The decision by Fidelity National Information Services Inc (FIS) and Misys plc (London: MSY) to abandon takeover discussions has sent the Misys share price into a tailspin, inevitably accompanied by a degree of unwind of risk-arbitrage positions, Jefferies said in a note to clients.
"While our expectation of a successful conclusion to these discussions has proven incorrect, we believe that management’s plan of action continues to centre on divestment of the Banking and Capital Markets divisions," said Milan Radia, an analyst at Jefferies.
The strategic attractions of the two businesses are substantial, albeit in different ways. Banking offers a potentially enormous upgrade-centric revenue opportunity from its installed base, which Radia quantifies at comfortably in excess of $750 million. Capital Markets, on the other hand, offers an acquirer 40 percent global market share on a plate.
Radia said if other interest could emerge that provides a better potential outcome, perhaps with greater complexity, then Misys was well-advised to not seek to address those discussions within the confines of the FIS offer period.
Radia does not expect Misys' management to linger unnecessarily with respect to moving forward with strategic developments.
-- Scenario 1 (no deal): This is, of course, a highly disappointing outcome in the short-term and one that seems to be a function of the substantial volatility that has punctuated financial markets globally over the past few weeks.
In these circumstances, Radia cited a share price range of between 3.00 and 3.40 pounds sterling. The lower end of this is led by risk-arbitrage funds heading for the door, but such a move should tempt some buying interest from long-only investors able to devote time to understanding the overshoot, Radia said.
Radia said one lasting effect of the discussions with FIS is a degree of positive recalibration with respect to the perceived quality of Misys’ financial systems businesses that have been perceived by some as a lost cause.
-- Scenarios 2A (Core Banking sale only): Radia has previously viewed this as an insurance option if none of the potential bidders for the whole of Misys were to decide to proceed.
Radia's sense has been that a previous process to sound out interest in just this division ultimately crystallised into a bid for the whole company. This is simply speculation on his part.
However, Temenos is a good example of a rival vendor that would be keen to acquire just the Banking business, which includes BankFusion. Similarly, FIS could still seek to opt to acquire Banking alone.
The valuation implications of this are still favourable as significant look-through upside would be generated for the Capital Markets business and as such Radia would anticipate share price upside to between 4.00 and 4.10 pounds sterling.
-- Scenario 2B (different acquirers for each of Core Banking and TCM): This scenario centres on separate bids emerging for each of the Banking and Capital Markets divisions.
At the turn of the year, Misys management acted to separate the two divisions to facilitate precisely this form of transaction, both across development and sales functions, although each is still based in the company’s Paddington Basin headquarters in London.
This turn of events would evidently involve greater complexity and transaction risk relative to an outright sale, but remains attractive now that discussions with FIS have floundered. Radia therefore assumed a price range similar to that for Scenario 3A, i.e. 4.40 to 4.60 pounds sterling.
-- Scenario 3A (one bidder in entirety uncontested): Radia retains his view that Misys would probably not have opened its books to FIS for an indicative offer of less than 4.50 pounds sterling and the fiscal 2011 results did not seem to contain any surprises that might have led FIS to materially reconsider its starting level.
That said, market conditions and sector valuations have deteriorated significantly since takeover discussions were announced on June 21. This does seem to make this scenario less likely, even for potential buyers with substantial net cash balances. Radia pegs his exit price range for this scenario at 4.30 pounds sterling up to 4.50 pounds sterling.
-- Scenario 3B (one bidder in entirety, competing offers): Were rival trade buyer interest to emerge in the entire company, then competitive tension would naturally be created, implying a higher price. Misys Capital Markets has 40 percent market share, almost three times that of the number 2 ranked vendor, namely Sungard.
Notably, none of the largest Banking systems vendors are present in the wholesale banking/capital markets segment, despite a number of synergies between the two areas. Radia's expected exit range in this scenario is 4.80 to 5.00 pounds sterling.
In broad terms, Radia has thought about potential takeover outcomes in three main categories as set out.
"We are currently in Scenario 1, where the market is factoring in no prospect of any deal. While the initial price reaction has taken the stock down to under 3.00 pounds sterling, we struggle to derive a valuation of under about 3.40 pounds sterling even using highly cautious multiples," said Radia.
"Given our stance that management resolve to complete the turnaround process with an exit from both divisions, Scenario 2B seems to be the most likely outcome from this point, with the timeframe of fiscal 2012 to end-May," Radia added.