Shares of legacy computer systems support specialist Micro Focus International (LSE: MCRO) fell by more than 55% this morning. The stock tumbled after management warned that problems integrating HP Enterprise’s Software division mean that sales are falling faster than expected.
Chief executive Chris Hsu will also leave the firm after just six months in the role. So what’s gone wrong?
Problem #1
In January, Micro Focus issued guidance for sales to fall by between 2% and 4% during the year to 31 October. The company now says that sales are likely to fall by between 6% and 9% over this period.
Problems with a new IT system are hampering sales and today’s statement reports “higher attrition of sales personnel,”“disruption” of customer accounts as a result of the HP demerger, and “sales execution issues” in North America.
It sounds to me as if the integration of this $8.8bn acquisition has been botched, with top sales executives leaving and customers receiving poor service. This has resulted in a sharp drop in licensing revenue.
The company says that the impact of these operational issues on profits for the year will be offset by cost savings. However, in my view these issues are likely to have knock-on-effects beyond the current year.
Problem #2
I also think that markets are pricing in a second problem for Micro Focus.
The group’s growth into a FTSE 100 member has been driven by regular acquisitions of smaller rivals, followed by cost savings to boost profits. This has worked well, but with the HP Enterprise acquisition performing poorly, I think investors are starting to question the firm’s growth potential.
The company’s focus on supporting legacy technology such as COBOL mainframe systems means that it lacks exposure to modern growth technologies such as AI.
I suspect profits will miss expectations this year. Net debt is also quite high, at around $4bn. Taken together, these factors suggest to me that this business should have a low valuation.
Although the forecast dividend yield of 8.8% is tempting, I think this payout could be cut. I plan to wait for the company’s next set of accounts before considering whether to invest.
One stock I would buy today
FTSE 250 gambling software provider Playtech (LSE: PTEC) is also out of favour with markets. The group’s share price has fallen by 24% since a profit warning in November. But in this case I believe the shares could offer a buying opportunity.
Although the group faced headwinds last year, mainly due to a disappointing performance in Asia, the group’s recent 2017 results didn’t seem to highlight any fresh problems. Cash generation remained strong, leaving the stock trading on a price-to-free cash flow ratio of 12.5.
One concern is that Playtech’s operating margin fell from 26% to 21% last year. But this is still a creditable figure that’s much higher than most high street bookmakers. And the group ended last year with net cash of €107m.
Adjusted earnings per share are expected to rise by 14% in 2018 and by 10% in 2019, putting the firm on track for steady growth. With the shares trading on a 2018 forecast P/E of 11 and offering a forecast yield of 4.4%, I believe Playtech looks good value at current levels.
