Notes to Myself…Open Text Corp…One of my Core Holdings

Notes to Myself…Open Text Corp…One of my Core Holdings

Open Text Corp…55.47 on the TSX…42.52 on the Nasdaq

Since Open Text has grown to be one of my largest holdings (and that’s saying something considering my huge positions in Brookfield Infrastructure Fund as well as Renewable Power and Property Partners…I thought I would jot down a few details about the stock to remind myself why it is one of my core holdings. I first bought Open text in the summer of 2015 after a second earnings miss and I think the CEO may have been suffering from Leukemia at the time…Anyway I already knew about the stock as it was one of the top holdings of a fund manager I follow in the states…The fund is Disciplined Growth Investors. The fund manager wrote a great book about growth stock investing called ‘Benjamin Graham and the Power of Growth Stocks’…great book by the way. I felt strongly that it was an opportunity to pick up a quality stock at a discount so I did…

Open Text Profile

Open Text Corp is a Canada-based company engaged in software development sector. The Company provides a platform and suite of software products and services that assist organizations in finding, utilizing, and sharing business information from any device. The Company designs, develops, markets and sells Enterprise Information Management (EIM) software and solutions. Its EIM offerings include Enterprise Content Management (ECM), Business Process Management (BPM), Customer Experience Management (CEM), Business Network, Discovery and Analytics. Its software and services allow organizations to manage the information that flows into, out of, and throughout the enterprise as part of daily operations. Its solutions incorporate collaborative and mobile technologies and are delivered for on-premises deployment, as well as through cloud, hybrid and managed hosted services models.

Recent Earnings Results from TD Securities Inc as of May 2, 2019

Revenue meets consensus; margins beat. We believe that investor sentiment heading into the quarter was cautious, given that Q3 has historically missed expectations. The above-consensus results should be received positively. Revenue of $719.1mm was in line with our estimate of $716.4mm and consensus at $710.4mm. EBITDA of $261.8mm was in line with our $259.4mm estimate, but 4% higher than the Street at $251.5mm. EPS of $0.64 was in line with our $0.63 estimate, but beat consensus of $0.60 by 7%. We believe that higher mix of license revenue helped margins exceed consensus expectations. The dividend has also been raised by 15%, in line with our expectations.

Guiding for muted seasonality in Q4. Q4 tends to be a seasonally strong quarter for OpenText. Given the strong results this quarter, management expects a more muted sequential increase. Professional Services is expected to deliver flat revenue of ~$71mm q/q and FX is expected to affect revenue by -$20mm. Opex is expected to rise 4-6% q/q, much lower than our forecast. Liaison is expected to affect EBITDA margin by 100bps, but the integration is on track for it to be on the OpenText model within the first year. The F2019 target model has been left unchanged. Given that the YTD EBITDA margin is already 38.5%, above the high-end of the range, we believe that OpenText will easily meet its target.

Record cash flow; strong balance sheet. The company generated another record quarter of $269mm in FCF, following the previous record of $244mm in Q3/F18. TTM FCF is now at a record $779mm, implying that the stock is trading at a TTM FCF yield of 7.5%, the highest in our coverage universe. The company ended the quarter with $1.9bln of net debt, or a net debt/EBITDA ratio of 1.7x, well-below management's comfort level of 3.0x.

Tit-bits from TD Securities Action List at the Beginning of the Year

Proven integration capabilities. OpenText deployed ~$2.4bln in capital to complete numerous sizeable acquisitions in F2017 and F2018. Despite the large acquisitions, OpenText expanded its EBITDA margin to 36.2% in F2018, from 34.6% in F2017. As of Q1/F19, OpenText's TTM ROIC is 14.4%, a steady increase from 12.6% in F2017. We believe improved margins and ROIC demonstrate management's ability to source and integrate accretive acquisitions.

Healthy recurring revenue should provide financial stability. We highlight that OpenText achieved 73.6% recurring revenue during the last twelve months. We believe businesses will continue to shift towards the cloud. As a result, we expect OpenText's recurring revenue to keep growing, providing financial stability and predictability.

Recent Developments

WATERLOO, Ontario, July 11, 2019 /PRNewswire/ -- OpenText™ (NASDAQ: OTEX), (TSX: OTEX), a global leader in Enterprise Information Management (EIM), and Mastercard (NYSE: MA), a technology leader in the global payments industry, today announced a partnership to help companies increase financial efficiencies across global supply chains, starting in the automotive industry. The collaboration will further advance a connected and scalable digital ecosystem, allowing companies irrespective of size, location or technical capability to build increased trust and security into trading partner relationships.

The new solution from OpenText and Mastercard aims to increase the speed, compliance and security for business information, payments and financing in the automotive supply chain. It is designed to facilitate integrated payments and to enhance the management of vendor master data, enabling suppliers to better manage risk for trade finance, accelerate cash flow for outstanding invoices and secure financial transactions with enhanced digital identity.

The integrated OpenText and Mastercard offering will also provide OpenText Business Network customers the ability to access spot financing through the Mastercard Track™ B2B global trade enablement platform. It will leverage the OpenText Supplier Portal (formerly Covisint Supplier Portal), the OpenText Identity Portal and the OpenText IoT Platform, integrated with Mastercard's financial partners.

OpenText and Mastercard will provide a single user interface which links users to supplier portal functionality and to Mastercard Track, with a secure, permissioned repository of more than 210 million registered entities worldwide. Buyers and sellers maintain and exchange key information related to their businesses and Mastercard Track provides monitoring on sanctions, credit and other business standards. This eases supplier selection, compliance and risk management; enhancing the comprehensive up-to-date supplier profiles in the OpenText Supplier Portal. Expanded supplier portal capabilities such as parts and services management and IoT contextual telemetry help auto companies avoid supply chain disruptions by identifying vendors with available parts to fill production gaps.

Waterloo, ON – 2018-11-7 – OpenText™ (NASDAQ: OTEX, TSX: OTEX), a global leader in Enterprise Information Management (EIM), today announced a new partnership with Google Cloud to bring key OpenText EIM solutions to Google Cloud Platform. 

“The world’s leading enterprises need a stable and secure hybrid-cloud infrastructure to manage their most valuable business assets, information,” said Mark J. Barrenechea, Vice Chair, CEO and CTO at OpenText. “OpenText is committed to providing the widest possible range of deployment options to customers, and Google Cloud provides a strong platform for companies to securely manage their content and applications with planetary scale.”

As part of this collaboration, Google Cloud and OpenText will work together to deploy OpenText’s EIM solution suite on Google Cloud Platform. This work will include a containerized application architecture for flexible cloud or hybrid deployment models. Deploying OpenText solutions on Google Cloud Platform will allow customers to autoscale their deployments as their businesses demand.

OpenText has selected Google Cloud as its first partner to support OpenText Anywhere to deliver hyper-scale hosting functionality to customers.

“Information is a critical asset for any business, but many large enterprises have not yet fully realized the value of their Enterprise Information Management solutions. That’s why we’re delighted to partner with OpenText to help customers run their Enterprise Information Management solutions securely, flexibly and at scale,” said Kevin Ichhpurani, Corporate Vice President at Google Cloud. 

“Enterprises across all industries are looking for a flexible, secure and stable cloud infrastructure to support their transformation into intelligent and connected enterprises,” continued Barrenechea. “We are committed to working with partners, like Google Cloud, to support our customers on their cloud journey.”

Finally some observations from James Telfser of Avenue Asset Management as of May of this year on BNN’s Market Call

Open Text is a solid long-term investment with mid-single digit organic growth, substantial free cash flow growth and catalyst potential through acquisitions ($6 billion spent on 30 acquisitions in the last 10 years). Open Text trades at a significant discount to peers in the software space (11 times EBITDA versus peers at 17 to 18 times). While this discount has been driven by “lumpy” quarterly results over the years, we’ve noticed a change in management focus towards consistency, return on capital and organic growth which will help close this gap. We like the fact that annual recurring revenue makes up 75 per cent of total revenue, including cloud-based services which in the recent quarter were up 14 per cent year-over-year. We also like that the business model of Open Text drives significant free cash flow, which helps drive the M&A cycle. If you think in years versus quarters with Open Text, we believe you will be rewarded with strong shareholder returns that will likely outpace the major indexes.

Postscript

I visited the companies’ website as well and downloaded a couple of investor slideshow presentations. There is so much information there my head was swimming but the important point is this…try to get a handle on the broad-brushstrokes of what is going on. Peter Lynch once said that you should be able to explain your investing thesis with a crayon…So with Open text I see high recurring revenue coupled with lots of free cash flow which seems to be based on their business model as detailed below from an earlier blogpost of mine...and one more thing, a lot of free cash flow makes the debt a company carries on its books much less of a problem as management can pay down their debt using the cash flow churned out by the business itself...

‘Companies that have high recurring revenue usually exhibit lower sales volatility and greater predictability of their earnings and cash flows which help management lessen the operational risk of running their business. It reduces the strain from growth since a company with high recurring revenue has to put forth a lot less effort to grow revenues. Companies whose customers need to buy their products or services on a consistent basis usually exhibit less earnings volatility thus lessening risk to both the company and its investors.

The purest form of recurring revenue involves periodic licensing fees that follow upfront product purchases. This license model often appears in the software industry, where customers pay an upfront installation charge and subsequently make monthly or annual payments for maintenance, support and upgrades.’

I'll re-visit Open Text in the future and next time I'll seek out information from the management team themselves...and a big thank goes out to Frederick K. Douglas and the management team at Disciplined Growth Investors who first alerted me to this outstanding company.