The Micro Focus share price has doubled in a month. I’d keep buying

The Micro Focus share price is surging higher. Roland Head explains why he thinks the stock is worth more, despite two key risks.

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The Micro Focus International (LSE: MCRO) share price has doubled in just one month. The shares are up by 15% today as I write, even though the software company hasn’t issued any new trading information.

Is this the start of a stunning comeback for this former FTSE 100 share, which was valued at more than £10bn a few years ago?

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I certainly think that Micro Focus shares should be worth more. However, I do think there are a couple of risks that may limit the eventual value of this business.

Gaining pace?

On 18 November, Micro Focus gave a trading update for the year to 31 October. The company said that revenue for the year would be around $3bn, but that profit margins would be “towards the upper end of management expectations”.

The news sent the Micro Focus share price up by 30% on the day. The stock has since risen by another 40%, as investors buy in to CEO Stephen Murdoch’s vision of a more efficient and focused business.

It’s still early days, as the company is less than one year into Mr Murdoch’s three-year turnaround plan. But with the shares trading on just four times forecast earnings for 2021, I think there’s still room for further gains.

What I’d watch

As I mentioned, I have a couple of concerns about Micro Focus shares.

The first issue is that this business isn’t showing many signs of growth. Although this is a software business, its main activity is helping companies maintain and develop older IT systems. Often, this includes digital transformation. Mostly, this means making old tech work with modern online services.

The last time the company reported any sales growth was 2018. Since then, revenue (reported in dollars) has fallen from $4.754bn to about $3bn in 2020. The latest broker forecasts for 2021 suggest that revenue will slip lower again next year, to $2.834bn.

Businesses that are in decline generally attract low valuations, even if they remain profitable. Mr Murdoch hopes to return Micro Focus to growth. I think there’s a good chance he’ll succeed, but it’s not a certainty.

Micro Focus share price: don’t forget debt

If the shares continue to trade at current levels, I wouldn’t be surprised to see Micro Focus become a bid target. But anyone buying the company would need to buy its debt as well as its shares.

The group had net debt in GBP of £3.2bn at the end of October. Adding this to the Micro Focus market cap of £1.7bn gives a total value for the business of about £5bn. This is known as the enterprise value — it’s the total commitment someone buying the whole company would have to make.

How much is Micro Focus worth? I can’t say for sure, but I believe that even with the current debt load, this business is worth more than the current share price suggests.

So, I’d hold the stock at 500p and monitor the performance of the business as we head into 2021. I think there could be more to come from this turnaround.

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