OpenText’s Micro Focus Buy To Nearly Double Revenue To $6 Billion

Are acquisitions one of the simplest ways for a big firm to continue to grow? Because the majority of acquisitions fail to earn again their price of capital, the reply is possibly. As I’ve written, acquisitions can add greater than their price of capital in the event that they move 4 assessments:

• Is the market by which the acquired firm competes giant, fast-growing and worthwhile?
• Will the merged corporations acquire extra market share than if that they had remained impartial?
• Does the worth in current {dollars} of the merged firm’s future money circulate exceed the acquisition worth?
• Can the mixed companies be built-in to look seamless to workers, clients, and companions by the point the deal closes?

Nonetheless, I’m rethinking the third take a look at as a result of traders appear to disregard it and focus extra on whether or not a merger yields sooner than anticipated income and revenue progress.

This involves thoughts in contemplating Waterloo, Ontario-based OpenText, a $3.5 billion supplier of data administration software program and companies, that introduced in August the $6 billion acquisition of Micro Focus, a $2.7 billion (most up-to-date 12 months’s revenues) UK-based enterprise software program firm.

This deal doesn’t move all of my 4 assessments for profitable acquisitions. Nonetheless, if OpenText — whose inventory worth trades 46% beneath its September 2021 excessive — can beat its modest progress expectations, its inventory may rise from right here.

OpenText’s Enterprise And Monetary Efficiency

OpenText helps corporations handle and transfer data. Its software program and companies allow corporations to collaborate on producing content material, handle information, signal paperwork electronically, archive data, and convert paper and different data into digital content material. Its services assist corporations in industries reminiscent of “Authorized, Automotive, Banking, Healthcare, Life sciences, Public sector, and Oil and Gasoline,” in accordance with CNBC.

OpenText is barely rising. Within the September-ending quarter, OpenText reported slight progress in income and a major loss — in contrast with a year-before revenue. Income rose 2.4% to $852 million whereas its web lack of $116 million in contrast unfavorably to a year-before revenue of $132 million.

OpenText’s outlook for the present quarter is barely muted. “For the second quarter of fiscal ’23,…in fixed foreign money, we count on cloud income up 12% to 14%, whole revenues up 4% to five%. We count on FX to be a income headwind of $50 million to $55 million,” CFO Madhu Ranganathan advised traders in November.

Earlier in 2022, OpenText’s outlook was extra optimistic. CEO Mark Barrenechea advised traders in August, “We’re elevating the bar on our medium-term [constant currency] aspirations which embody progress in enterprise cloud bookings of 15% plus, whole income natural progress between 2% and 4%, elevated bookings to drive elevated cloud natural income progress of 6% to eight%.”

OpenText’s Micro Focus Acquisition

Acquisitions have been an enormous a part of OpenText’s progress technique. “We’ve got accomplished over 80 acquisitions. We’ve got doubled the scale of the corporate between 2019 and 2022. We have a look at timing, the standard of the belongings, the chance for worth creation, and return on funding. We attempt to combine the acquired firm earlier than the deal closes,” Ranganathan advised me in a November 30 interview.

So when OpenText introduced a deal to amass UK-based Micro Focus, a enterprise software program and consulting agency, for $6 billion, the merger — priced at a 99% premium to its pre-announcement inventory worth — didn’t come as a complete shock.

The merger got here after Micro Focus’s inventory had fallen 70% from its 2017 excessive. Because the Telegraph reported, the decline in inventory worth started following a “troubled merger with Hewlett Packard Enterprise’s
HPE
Autonomy which HP
HPQ
acquired for $11 billion in 2011 — finally writing down the valuation by $8.8 billion. Whereas Micro Focus picked up elements of that enterprise in 2016 for $8.8 billion, the deal did not raise Micro Focus.”

Micro Focus and OpenText expressed enthusiasm for this deal. The businesses highlighted their giant international buyer base, huge bundle of enterprise software program options, and potential to generate $6.2 billion in income, reported the Telegraph.

Market Attractiveness: Fail

Can the mixed corporations move the 4 assessments for profitable acquisitions? For my part, the merger fails the market attractiveness take a look at — that the acquired firm competes in a big, fast-growing, worthwhile business.

Moody’s Investors Service — which in November lowered OpenText’s debt ranking from Ba1 to Ba2 — was significantly unenthusiastic concerning the industries by which the businesses compete. As Moody’s wrote, “Each corporations generate a big share of their revenues from declining and mature merchandise and the challenges are compounded by the extremely aggressive software program segments they function in which are more and more adopting cloud software program options.”

OpenText views acquisitions as a way to broaden the scale of its whole addressable market. “Acquisitions have elevated our whole addressable market from $90 billion to $170 billion and can improve our revenues to over $5 billion,” Ranganathan advised me.

Moody’s evaluation makes me assign a low likelihood to the likelihood that the industries by which Micro Focus competes will develop and grow to be worthwhile. That doesn’t imply it might be unattainable for the mixed firm to speed up income progress.

It does counsel to me that with the intention to obtain that, Open Textual content might want to swim onerous towards the tide.

Higher Off: Doable Go

What does it take for a merger to make the mixed agency higher off? For my part, an acquisition passes this take a look at if the mixed corporations can improve their market share above the extent that every would have loved had they remained impartial.

That is troublesome to measure; nonetheless, I believe companies will acquire market share if they’ll do two issues:

• Present a worth proposition that customers view as far superior to the one which opponents present.
• Carry out important actions — reminiscent of product growth, advertising and marketing, gross sales, and human assets administration — extra successfully than do rivals.

It’s doable that the merger between OpenText and MicroFocus will make the mixed corporations higher off. However to ensure that that to occur, there’s a lot work to be accomplished. That’s as a result of “natural progress at each corporations has considerably lagged the expansion of the enterprise software program business,” in accordance with Moody’s.

Moody’s evaluation relies on its expectations that Open Textual content’s natural progress will improve by round 2% within the subsequent two years “pushed by progress in its cloud portfolio” whereas MicroFocus shrinks at about 5% a 12 months over the following two to a few years.

OpenText says that the mixed corporations will obtain significant enlargement of their cloud revenues, adjusted EBITDA and money flows in fiscal 2024. This might be achieved by way of $400 million in price financial savings,” in accordance with the corporate.

OpenText expects a substantial income enhance from MicroFocus. Barrenechea estimated that MicroFocus would improve income by greater than 40%, in accordance with TechTarget. He defined that OpenText’s 5 years of skilled promoting within the public cloud would assist make cloud Micro Focus’s largest enterprise.

That cloud advertising and marketing expertise may benefit Micro Focus’s clients. Nonetheless, it stays to be seen whether or not the mixed corporations will have the ability to construct merchandise that clients understand as offering higher advantages for the value than do rivals’.

NPV > 0: Unclear

The monetary take a look at for a merger’s success is whether or not the worth of its future money flows in as we speak’s {dollars} exceeds the acquisition worth.

It’s unclear to me whether or not OpenText’s merger with Micro Focus will move this take a look at. Nonetheless, by including $4.6 billion to its debt, the corporate is taking over excessive monetary threat. “Open Textual content’s gross leverage was excessive at 3.6x (Moody’s adjusted) previous to the acquisition and Moody’s expects it to extend to mid 4x, professional forma for the acquisition,” in accordance with Moody’s.

To be honest, Moody’s set a steady outlook for its ranking. The ranking company accepts OpenText’s assertion that it’ll “prioritize debt discount and cut back web debt to EBITDA towards its goal of lower than 3x inside eight quarters of closing the acquisition of Micro Focus.”

Whereas OpenText is clearly optimistic, I couldn’t discover a forecast of the money flows from the merger over the following 10 years — which I’d discover helpful for assessing whether or not the deal passes this third take a look at for profitable acquisitions.

Integration: To Be Decided

For my part, mergers must be built-in between the time a merger is introduced and the day that deal closes. In that approach, the mixed corporations will function seamlessly for workers, clients, and companions as soon as the merger is official.

The longer that integration is delayed, the extra weak corporations are to rivals who rent their finest individuals and choose off their clients. Basically, OpenText makes an attempt to do that. “We attempt to combine the acquired firm earlier than the deal closes,” Ranganathan advised me.

By integration, I imply that the businesses determine who’s answerable for every operate, draw clear reporting strains, full all price discount rapidly, and be sure that all workers, clients, and companions are utilizing the identical techniques to work together with the corporate.

OpenText started the mixing course of after it introduced the deal in August. As Ranganathan advised me in a January 3 interview, “The OpenText and Micro Focus working groups started coordinating in August and our gross sales forces might be able to go after new alternatives when the deal closes.”

Eighteen months after that, Open Textual content expects “to have Micro Deal with our working mannequin,” Barrenechea stated. As Ranganathan advised me — citing an August 2022 presentation to investors — because of this Micro Focus’s enterprise mannequin might be “uplifted to the cloud” and the businesses will obtain adjusted EBITDA within the 37% to 39% vary and “higher quartile” free money circulate of no less than 20% of income.

If you happen to suppose Open Textual content and Micro Focus will have the ability to compete extra successfully as soon as mixed and obtain these bold monetary targets by fiscal 2025, now could be a great time to purchase the inventory.