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How long should a strategic review take? We ask apropos of Micro Focus, which has delivered one this morning that results in the disposal of its chairman and almost nothing else.
You may remember that Micro Focus said with a late August profit warning that it had “accelerated” its strategic review to “consider a range of strategic, operational and financial alternatives available to the company.” But where was it accelerating from? The previous mention of a strategic review was November 2018 results, where Micro Focus noted an ongoing review specifically to fix the many broken back-office systems brought on board via its disastrous HPE purchase. So, that’s at least 15 months — unless we spin back to the only mention to shareholders of a strategic review actually beginning, in which case it’s 13 years.
Anyway. Micro Focus has concluded the process and decided that it should try to save itself rather than waiting to be rescued. No assets are flagged for disposal, which seems likely to be because no one has shown a serious interest in buying them. (Note that back in October Canada’s Open Text was bounced into saying it was not considering a potential acquisition of Micro Focus, after Bloomberg reported that it had.) Kevin Loosemore exits after 15 years, effective Valentine’s Day, to be replaced by Greg Lock as non-executive chairman. There’s also another small, not terribly surprising profit warning as investment requirements get cranked up for the long-term good. Will Wallis at Numis can give us the detail of the strategy review:
We summarise the outcome as a focus on self-help, requiring upfront P&L investment. Key actions are: 1) improved product portfolio positioning, including Security and Big Data to be run broadly autonomously (along the model of SUSE previously); 2) acceleration of the SaaS transition, albeit in a measured fashion; 3) transformation of the sales organisation; 4) successful conclusion of the ongoing systems improvements. Over the medium term, which we read to be c.FY23, management intends these self-help actions to deliver revenues flat to low single-digit growth, with EBITDA margins in the mid-40s.
On our new forecasts, the valuation is FY21 7.5x EBITDA, 7.8x P/E, 13% EqFCF yield and 6.5% dividend yield. We think additional self-help and near-term investment is in the long-term interest of the group. Our price target of 1,200p (was 1,500p) recognises the ongoing challenge, although we think 2,000p is realistic if the group hits management’s medium-term objectives.
And here’s Credit Suisse with the new numbers:
The outlook points to medium term ambitions to return the business to flat to low single digit growth. But we can’t remember the last time Micro Focus actually delivered that. We reiterate our Underperform rating.
Guidance for FY20 is another year of -6 to -8% revenue growth and $70-80m of investment into the business. If we assume that underlying margins are flat, so EBITDA falls 7%, and deduct $75m of investment, it implies FY20 EBITDA of c$1.2bn vs cons at c$1.3bn.
And Stifel’s George O’Connor can do the c-suite stuff:
While we are surprised by Mr Loosemore’s departure, we note; (i) a spate of departures in the diaspora (Ginny leaves IBM, Mike leaves dxc), which we blame on a changing market as much as ‘time of life’, (ii) newbie Chair Greg Lock is well known to UK investors – he preceded over a halcyon period at Computacenter – a vote for continuity, and (iii) CEO Stephen Murdoch has been at Micro Focus since 2012 – he owns the playbook – note also he previously worked with Mr Lock at IBM. While UK investors are likely more nonplussed by the departure, the Mr Loosemore exit may unsettle some US investors who ‘bought the team’, but we are reminded of Saxon White Kessinger who tells us that “there’s no indispensable man” [his link, not ours].
The current issues are fixable, in our view. Remember Micro Focus navigated through similar problems in 2005 and 2012 when it faced declining maintenance and revenue. Investors have seen Sage (SGE.LN) recover from similar travails – it needs People, Products, Process. We urge: (i) more corporate actions to accelerate portfolio changes with a retire/sell the rest, (ii) increased sales productivity, (iii) a more aggressive building the SI partner base, (iv) be clearer on advocating certain products which support the ‘four pronged’ product vision, use this to reconnect with customers. (v) Restructuring continues.
Of course it does.
But what about that Tesla, eh? Hitting $845 in premarket at pixel, having been up nearly 20 per cent overnight, its $780 regular session closing price giving the Wonka-esque car maker a market cap just shy of $141bn. Toyota, the world’s biggest automaker, is valued at $200bn or thereabouts — meaning Tesla is being valued at 0.7 of a Toyota having done about 3 per cent of its deliveries last year. Okay, fine.
Pundits have agreed as one that it’s a short squeeze, a theory the data only partly supports. Tesla shares on loan as a percentage of those outstanding have come down from 20 per cent-plus in early September to a recent-memory low of 7.19 per cent in mid January, Markit data show. Here’s the chart:
Explanations involving supply-demand interaction don’t help the analysts though. Morgan Stanley’s Adam Jonas — deep underwater with a $360 target and a sell downgrade two weeks ago — has taken to approaching Tesla as a kind of thought experiment.
At the time of this writing Tesla appears on track to trade roughly 47 million shares today (Feb 3rd, 2020) for a value of shares traded over $30 billion. For comparison, Apple (the world’s most valuable equity at more than 10x the market cap of Tesla) is on track to trade around $10bn of value today. Tesla shares will trade 3x the value of Apple. In our view, this sends a message not just to auto and tech investors, but to the management teams and board of directors of the world’s auto companies.
Stretching conventional thinking on what Tesla is. It is a topic of ongoing debate on the buy-side as to whether Tesla is an auto company, a tech company, or something altogether different. In our opinion, Tesla is all of the above. For example, we are picking up investor excitement around Tesla’s potential to generate substantial returns in the battery business as a separate, vertically integrated business.
There follows a very long discussion about whether Tesla will keep buying lots of battery cells, start making lots of battery cells, or both. Contact Morgan Stanley directly if lithium-ion this is your thing. For everyone else we’ll cut to the numbers.
What’s in the price? Our $360 price target is predicated on Tesla achieving 2 million units of sales by 2030 with a 15% EBITDA margin. On our calculations, each incremental 1 million units of deliveries on top of this is worth between $150 and $200 per share depending on incremental margins, assumptions on capital intensity and other factors including the multiple applied on incremental volume by 2030. Solving only for auto division unit deliveries at $40k/unit and a 15% EBITDA margin, we estimate the current share price discounts between 3 and 4 million units by 2030 (at a 6x EV/EBITDA on 2030 and a 15% EBITDA margin).
The basic argument here is that if Tesla can grow to become the OEM supplying industry standard-bearer for battery production and/or autonomous driving then it can grow into the current valuation. If it can’t — and there is no particular reason aside from cultism to believe that it will — then it’s just a wildly overvalued car maker in an increasingly crowded market.
Before we leave the theme, have another chart.
That’s Alphaville readers arriving via search (orange) and social media (blue) to Jamie Powell’s very entertaining 2018 tick-tock about the short squeeze that briefly made Volkswagen the world’s biggest company. Wonder why the sudden burst of interest there?
Back to the UK, and NMC Health has responded to Monday’s 20 per cent drop with a statement that it “knows of no specific reason for the fall”. It continues: “The independent review being undertaken by Freeh Group International Solutions LLC, announced on 17 January 2020, is proceeding. The Company’s operations continue to perform strongly and the Company expects to report full-year 2019 results in-line with management’s expectations.”
There was an NMC share-price move story overnight though, frankly, it doesn’t add a whole lot to the picture. The problem we have reporting on NMC’s daily volatility is that the shareholder list is both tight and multi layered. Add in a shrinking market cap (£2.17bn as of this morning, putting it mid FTSE 250 at the next index review) and it doesn’t take much to cause double-digit share price moves. Monday’s seemed to be triggered by a big seller willing to take nearly any price. Why? Dunno.
Ferguson, the plumbers’ merchant once known as Wolseley, has confirmed that it will be asking shareholders whether they would prefer a primary or a secondary US listing. A domicile review already feels like it has been talked about forever but, given how much this stuff annoyed Unilever shareholders, a cautious approach is understandable.
Option one would mean Ferguson would lose its place in the FTSE. Option two would likely retain most of the UK discount the stock currently bakes in versus US peers. Both options require 75 per cent shareholder approval. Consultations will run until spring with the chance of a listing by the calendar end of the first half 2021, Ferguson says. Here’s UBS:
While the review leaves several options open, “The Board believes that Ferguson’s longterm listing location is in the USA”. The issue of re-listing has always been around index inclusion and what the implications are for UK-based shareholders. We think the company’s preference is for a primary listing in the US but will now garner shareholder preferences before proceeding. Ferguson trades on 16.5x P/E (CY20E), below the average peer group multiple of 21x. Our PT is based on 70% peer group multiples and 30% DCF. We think the reaction to the announcement, while it does not give a definitive outcome, should be positive.
And Canaccord:
The shares are up by +33% over the last twelve months; the re-rating is arguably partly as a result of the anticipation of an announcement such as today’s. The shares currently trade on a 2020E PE multiple of c.17 times and an EV:Sales multiple of c.0.92 times in the context of Group margins of c.7.6%.
Taking the average PE for a group of “US peers” and assuming that Ferguson traded in line with this crude average would imply a c.+20% increase in the share price. Clearly, there remains the uncertainty over which listing option gains approval if the listing structure is changed, and Ferguson is not identical in terms of the returns, margins, risks and growth prospects of many of the peers generally chosen for comparison. In our view, a clear outcome of option 2 being pursued would likely result in the more significant rerating of the shares as the Group would trade more in line and closer to US peers.
To sellside, and Berenberg downgrades Royal Mail to “sell” from “hold” as part of a sector review.
Legacy postal companies continue to battle with letter volume declines but parcels prove a problematic alternative: The European postal sector has had a tough 18 months but, we think, it is unlikely to see any relief in the near term. Our latest survey of industry participants has revealed that the parcel industry outlook is broadly positive, with 2020 volume and pricing momentum remaining steady for now. However, letter volume declines continue remorselessly and returns-on-capital keep falling due to margin-dilutive but more capital-intensive parcel growth. We downgrade Royal Mail to Sell – we think it is in a difficult position to deal with these trends – and reiterate our top pick of Deutsche Post, which benefits from limited postal exposure, alongside profit growth and self-help opportunities elsewhere. We still like UPS (Buy: competitive gains from FedEx, automation investment realisation) and PostNL (Buy: domestic-letter consolidation upside), and continue to think that Austrian Post (Sell) does not deserve its premium valuation.
[Royal Mail’s] five-year profit-turnaround plan requires both a slowdown in letter volume declines in the UK and a step change in operational productivity. We think that the former is unlikely, given the still-high mail base in the UK and worsening momentum for letter volumes. The latter may be either hamstrung by employee unions or offset by wage inflation. If the turnaround cannot be achieved on time, the already re-based dividend might be called into question.
Berenberg is much more keen on Keywords Studios, the for-hire video games studio rollup.
2019 was a year of investment for Keywords Studios. While this put pressure on margins and earnings delivery in the near term (the reason for our downgrade to Hold in June 2019), we have always argued that Keywords is a multi-year winner. It is now time for a re-evaluation. With a very strong growth outlook, margin expectations sufficiently rebased and M&A likely to increase in the coming months, Keywords’ outlook is robust. We increase our FY 2020-22 EPS estimates by c5% as a result. With its valuation materially below historical levels and attractive versus its growth profile, we upgrade Keywords to Buy and increase our price target to 1,700p.
And RBC Capital Markets advises taking profit in AB Foods. Unchanged £28.50 target.
ABF should offer a steady Primark space expansion story, with leverage to the sugar price and improving Grocery margins. However, we think Primark UK is showing signs of maturity, with tougher comps near term, and Primark’s lack of a transactional e-com offer is likely to constrain its long-term profit pool and implied multiple. We move to Sector Perform given less valuation upside potential to our PT.
What are we missing? Quite a lot to be honest. BP results are better than expected, as is Glencore’s Q4 production report. …. Atos has sold 13.1 per cent of Worldline and the Von Finks have exited SGS … Mike Ashley’s picked up a bit of handbag maker Mulberry. … Google numbers disappoint. … Nokian of Finland has results due later today, the persistent rumour mill surrounding the tyre maker having most recently moved onto possible early-stage PE interest. … Kantar supermarket figures for January are pretty dull. … The Wuhan coronavirus shuts down Macau’s casinos and lifts global markets. … Citi rogue trader allegations take the biscuit. … And America publicly embarrasses itself yet again.
Anything else? Reader, please tell us below.
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