Time to revisit Micro Focus cash point

Micro Focus offers a broad range of software products that modernise organisations' ageing mainframes and servers, allowing them to communicate with the latest tablets and cloud-based applications and ensuring those historical investments don't go to waste. The company has a stellar track record of generating tonnes of cash and recycling excess funds back to investors via "returns of value", or special dividends. Indeed, it has returned over £554m to shareholders via dividends, share buybacks and four cash returns since March 2011.

The directors of Micro Focus put cash returns on hold after the group acquired US peer Attachmate in the second half of 2014 for $2.5bn (£1.8bn) - a deal that roughly doubled the size of the company. The expansion of the group was aimed at addressing growth concerns due to the maturity of its end markets. Indeed, the Micro Focus's business, which accounts for four-fifths of turnover, saw a 5 per cent first-half sales decline. But following an expected 2 to 4 per cent fall in group sales this year, management expects to establish a "solid core" from which the company can grow from the 2018 financial year onwards.

Only modest top-line growth is needed over the medium term to power strong returns and management will consider reinstating cash returns once net debt falls below 2.5 times adjusted cash profit; it stood at just over 2.6 times at the end of October 2015. What's more, the next windfall for investors could be substantial. Analysts at Canaccord Genuity think the company could return about $380m, or 116p a share, in the next financial year. Combined with a regular dividend of 39p a share, that equates to a yield of 11 per cent. Meanwhile, Investec analysts think the company could sell its fast-growing SUSE business, which accounts for one-fifth of sales, for about $1.4bn to finance the return of £1.6bn to shareholders within the next two years, representing about half the current market capitalisation.

Micro Focus has realised cost savings from the Attachmate deal more quickly than expected. That helped it to outperform consensus growth forecasts for the six months to October 2015, leaving analysts scrambling to upgrade their forecasts. The merger meant constant-currency revenue and cash profit roughly tripled. Even on a pro-forma basis, operating profit climbed 13 per cent to $264m. That reflected good growth at Attachmate and underlying sales rose 18 per cent at its SUSE division - which achieved a cash-profit margin of nearly 37 per cent - as customers clamoured for open-source Linux software, enterprise servers and cloud storage. The group also realised $42m in adjusted cost savings.

Micro Focus leads the software sector in terms of total shareholder return. It has delivered compound annual returns of about 26 per cent over the past decade and management is targeting an annual return of between 15 and 20 per cent in the future. Its strong track record and recent gains underpin robust growth forecasts. Panmure Gordon - which describes Micro Focus as the software sector's "cash point" - expects the Attachmate deal to drive cash profit up 46 per cent to $523m in the year to April 2016, and then 6 cent in the next financial year. Yet despite the group's robust cash generation, improved growth prospects and the likelihood of a big cash return to shareholders, its shares trade at just 13 times forecast EPS for the coming financial year. That rating represents an unjustified discount to sector peers.

One concern for investors might be weaker first-half cash conversion caused by the unwinding of deferred revenue at Attachmate.