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Should You Sell Micro Focus International plc After Results And Buy Blinkx Plc Instead?

“Buy low and sell high” is an old investing adage that some shareholders of FTSE 250 firm Micro Focus International (LSE: MCRO) may be pondering after the software group released its annual results today.

After all, anyone who backed the company when it joined the stock market 10 years ago has seen a 10-fold increase in the value of their investment, while anyone who took the plunge when the company issued two profit warnings soon after its flotation has done even better.

So, should investors in high-flying Micro Focus consider switching to sector peer Blinkx (LSE: BLNX) — a company whose shares are currently down in the dumps after two profit warnings last year?

Micro Focus

Micro Focus made a transformational $2.5bn acquisition of Attachmate Group last year, and today reported revenue, underlying earnings and cash generation ahead of analyst consensus expectations. Underlying earnings per share (EPS), for example, increased 33% from 62.65p to 83.61p — smashing City forecasts of 76.1p.

Despite the positive results, Micro Focus’s shares are little changed from last night’s closing price of 1,369p, putting the company on a price-to-earnings (P/E) ratio of 16.4, which appears generous compared with the FTSE 250 P/E of 17.9.

Looking for negatives, the big Attachmate acquisition has resulted in Micro Focus’s net debt rising to $1,403m from $261m last year. Debt to earnings multiples are a little on the high side — higher than management is targeting — but the business has strong recurring revenues and cash flows; indeed, the company has already made an early repayment of $150m of $2,000m debt facilities raised for completion of the Attachmate deal.

The next couple of years will be a period of consolidation, as Micro Focus restructures, rationalises and integrates. Management told us today that “we intend to reduce revenues to a solid core … As a result we anticipate revenues in the year [to March 2016] declining between 2% and 4%”. Growth is targeted for the year to March 2018.

Many long-term shareholders will no doubt be happy to stick with the company. And, indeed, given the track record of investment returns and the current valuation, I think there’s every reason to do so. But is there any merit in taking some profit off the table and recycling it into Blinkx for a potential repeat in the next 10 years of the kind of gargantuan gains Micro Focus delivered in the last 10?

Blinkx

Blinkx is certainly unloved after last year’s profit warnings, just as Micro Focus was a decade ago. In fact, Blinkx’s shares — trading at 27.25p as I write — are no less than 88% below their 230p peak of 2013.

For its financial year ending 31 March 2015, Blinkx swung to a $25m loss before tax from an $18m profit the previous year. The video search engine firm blamed a rapid industry shift away from desktop towards mobile, video and programmatic advertising channels.

Management has responded with acquisitions and organic investment in this emerging growth area, and I saw some signs of encouragement in the second half of the year, notably in a much reduced cash burn (excluding acquisitions) compared with the first half. Furthermore, Blinkx still has $96m cash available for investment and acquisitions.

If Blinkx could get back to its previous peak EPS of 4.24p, achieved in 2013/14, the P/E would be just 6.4 at today’s share price, making the shares an absolute snip.

However, one concern I have is over allegations that those peak earnings were achieved on the back of unsustainable practices that ripped off advertisers. Blinkx denied a number of the allegations, but went on to tighten up “supply quality and brand safety” at the same time as profits nosedived. The cynic in me wonders whether there may have been more to Blinkx’s loss of performance than the industry structural shift from desktop to mobile, stressed by management.

Still, with some signs of improvement in the second half of last year and a war chest for acquisitions, Blinkx could be a big winner in the future, if management makes the right moves. However, I think it’s too early at this stage to be confident enough to seriously consider buying the stock. In short, I would rate Micro Focus as a hold and Blinkx as one to watch.

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G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended 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.