What a challenge July proved to be for Micro Focus International (LSE: MCRO) and its shareholders, the business shedding 16% of its market value over the course of the month.
Prices steadied during the latter half of July but it’s back on the defensive in early August, the FTSE 100 firm flirting with six-month lows as fears over US-Chinese trade wars smack broader risk appetite.
This fresh batch of selling leaves Micro Focus dealing bang on the widely-accepted bargain basement levels, a forward price-to-earnings (P/E) ratio of 10 times. Such a low valuation’s compelled me to consider: does this represent a prime buying opportunity, or is it simply a sign of a classic investment trap?
HPE continues to weigh
Let’s cut to the chase: Micro Focus isn’t a share I’ll be buying any time soon, certainly while the legacy issues owing to its troubled acquisition of Hewlett Packard Enterprises (HPE) continue to linger, a problem laid bare again in last month’s interims.
In those financials the software firm commented that the complexities of the HPE deal “continue to require detailed attention and substantial programme planning and execution.” We’re two years down the line from the takeover and yet huge sums are still being paid out to rectify these problems — while down from the prior year, Micro Focus still forked out more than $160m in ‘business integration-related costs’ in the first half.
It’s no wonder that investors headed for the exits again, though fragile investor confidence wasn’t helped after chairman Kevin Loosemore scythed down his holdings in the business. He dumped 650,000 Micro Focus shares — equating to around half of his stake — in the immediate wake of the release, a move prompted by a desire to “diversify a little.”
Problems related to HPE put paid to the Footsie company’s share price last year, a series of profit warnings and comments that the acquisition was a year behind schedule making it one of the worst-performing shares on Britain’s blue-chip index in 2018. Sure, the takeover might still have plenty of long-term sales opportunities for the firm. But right now Micro Focus continues to take a hiding and this threatens to keep the stock price locked in a downward trend.
I’m not a total stick in the mud though. There’s one thing which was mighty impressive about Micro Focus in the first half which is worth discussing: cash generation. Free cash flow almost doubled between January and June to around $430m, and adjusted cash conversion leapt almost 20 percentage points to 115.1%. No wonder, then, that current City projections speculate a chubby dividend for 2019 that yields a mammoth 5.7%.
This also isn’t enough to tempt me in, however. Aside from those aforementioned trading and integration issues, Micro Focus is still sitting atop a colossal debt mountain — adjusted net debt sat at $3.81bn as of June. Why take a chance with this high-risk company here when there are so many other terrific income shares to choose from?
Royston Wild 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.