in the company set to yield 4.3% next year. Although details of dividend policy are to be confirmed, it would be surprising for them to shift significantly. Thats because, as mentioned, Attachmate fits a similar profile to Micro Focus (stable earnings, high degree of recurring revenue) and so the future income potential for the combined entity could be bright.
Indeed, with the two companies seemingly being a good fit, the future could be a profitable one for investors in Micro Focus. Certainly, bottom-line growth should be more forthcoming than previously thought which, when combined with enviable income prospects, means that shares could perform well moving forward.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has recommended shares in Micro Focus. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.