Open Text Corp: A Software Firm with Growth

| About: Open Text (OTEX)

Investors in Open Text Corporation (NASDAQ:OTEX) have been on a wild ride the past few months. After topping out at $39 in late September, the vicious market sell off took the shares to a low of $22. That’s a 43% drop which took place in the course of just 5 weeks! The stock has since recovered and is hovering just above the $30 level as I write.

Open Text is one of the few remaining successful growth stories that is trading at a reasonable multiple. The company has seen its growth rate decline from the 30-40% level to what will likely be 16% in the fiscal year ending June 30, 2009. But in this environment, any growth should be seen as extremely positive.

The company develops content management software which helps customers keep track of the growing mountains of data. One of the primary growth drivers for OTEX is a growing regulatory burden that requires firms to store, manage, and be able to retrieve a vast amount of information. With a new administration taking office and relegating more power to the government, you can expect this trend to continue.

During the quarter ended September, 2008, the company reported earnings of 53 cents per share which was up 28% over the same quarter last year. Revenue growth was only 11% coming in at $182.6 million. These metrics show that the company is able to leverage their fixed costs and efficiently drive new revenue straight to the profit line. With an impressive gross margin of 68%, the company appears to be operating very efficiently.

Management is committed to maintaining strong profit margins which is why the company will cut their headcount by 10%. This move is to take place after a new acquisition is completed and will eliminate redundant positions within the company. As a result of this move, the company has taken a restructuring charge of $20 million, but with that charge behind us, it should be smooth sailing for the next quarterly report.

OTEX reports earnings next week (January 28) and investors will be listening carefully to management’s perspective on the current market. The customer base is certainly diversified by geography and by industry, but this may not be enough since the economic slowdown is so broad. Still, a healthy balance sheet with plenty of cash should help to buffer any industry weakness. The company is also in the middle of a large share repurchase program which could help the “per share” numbers look a little better.

Given the low multiple on the stock, the strong balance sheet, and management’s commitment to profitable growth, I would expect the stock to trade higher over the next few months. In order to see profits, we will need the broader market to show some resiliency. But with all the stimulus capital being put to work, I believe the overall environment will take a turn for the better in the remainder of this quarter. Please use caution with this name as it has a volatile pattern. But if timed correctly, it could yield superior returns.


OTEX Notes

Disclosure: Author does not have a position in OTEX.