HP Inc. (HPQ) – Market cap as of 30/09/2016: $26.57bn

Hewlett Packard Enterprise Co. (HPE) – Market cap as of 30/09/2016: $23.08bn

Micro Focus International plc (MCRO) – Market cap as of 30/09/2016: $5.04bn

Introduction

On September 7, 2016, Micro Focus and Hewlett Packard Enterprise (HPE) announced an $8.8bn “spin-merge”, where Micro Focus will acquire “non-core” software assets from HPE, and HPE shareholders will hold 50.1 percent of the merged company. The new company will keep its current name (Micro Focus) and its listing on the London Stock Exchange.  The announced deal will be the largest acquisition by a British firm of a foreign technology company and it represents the latest Hewlett Packard’s move in its attempt to refocus and narrow its business model.

About HP Inc. and Hewlett Packard Enterprise

Founded in 1939 by two Stanford graduates, Hewlett Packard Company was an American multinational company active in the sector of Information Technology. The company was specialized in the development of computing hardware and software and it served both consumers and corporate clients. However, in order to become more agile and to avoid the plague of large conglomerates, the company decided, in October 2014, to spin off its faster-growing and higher margins enterprise hardware and services business from its PC and printers operations. The deal closed in November 2015 resulting in two publicly trading company: HP Inc. (HPQ) and Hewlett Packard Enterprise (HPE). HP Inc. is a now only a provider of personal computing devices and printing products, while HPE offers technology solutions to corporate customers worldwide. Both companies generate more than $50bn revenues. Following the spin-off, Meg Whitman, former CEO of the conglomerate firm, became CEO of HPE while Dion J. Weisler, former Executive Vice President of Printing & Personal Systems, was appointed CEO of HP Inc.

About Micro Focus

Founded in 1976, Micro Focus International plc is a UK-based multinational IT company. The firm specializes in providing software and consultancy services for corporate clients updating their IT infrastructure to more modern platforms. The company serves approximately 20,000 customers widespread in more than 30 countries.

Among others, Micro Focus provides software and solutions in the fields of: (i) application delivery and testing, (ii) security management and (iii) identity and access management. The company went public on the London Stock Exchange in 2005 and subsequently became part of the FTSE 100 Index. In FY2016 the firm generated $1,245m revenues and $532.5m EBITDA and it currently counts more than 4,500 employees.

Micro Focus has a proven track-record of successful acquisitions. In 2014, it acquired Houston-based company Attachments specialized in distributing the Linux operating system, while in 2016 it acquired Serena Software a leading provider of Application Lifecycle Management software, which helps companies to automate and control their IT processes.

Deal Structure

The transaction is going to be worth a total aggregate value of $8.8bn. The acquisition will be financed with both equity and cash. Micro Focus will pay HP Enterprise a total amount of $2.5bn in cash, while the remaining $6.3bn will be paid to HP Enterprise with the equity of the newly-formed entity. HP Enterprise will indeed acquire the control of Micro Focus with a 50.1% stake into the company, whereas the rest will be split among existing shareholders. After the acquisition, Micro Focus will generate c. $4.5bn in combined revenues and c. $400m in synergies.

Deal Rationale

This acquisition will bring two well established software vendors with highly complementary portfolios together. It will allow Micro Focus to be better positioned against competitors such as Microsoft, IBM and more specialized companies such as Red Hat. After the acquisition, Micro Focus is expected to have combined annual revenue of $4.5bn, rising almost fourfold from the current $1.2bn. Kevin Loosemore, executive chairman of Micro Focus, said that “the time is right for consolidation in the infrastructure software market and this proposed merger will create one of the leading players in this space.” Indeed, the combined entity will be one of the world largest infrastructure specialized software company.

Micro Focus has recently shifted strategy towards buying higher growth software businesses such as SUSE, the world’s number 2 maker of Linux software, and HPE’s software business fits this strategy well.

The company is expected to leverage the newly acquired assets to bolster its software products that serve clients in a variety of operations including business application, security and data centers. Micro Focus expects to improve margins on HPE software assets by one fifth by the end of the third full financial year following the close of the transaction. This would bring core earnings margin for the mature assets in the deal from 21% today to Micro Focus’s existing 46% within three years.

Additionally, separation of HPE’s software business is consistent with Meg Whitman’s – HPE’s CEO – plan. Indeed, she is refocusing the group on fewer segments such as networking, storage and technology services.

The transaction is expected to accelerate HPE’s strategy to improve growth, margins and free cash flows. With approximately $28bn in annual revenues, the future of HPE will have significant scale and a diversified portfolio with a global footprint created to provide solutions that meet evolving needs of its customers and partners.

Finally, HPE and Micro Focus announced plans for a commercial partnership that will name SUSE as HPE’s preferred Linux partner and will match HPE’s Helion Open Stack and Stackato solutions with SUSE’s OpenStack expertise to provide top-quality enterprise hybrid cloud offerings for its clients.

Market Reaction

On the day the deal was announced, Micro Focus shares surged by 14.7%, while HP Enterprise ones plunged by c. 4%. Investors seem to be confident in the fact that Micro Focus will be able to expand its core business by external growth, while HPE shares fell probably because of uncertainty on the value of the deal for the company’s shareholders.

Advisers

JPMorgan Chase & Co. is Micro Focus’s lead financial adviser and is providing $5.5 billion of financing. Numis Corp. also is advising the U.K. company. HPE is being advised by Goldman Sachs.

 

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