Should you grab "falling knife" Micro Focus International plc?

The Motley Fool

Management software specialist Micro Focus International(LSE: MCRO) proudly describes itself as one of the largest pureplay software companies in the world. Well, right now the FTSE 100 listed tech stock is also one of the fastest falling knives.

Out of Focus

Last Monday's profit warning, the second this year, sent its shares crashing from around 1,900p to 963p at time of writing, slashing its market cap from a once mighty £8bn to around £4bn in a matter of days. Imagine losing £4bn in a week. This kind of drop attracts bargain seekers.

Micro Focus, whose customers include BMW and American Express, was always taking a chance by splashing a whopping £6.8bn on Hewlett Packard Enterprises' (HPE) software business to create Britain's largest technology company, and its bravado has backfired. It has been punished by issues relating to its new IT system implementation, poor performance of sales personnel and other factors which my Foolish colleague Edward Sheldon sets out in greater detail here.

Word of warning

In my experience, profit warnings tend to come in twos and threes, and that is once again the case. In January, its interim results said sales were likely to fall between 2% to 4% for the year to 31 October, and now we are looking at a somewhat heftier 6% to 9%.

Catching a falling knife is always tempting, as investors can cash in if the share price snaps back over the next year or two. The danger is that those profit warnings point to a serious problem at the heart of the business. The HPE Software acquisition left Micro Focus with £4.2bn debt on its balance sheet, which is now more than its market cap.

Systems shift

Management is assuring investors that it is tackling its problems by investing in field sales reps, renewing its focus on top global accounts, and strengthening its sales management team in North America. It claims its system issues are now under better control and it is making better than expected progress on cost reductions.

However (there is always a 'however 'at times like these, isn't there?) management still expects revenues to decline on a constant currency basis by 9% to 12% for the six-month period ending 30 April. You also have to set its problems against wider stock market uncertainty, which has made many investors jumpy and less willing to take a chance on stocks like this. Micro Focus did recover some lost value on Friday as bargain seekers jumped in, rising 4.85%, but it is down 1.82% today.

Mind your fingers!

Micro Focus specialises in extending the life of clients' older IT systems, sparing them from having to buy new systems. That market is still there, but I am wary. Last year I warned against catching falling knives such as Carillion, and look what happened there.

At times like these, fundamentals go out the window. Micro Focus is now trading at a forecast valuation of 6.8 times earnings, which would ordinarily intrigue, as would its forecast yield of 7.9%, covered 2.1 times. Tempting? Yes. A buy? I would wait until more bad news has been flushed out of the system.

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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has recommended Micro Focus. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.