Micro Focus's major pain is set to continue

Massive beatings of Micro Focus shares could become less frequent from here

Though massive beatings could become less frequent from here

The latest and most spectacular collapse of shares in Micro Focus, the FTSE 100 group whose ‘legacy’ software strategy continues to come unstuck, is a dump of as much as 34%. That’s the £4bn group’s deepest one-day collapse since an almost 50% crash on 19th March 2018. Then, like now, it was downgraded guidance that spooked investors. Holders have become so hypersensitive to possible understatement of revenue downside, they precipitate the very value destruction they’re trying to avoid in the first place. Its another unfortunate consequence of MCRO’s $8.8bn acquisition of Hewlett Packard Enterprise assets that has turned out to be little short of disastrous

There are fair reasons to see Wednesday’s slump as even more of an over-reaction. The stock remained 30% lower into afternoon trading, despite only a fairly marginal downgrade of already dire expectations. The group reduced guidance of its expected full-year revenue decline to a range of -6% to -8% in constant currency terms, from -4% to -6% before. The cut looks just as symbolic as it might be material. That’s assuming the group even has sufficient visibility to predict a two-percentage point sales growth reduction, at the midpoint, relative to previous forecast. Either way, it’s hard to square the toasting of £1bn-plus in market value over a change that could be worth about $69m, given 2019 revenues seen around $343bn. (MCRO reports results in dollars).

There’s no question MCRO’s outlook remains deeply unattractive, but the case for ‘rock bottom’ is growing more cogent:

  • The new CEO had already began to jettison weak assets after launching a review process some months, before MCRO’s latest downgrade
  • After Thursday’s drama, Stephen Murdoch is doubling down: "Following the recent disappointing trading performance, we have determined that it is appropriate to accelerate the undertaking of a strategic review.” No further details are offered for now
  • His approach has already resulted in the disposal of SUSE (a Linux pioneer) for $2.54bn. Further ‘bolt-off’ disposals are probable as MCRO unwinds years of bolt-on buys with questionable rationales
  • Asset sales subsequent to Elliott Management’s stake build are almost certainly not coincidental
  • At multiple of 5 times 2020’s estimated $860m free cash flow, MCRO ought to tempt buyers, though the concept of a wholesale buy-out would hold more water further down the line
  • The medium-term focus remains on continued disposals of least-accretive units
  • That won’t dial down the stock price pain any time soon. Therefore—upticks aside—further downside into Q4 is likely

Chart thoughts

  • Technically speaking, MCRO is nowhere near ‘rock-bottom’. It has held off from March 2018’s 771p low by some margin, also avoiding long-term support initially codified by October 2014’s 969p low
  • The 78.6% retracement of its April 2018-July 2019 top has assisted the stock on Thursday
  • Based on a Relative Strength Index (RSI) that hasn’t been more oversold in 16 months, MCRO has a greater chance of a melt-up than of melting down further
  • Counter-arguments include that the huge gap opened Thursday is reinforced by a 61.8% retracement interval
  • That is pennies away from a double-tagged kick-back low from late December ‘18/early-January ’19
  • The underside of the determined buying seen then should be an obdurate resistance to go higher from here, unless there’s significant fundamental improvement

Micro Focus CFD – Daily

Source: City Index

Disclaimer

This report is intended for general circulation only. It should not be construed as a recommendation, or an offer (or solicitation of an offer) to buy or sell any financial products. The information provided does not take into account your specific investment objectives, financial situation or particular needs. Before you act on any recommendation that may be contained in this report, independent advice ought to be sought from a financial adviser regarding the suitability of the investment product, taking into account your specific investment objectives, financial situation or particular needs.

StoneX Financial Pte. Ltd., may distribute reports produced by its respective foreign entities or affiliates within the StoneX group of companies or third parties pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Where the report is distributed to a person in Singapore who is not an accredited investor, expert investor or an institutional investor (as defined in the Securities Futures Act), StoneX Financial Pte. Ltd. accepts legal responsibility to such persons for the contents of the report only to the extent required by law. Singapore recipients should contact StoneX Financial Pte. Ltd. at 6826 9988 for matters arising from, or in connection with the report.

In the case of all other recipients of this report, to the extent permitted by applicable laws and regulations neither StoneX Financial Pte. Ltd. nor its associated companies will be responsible or liable for any loss or damage incurred arising out of, or in connection with, any use of the information contained in this report and all such liability is hereby expressly disclaimed. No representation or warranty is made, express or implied, that the content of this report is complete or accurate.

StoneX Financial Pte. Ltd. is not under any obligation to update this report.

Trading CFDs and FX on margin carries a high level of risk that may not be suitable for some investors. Consider your investment objectives, level of experience, financial resources, risk appetite and other relevant circumstances carefully. The possibility exists that you could lose some or all of your investments, including your initial deposits. If in doubt, please seek independent expert advice. Visit cityindex.com.sg for the complete Risk Disclosure Statement.