Micro Focus under scrutiny after slashing sales forecasts

British tech giant has struggled since its $8.8bn swoop for part of HP. Now it could be forced into disposals of its own, finds Matthew Field

It is Britain’s second biggest technology company and a stalwart of the FTSE 100 that has grown steadily for decades through a string of modest acquisitions of smaller rivals. But when Micro Focus, the Newbury-based software company, attempted an ambitious $8.8bn (£7.2bn) deal to merge with the sprawling software business of US giant HP in 2017, it turned out to be a serious strategic blunder.

When the company issued an unscheduled trading update and profit warning yesterday, investors were left fuming after the company’s share price plunged by almost 30pc in minutes.

The humiliating announcement saw revenue guidance fall from minus 4pc-6pc to minus 6pc-8pc.

Stephen Murdoch, chief executive, also announced plans for a strategic review, paving the way for possible asset sales and triggering speculation about a possible sale of the business to private equity.

With well over £1bn in value wiped from the firm in a matter of hours, investors have been left with plenty to chew over. “It will be important to understand the degree to which they still have operational or execution issues and the degree to which it is more macro,” said one investor.

Micro Focus has always been a complicated beast.

Founded in 1976, it sells mature software technologies to companies, including software used for core functions in retail and banking. But it has branched out into a web of business

lines, including data analytics, cyber security and consulting. The software firm has built a business out of acquiring legacy software companies and squeezing out costs.

But after 43 years of modest bolt-ons, mergers and sales, Micro Focus’s deal to merge the UK firm with US technology giant HP’S software business was simply too big and unwieldy to succeed. Many believe Micro Focus bit off more than it could chew.

Two years after the much-maligned deal and in the wake of the departure of the chief executive Chris Hsu, investors are still looking for answers as to whether it can be turned into a success.

For years, the company worked up a profitable business of buying up rivals. Between 2011 and 2017, the firm delivered 700pc shareholder returns.

“Micro Focus’s strategy has historically been to acquire and sell those assets that have been ‘sticky’ with their customer base,” says Julian Serafini, an analyst at Jefferies, “assets that a customer would not be likely to be able to replace easily.”

Major issues began, however, when its deal making stepped up a level in 2017. The HP deal propelled Micro Focus from being the 23rd largest software firm in the world to the seventh, behind companies such as Adobe and Microsoft.

The deal grew its headcount to more than 14,000 employees, with fewer than 4,500 coming from the Micro Focus side of the business, and gave the firm vast US operations. It forced it to carve out HP’S software teams from its main business.

In what Meg Whitman, HP chief executive at the time, described as a “spin-merge” to create “one of the world’s largest pure-play software companies”, Micro Focus took control of HP’S floundering software assets, including its Autonomy business, which had been written down by $8.8bn in 2012. (HP’S original takeover of Autonomy has since been mired in fraud claims, which Autonomy’s former bosses deny.)

The unusual deal also saw HP’S chief operating officer and former private equity man, Chris Hsu, appointed chief executive of the combined firm. HP had for years been attempting to untangle its web of businesses and dispose of chunks that had never truly integrated. At the time of the deal, one trade publication described Micro Focus as a “hospice bed” being filled by “Hewlett Packard’s sickly software business”.

And the two years since the deal have given plenty of fuel to sceptics.

The company has seen a slew of executive exits. Hsu was out in March 2018 just a few months after the deal completed, with no payout. Its share priced halved on the news.

It was also rocked by an exodus of sales staff, particularly in its US teams, while a glitch in its combined IT systems made life harder for staff. The company’s chief financial officer, Chris Kennedy, also quit the firm shortly after the deal to join ITV. According to anonymous reviews on employee message site Glassdoor, there have been cultural issues to contend with too, from “misfocused priorities”, “constant lay-offs” and “good people leaving, deadwood staying”.

In March 2018, Micro Focus returned to Stephen Murdoch, the firm’s previous chief who stepped aside to allow Hsu control after the HP deal.

The firm has since made major efforts to win back shareholders. It attracted interest from New York hedge fund Elliott Advisors, which is believed to have pushed the firm to slice off its fast-growing Suse open-source business for $2.5bn in July 2018. The move boosted its share price by around a third. It also extended its share buyback to $510m earlier this year.

And long-term investors do see the upside to the business, which, despite recent troubles, has provided healthy returns for many years. “Despite the downgrades, it is still very cash generative and attractive,” says one.

Others point to the size of its legacy technology market as a reason Micro Focus has been seen as a strong bet.

“The Micro Focus team are very experienced and their track record up to the HP acquisition was pretty good,” says Richard Holway, an investor and founder of Techmarketview. But despite what appeared to be signs of a thaw, the latest profit warning suggests problems remain.

“Weak sales execution has been compounded by a deteriorating macro environment resulting in more conservatism and longer decision making cycles [at customers],” the company said on Wednesday. Shares, which were trading about £21 apiece in July, fell 32pc to £10.51 yesterday.

Investors are now mulling what will come of Murdoch’s latest plans for a major overhaul of the firm. “We have determined that it is appropriate to accelerate the undertaking of a strategic review,” Murdoch said, which will include “strategic, operational and financial alternatives”.

With its core focus on legacy tech, there have been questions on whether the rapid push by businesses to cloud operations, many of them run by Amazon’s Web Services or Microsoft, could hurt the business. “Longer term, it’s definitely something to watch out for,” says Jefferies’ Serafini.

Murdoch and the executive team are understood to be considering all options in the review. This could even lead to conversations about whether the firm should be taken private, as New York’s Elliott was said to be calling for in 2018. While the company is not making active plans for a sale, Murdoch said yesterday: “As a public company, we are for sale everyday.”

However, such a deal might be an unusual fit, given the firm’s previous focus on providing shareholder returns and buybacks. Many of its businesses have already been stripped down.

Whatever happens, investors and analysts will now be expecting a drastic new course of action to try to lift, as one source put it, the “curse of the Hpautonomy deal”.