Open Text Corporation (OTEX, $43.38): “The Cloud Acquisition Machine Keeps Churning”
By: Alex Malitas, AIM Student at Marquette University
Disclosure: The AIM International Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.
Summary
· Open Text Corporation (OTEX, $43.38) is a software company that engages is the development and sale of enterprise management software which include customer experience management, digital process automation, content delivery, and analytics solutions.
· Open Text recently completed an acquisition of Carbonite in December of 2019. Carbonite provides cloud-based subscription data protection and endpoint security to small and medium businesses.
· The company has acquired more than $1 billion in cloud revenue over the last eight years.
· Cloud services has been a major driver for Open Text and with a continuous shift to the cloud, this operating segment will continue to grow.
· Open Text has seen a 14.58% increase in share price over the last 52 weeks, however this would have been much higher if recent market conditions are taken into consideration.
Key points:
In Q2 of FY2020, Open Text was able to generate revenue growth of 5% y/y to $772 million which was above street estimates. This was mainly due to continued strong growth in license revenue business segment. Management has outlined a clear and strategic path forward to integrate Carbonite into its existing business model and it appears that managements outlook suggests a 10% accretive effect from the Carbonite acquisition. While Open Text has been able to use acquisitions in the past to fuel growth, Carbonite is a unique story because of their prospective future growth in the cloud space. The estimated revenue contribution of cloud services for Open Text including Carbonite integration is in the 40-50% range.
Open Text’s main source of cloud revenue comes from the ‘business network’ segment which focuses on integration of management and secure data exchanges across systems. This allows customers to communicate and interact directly with suppliers in order to efficiently exchange information essential to business operations. Importantly, as Open Text has rolled out their cloud platform, they have seen margins increase, although license and maintenance remains higher, it is likely that cloud offerings will continue to drive higher margins in the future.
Open Text has also shown the ability to generate strong free cash flows which the consistently use to quickly de-lever themselves after major acquisitions. It is likely that management will use FCF’s to de-lever itself after the major Carbonite acquisition.
The company recognizes annual recurring revenue as 73% of their total revenue stream. This rose 6% y/y recently and stems most directly from increases in cloud platform revenue. This high amount of recurring revenue gives the company predictable base revenue streams in the future as they continue to acquire new clients both organically and through acquisitions.
What has the stock done lately?
Open Text has been a long standing holding in the AIM portfolio, being added in 2008. Since then the stock has seen two separate 2 for 1 stock splits. In the last three fiscal years the company has beaten EPS guidance and continues to see revenue growth year over year. The company’s ability to continually utilize innovative acquisitions to drive growth particularly in the growing cloud space has allowed the company to see sustained price appreciation. The company also offers a dividend at a 1.6% yield.
Past Year Performance:
OTEX has increased 14.58% in share price over the last 52 weeks, however this increase should be considered much higher based on current volatile market conditions relating to the coronavirus. In August on 2019, the company reported earning s that beat EPS consensus yet fell below revenue projections which had a negative impact on the share performance yet through the rest of 2019 the share price rebounded and surpassed its 52-week high.
Source: FactSet
My Takeaway
Open Text continues to use acquisitions to fuel its growing cloud platform and has been named a leader in business networks and content services by MarketScape and Gartner respectively. With the developing and effective shift towards a cloud platform, Open Text will continue to be well positioned for future growth which will lead to further stock price appreciation. I believe the stock can push through the current market volatility to reach and surpass 52-week highs.
Source: FactSet
