FTSE 350: More consolidation in software and tech?

That said, in the past 12 months two software groups managed to satisfy their UK shareholders by engaging in M&A activity, but retaining their footholds on the FTSE 100. Micro Focus (MCRO) completed its tie-up with the software division of US-listed Hewlett Packard Enterprise (US:HPE) in September 2017 – a deal that made it the largest listed technology company in the UK with a market capitalisation of £9bn at the time of writing. However, we closed out our buy tip on Micro Focus at the start of this year following a mildly disappointing performance for the six months to 31 October and uncertainty regarding the HPE integration. 

Meanwhile, it was third time lucky for Aveva (AVV) and Schneider Electric’s software business. The companies agreed the terms of a merger in September, after two previous rounds of talks failed. The £3bn deal will see Aveva maintain its membership of the London Stock Exchange, although Schneider will own 60 per cent of the combined entity. We may well see more deals of this ilk over the next 12 months, with scale, international expansion and cost synergies at their core. Micro Focus certainly seems to be preparing for future consolidation having recently created a new management role: director of M&A.

Seemingly, despite being steeped in political uncertainty after 2016’s Brexit vote, London has retained its status as an attractive home for listed software. Indeed, Alfa Financial Software’s (ALFA) flotation in May 2017 marked the biggest UK tech IPO since 2015. Today, it has a market capitalisation of £1.6bn. The group, which specialises in software for the asset finance industry, reported a 57 per cent revenue increase year on year to £45.1m for the six months to 30 June 2017, or 29 per cent at constant currencies. This momentum fed through to a strong rise in EPS from 2.61p to 3.58p.

Entrance to the IC's FTSE 350 list isn’t confined to IPOs, as proved by FDM’s (FDM) promotion to the UK's second tier of companies in June. The IT consultancy reported 35 per cent sales growth year on year to £117m for the half-year to 30 June, with expansion into North America enabled by its team of ‘mountie’ employees. Good news for existing investors, but the group’s demanding valuation might be off-putting for prospective buyers.

The Wannacry ransomware cyber attack in May created havoc for organisations as diverse as the UK's National Health Service, Spanish telecoms group Telefonica and US pharma giant Merck, but provided a boon for cyber security stocks. Shares in Sophos (SOPH) rose by more than 120 per cent from January to December 2017, buoyed by increasing recognition of their value to customers, and an improved outlook for the year to March 2018. Softcat (SCT) – as one of the partner channels that Sophos works with – also had a good year. The IT infrastructure group makes a quarter of its revenue from security services, which helped push sales and pre-tax profits higher. As the world becomes more digital, hacking attempts are unlikely to let up and the EU's new data protection laws (which come into effect in May) add further weight to the importance of cyber defences.  

Regulation will also play an important role in Fidessa’s (FDSA) performance during 2018. The Mifid II rules come into effect this month, compelling companies to clarify pricing around research and execution. Within Fidessa’s 2017 half-year results, management alluded to its “global, scalable, fully managed platform” with a “range of execution tools” which “fits well with the direction of the industry”.

Elsewhere, accounting software group Sage (SGE) completed a transformation programme – announced in June 2015 – and launched its business cloud offering. Results for the year to 30 September revealed particularly strong growth from the international segment and 6.6 per cent organic growth overall. That said, we revised our Sage tip down to neutral in July, noting the accounting software group now looked fully valued.

Computacenter (CCC), meanwhile, remains an IC buy tip and we expect to see further growth in 2018. This anticipation is grounded in a November trading update, which stated that earnings for 2017 would be “comfortably in excess” of management’s previous expectations.