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Here’s why Micro Focus could be the FTSE 100’s hottest bargain

Shares in Micro Focus (LSE: MCRO) fell off a cliff in March after the software specialist downgraded its revenue forecasts. And in a week of blood-letting, the company saw its market cap slashed by 50%.

It stemmed from problems with the firm’s acquisition of assets from Hewlett Packard Enterprise, and with the chief executive standing down too, share price carnage was perhaps inevitable. But was the extent of the sell-off an over-reaction?

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I think it was. If I didn’t have a better reason, just the fact that such crashes in FTSE 100 stocks are almost always overdone puts the statistics on my side. But I do have a better reason too — it’s a profitable company which generates healthy cash, and the market reaction plunged the shares down to what I see as a silly low P/E rating.

In fact, even after Micro Focus shares have recovered by 36% from their low point, we’re still looking at forward P/E multiples of under nine on current forecasts. On that basis, you could have picked them up on a effective P/E of around 6.5 if you’d been canny enough to get in at the bottom.

Two pieces of news Wednesday boost my thoughts that Micro Focus is now a bargain too. 

Positive news

The company told us it gained shareholder approval on 21 August for the sale of its SUSE business segment to Marcel Bidco of Germany, for a cash consideration of approximately $2.5bn. The deal is still dependent on a number of things, including the separation of the SUSE business (which will involve antitrust and competition factors, and government clearances), but the company is aiming to complete the deal in the first quarter of 2019. 

The second is the announcement of a new share buyback programme, which should start with an initial tranche of up to $200m and should complete by 24 October. The company will subsequently reveal any further buyback tranches if it decides to extend the programme.

Some investors are sceptical of buybacks and whether they’re a good way to return cash to shareholders. The intention is that future profits will be split between a smaller number of shares, and so the value per share should rise in proportion to the buyback.

Critics might suggest just handing over spare cash to shareholders is a better way to go about it. But companies really only buy back their own shares when they feel the market is undervaluing them, providing an extra potential return for shareholders. And just the announcement of a buyback can give the shares a filip — the Micro Focus price was up a couple of percent by mid-morning on the day of these announcements.

Top dividend

Another valid reason for using buybacks is to spread shareholders’ returns between income and capital gains, and at today’s depressed share price, Micro Focus is already set to hand over some impressive dividends. Forecasts suggest yields of 6% this year and 8.4% next, which are among the best in the FTSE 100, and they look to be adequately covered by predicted earnings.

There will be fears of further problems, and the troubled assimilation of those Hewlett Packard assets looks certain to take some further time yet to sort out. But I’m seeing a solid long-term company at a bargain price now.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has recommended Micro Focus. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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