Two software powerhouses with extensive software portfolios aimed at proprietary IBM systems are coming together with Micro Focus shelling out $1.2 billion and assuming a bunch of debt to acquire Attachmate. The combination will create a software giant with just under $1.4 billion in sales and 34,000 customers between the two of them.
Micro Focus, which is perhaps best known for its COBOL application development tools, is oddly enough the smaller of the two companies, so it might seem unusual for Micro Focus to be doing the buying. But it was always assumed that the private equity owners who had assembled the Attachmate conglomerate over the past decade would want to cash out someday and in a big way as they have done with this deal. Those equity partners include Golden Gate Capital, which owned a majority stake in Micro Focus after its initial public offering back in 2005, and was the biggest shareholder in Attachmate with a 31.5 percent piece. (The company divested its Micro Focus holdings in 2009.) Francisco Partners has a 29.9 percent stake of Attachmate, followed by Thoma Bravo with 14.1 percent, Elliot Management with 13.2 percent, and management and others with 11.3 percent. After the deal is done, these combined equity partners will have a 40 percent stake in the company, which will be Micro Focus and which will still have its shares traded on the London Stock Exchange.
In its most recent incarnation, Attachmate is privately held. The private equity partners bought Attachmate, predominantly a supplier of terminal emulation software for proprietary systems like IBM mainframes and midrange gear, and combined it with rival WRQ back in 2004. Then this company bought NetIQ, a provider of security software, in 2006 and five years later it acquired NetWare and SUSE Linux software maker Novell for $2.2 billion. Novell had $1 billion in cash, so Attachmate did not pay as much as you think for Novell. Micro Focus is paying more than it might appear to get control of Attachmate. The equity partners are getting $1.18 billion in shares of Micro Focus and the COBOL tool maker is assuming $1.16 billion in debt and other charges (including payouts to equity partners) for a total value of $2.35 billion. This is a fairly large chunk of change for Micro Focus, but the deal will triple its revenues and boost its earnings before income taxes by around a factor of 2.6. There is no way that Micro Focus could accomplish such a feat with its own product lines or by doing a series of smaller acquisitions.
The amazing thing about both Micro Focus and Attachmate is that they have very large customer bases and they both get the lion’s share of their sales each year from recurring revenue streams such as maintenance and subscriptions. A relatively small portion of their sales come from professional services, and license revenues for the combined company represented about a quarter of the revenue stream in a hypothetical fiscal 2014 that ended this spring. (Micro Focus ends its fiscal year in April, Attachmate ends it in March.) In this fiscal 2014, the combined companies derived 70 percent of revenues from recurring deals, not license sales or professional services.
“This is a transformational deal for Micro Focus,” explained Kevin Loosemore, executive chairman of Micro Focus, in a statement in a regulatory filing going over the deal. “The merger presents a rare opportunity to create a leading infrastructure software company with the scale and breadth to compete successfully at a global level. It provides us with a platform from which I am confident we can deliver significant and sustainable returns.”
As you can see, the Visual COBOL, enterprise application modernization tools, and the Rumba terminal emulators represent the largest portion of revenues at Micro Focus and together they have about 8,000 customers and accounted for $309 million. (That’s the purple and blue parts of the columns above added together.) The company acquired application development tool maker Borland five years ago for $75 million, and this business has about 2,000 customers and brought in $65 million, Various other tools make up the remainder of the Micro Focus revenue stream and have about 1,400 customers. The core COBOL development business is shrinking a bit–1 percent in fiscal 2014–and the other units are growing.
Attachmate, by contrast, saw its core host connectivity business contract by 8 percent in fiscal 2014, to $186 million. This includes the Reflection, InfoConnect, Verastream, and DataBridge product lines, which together have around 4,000 customers worldwide.
The Novell business, which includes NetWare and its Open Enterprise Server hybrid with SUSE Linux as well as GroupWise collaboration and ZENworks file and network endpoint management tools, accounted for $285 million in revenues, but shrank by 12 percent last fiscal year. NetIQ application and security management software brought in $289 million in revenues and grew 1 percent, and SUSE Linux, thanks to help from the supercomputing and SAP HANA markets, grew by 9 percent to $197 million last year. Red Hat does not break out Enterprise Linux as a separate line item in its financials, but the bulk of its revenues come from Linux support contracts even to this day and it is probably selling between four and five times as much Linux support contracts as SUSE Linux.
Add it all up, and this much-embiggened Micro Focus has been shrinking a tiny bit over the past three years but managing to keep earnings before income taxes, depreciation, and amortization more or less flat. The company is among the top three vendors in most of its product categories–it is more distant from the front of the pack in collaboration, identity management, and security tools, but these are also crowded markets.
Under the deal that Micro Focus is proposing, it will retire $1.56 billion in existing debt from both companies (with just under $1.3 billion coming from Attachmate), give $136.2 million to Micro Focus shareholders as a deal sweetener, and take on $1.85 billion in new debt plus another $150 million in a revolving credit line. Bank of America Merrill Lynch, HSBC, RBC Capital Markets, Goldman Sachs, and Credit Suisse are ponying up the money. That debt is equivalent to a year and a third of revenues, and it is substantially larger than the mere $266.2 million that Micro Focus was carrying on its books (and that still represented more than half a year’s revenue). Micro Focus has committed to chopping that debt load by somewhere in the neighborhood of $500 million in the next two years after the deal closes.
Micro Focus stock jumped 17 percent in the days following the announcement of the deal, giving it a market capitalization of $1.43 billion, so Wall Street and the City of London both seem to think this deal is a good idea despite the debt load. Breadth and depth are more important than debt, apparently.
The plan for the Attachmate deal going forward is to get the new debt facilities secure by early October, when a prospectus will also be published. Micro Focus expects to have a general meeting before the end of October to vote on the deal and to close it in early November. The deal is obviously expected to be accretive to Micro Focus earnings in fiscal 2015. During that fiscal year, Micro Focus will do a detailed review of the combined businesses and “invigorate product management,” as the company put it. In fiscal 2016, Micro Focus will be rationalizing its legal entities and product lines, standardizing the systems that run its business, and come up with a new go-to-market model. Micro Focus has more than 1,200 employees and Attachmate has more than 3,300 and presumably there will be some redundancies here, too. The idea is to stabilize the top line in fiscal 2017 and boost profits and then actually grow the top line (and presumably profits, too) in fiscal 2018.