Micro Focus in US mega-deal

Micro Focus is paying over £1.5 billion for US software rival The Attachmate Group Inc in a "transformational" deal to create one of the country's biggest software companies. It's also significant in that Micro generates much better margins than the American firm. If management can work some of that magic on Attachmate, forecasts for modest profit growth could turn into something more spectacular.

Bosses have already said the deal should "significantly enhance" adjusted earnings per share (EPS) from this year. Numis Securities has taken heed and upgraded EPS estimates for the year to April 2015 by 20% to 129 US cents (79.4p), and by 22% for the following year to 141 cents (86.8p).

There's also "scope for further benefits as operational improvements are realised across the enlarged group," say Micro chiefs, which implies plenty of room for margin improvement. But they have a reputation for getting the best out of a business, too - rapid profit growth has generated annualised total shareholder returns (TSR) above 40% for the past three years.

As the press release points out, Attachmate generated revenue of almost $957 million in the year to March, more than double Micro's sales of $433 million. But Micro made an underlying cash profit of over $196 million giving a margin of 45.4%, much better than the 32.7% at Attachmate.

And management are certainly incentivised. Share options will only pay out on TSR of 50-100% over the next three years. If Micro managed TSR of 15% per annum - its current stated minimum objective - that would give a cumulative TSR of 52% and only 4% of the options would vest. Annual TSR of 20% - the upper range of Micro's objective - would still vest less than half the share options. To get the lot, executives will have to generate an annual TSR of about 26%.

Clearly, the amount of debt involved here will be a worry to some. Micro is using 86.6 million shares to pay for the deal - at 966p that's worth £837 million - but Attachmate also comes with $1.17 billion of net debt. Thankfully, earnings are tipped to grow smartly over the next few years and management expect to reduce net borrowing from 3.3 times cash profits post-deal to 2.5 times within two years of completion. Shareholders will also get the promised 60p a share cash return in November.

In terms of what this all means for Micro's share price, Numis reckons a 50% TSR by November 2017 would equate to a share price of around 1,130p at that point. Investors would also have received 99p of dividends. A 100% TSR would equate to 1,540p and 99p of dividends.

Yes, Micro now becomes an integration story, certainly in the short-to-medium term, but the odds on success look good, and an enterprise value-to-cash profits ratio of less than 9 is roughly in line with the sector.

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