Open Text Corporation's CEO Discusses Acquisition of GXS Group (Transcript)

Nov. 7.13 | About: Open Text (OTEX)

Open Text Corporation (NASDAQ:OTEX)

Acquisition of GXS Group Conference Call

November 5, 2013 08:30 AM ET

Executives

Greg Secord - VP, IR

Paul McFeeters - CFO and CAO

Mark Barrenechea - President and CEO

Analysts

Scott Penner - TD Securities

Paul Steep - Scotia Capital

Kris Thompson - National Bank Financial

Thanos Moschopoulos - BMO Capital Markets

Paul Treiber - RBC Capital Markets

Steven Li - Raymond James

Richard Tse - Cormark Securities

Operator

Good morning, ladies and gentlemen and thank you for standing by. Welcome to the OpenText Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. (Operator Instructions). I would like to remind everyone that this conference call is being recorded.

I will now turn the presentation over to Greg Secord, Vice President of Investor Relations. Please go ahead, sir.

Greg Secord

Thank you, John, and good morning, everybody. I’d like to staff off the call with the reading of our cautionary statement, regarding forward-looking statements. Please note that during the course of this conference call we may make statements relating to the proposed transaction between OpenText and GXS Group Inc., as well as the combined Company’s plans, objectives, expectations, intentions and other matter that contain forward-looking information.

While these forward looking statements represent our current judgment, actual results could differ materially from a conclusion, forecast or projection in the forward-looking statements made today. Factors or assumptions were applied in drawing such conclusion or while making any such forecasts or projection as reflected in the forward-looking information.

Additional information about the material factors that could cause actual results to differ materially from the conclusion, forecast or projection in the forward-looking information and the material factors or assumptions that were applied in drawing the conclusion while making the forecast or projections reflected in the forward-looking information, as well as risk factors that may affect the future performance and results of OpenText are contained in OpenText’s Form 10-K, Form 10-Q and recent Form 8-K filed earlier today on November 5, 2013, as well as our press release that was also issued earlier today, each of which may be found on the Investor Relations section of our website.

We undertake no obligation to update these forward-looking statements unless required by law. In addition, our conference call may include discussion of GXS’s non-GAAP financial measures. Reconciliations of all non-GAAP financial measures to their most directly comparable GAAP measures have been included in today’s presentation which may be found in the Investor Relations section of our website.

With that I would like to welcome everybody at the call. With me today is OpenText’s President and CEO, Mark Barrenechea as well as our CFO, Paul McFeeters. As with previous calls we’ll read prepare remarks followed by question-and-answer session and the call will last approximately 30 minutes with a replay available shortly thereafter.

And with that I’ll hand the call over to Paul McFeeters. Paul?

Paul McFeeters

Thank you, Greg. Today we announced we entered into an agreement and planned a merger to acquire GXS. We’ve included a transaction summary presentation under the Investor portion of opentext.com that summarizes the transaction and today’s announcement. The purchase price is $1.165 billion, which represents approximately 2.4 times GXS fiscal year 2012 revenues. We’ll fund the transaction through bank committed debt financing of $800 million, cash of $265 million and equity of $100 million.

Barclays and RBC Capital Markets have provided a committed financing for the transaction by way of term loan B. We are targeting to onboard GXS to OpenText’s operating model with two years. We’re also targeting the acquired operations to be accretive within this fiscal year on an adjusted earnings basis. The transaction is expected to close within 90 days, such as the customary closing conditions.

GXS Worldwide Inc. filed certain information and reports with the Securities and Exchange Commission. Note however that these public filings refer to GXS Worldwide, while we are purchasing their parent GXS Group. The primary difference between the two reflect certain items related to accrued interest on GXS subordinated notes, accretion of Series A dividends and amortization of deferred cost, items that would not affect OpenText operation upon acquisition.

For fiscal years ended 2011 and 2012, we reported total revenues of $480 million and $488 million respectively. For the six months ended June 30, 2013, the reported total revenues are $240 million. In their filings they report adjusted EBITDA and we have presented that in the transaction summary presentation as a reference. The reported adjusted EBTIDA for fiscal 2011 was $155 million and for fiscal 2012 was $146 million. For the six months ended June 30, 2013 adjusted EBITDA was $69 million. The September 30th Q3 results are not yet published.

I’ll now turn the call over to Mark.

Mark Barrenechea

Thank you, Paul, and thank you, all for joining our call today. The next generation of enterprise software is enterprise information management. All way forward remains smarter and collaborative content with ECM, smarter process applications with BPM, digital supply chains and smarter customer experiences with CEM, analytics and search with discovery and smarter transactions with information exchange.

Today’s GXS announcement is important. It strengthens our information exchange pillar with the addition of cloud based B2B integration services and message services that is complementary with EasyLink, strengthened all of EIM with the addition of cloud based managed services, expand EIM buying centers with the addition supply chain and procurement experts, brings more industry expertise and financial services, manufacturing, retail and consumer package goods and provides more scale in the fast growth markets of APJ at Latin America.

GSX is headquartered in Gaithersburg, Maryland, with geographic headquarters in Sunbury, UK for EMEA, Hong Kong for Asia, Tokyo for Japan and Sao Paulo, Brazil for Latin America. GXS has approximately 2900 employees in 20 countries with a marquee customer install base that includes 50% of the Fortune 1000.

As Paul mentioned, the last fiscal year revenues were $488 million with adjusted EBITDA of a $146 million. We are targeting to onboard GXS to the OpenText operating model within two years. GSX is the market leader in B2B integration services. Some call it EDI, some call it B2B integration, we call it information exchange. In all cases it is the engine room of commerce. This is where companies manage their transactions with their trading partners. These services are mission critical to business. Without these services, orders would stop, shipments would get lost, invoices would go unpaid, cash would not move. These services are constantly changing with new product introduction, new procurement teams, new exchange in integration and technology standards, ERP upgrades, to trading partners and industry consolidation.

Trading partners are global in nature and information exchange and B2B integration is mission critical. The best run businesses run on adaptive B2B backbones. GXS removes the complexity and risk from the B2B supply chain by providing a single point of integration between IT and trading partners.

GXS calls their solution the trading grid. The GXS trading grid connects over 550,000 trading partners in 12 languages, 200 plus document types and 59 countries. Over the last 12 months the trading grid enabled approximately 14 billion transactions. Combined with the EasyLink network, we would enable over 16 billion transactions a year. These are global, secure and enterprise ready information exchange networks that enable ACH, EDI, notification, managed file transfer, fax, fax to email and soon secure email. These message services help companies deliver business critical services that includes treasury management, financial supply chains, order processing and fulfillment, distribution management, shipment management, claims management, customer communications and much more.

Let me spend a few minutes walking through the four main areas of the GXS products and services. First, it’s messaging services. This is a global B2B platform that provides the link between internally hosted B2B gateway software and provides for a secure, automated and rely exchange of unstructured business documents across enterprises. Key features a value added network, protocol mediation and audit trails.

Second is managed services. This is a comprehensive B2B outsourcing service that includes all of the hardware, software and staff required to manage an B2B platform while providing mapping translation, visibility documents, business partner onboarding, program management and error resolutions. Key features include supply chain visibility, invoicing, PO to cash, process administration and trading community enablement.

Third is B-B software and services. This is specialized B2B integration gateways, managed file transfers and high performance desktop EDI, allowing customers to deploy B2B integration gateways on their premises. Key features include customer premise software, connectivity and transformation.

And fourth in the GXS products and services is data synchronization. This is a catalogue service for publishing, brand, price, promoting, packaging, weight, tax and regulatory data for each global trade item that enables the exchange of products and price between the suppliers of consumer products and the retailers that sell them. The key feature is catalogues.

We remain laser focused on EIM and our five pillar strategy. We formed Information Exchange over a year ago by bringing together our connectivity, fax and capture solutions, when we acquired EasyLink. With today's announcement, we expect to deliver even greater value to our customers and partners through new services and market leading B2B integration from GXS. Upon closing, OpenText and GXS together expect to serve more than 80,000 customers and support over 16 billion annual transactions in the cloud.

Let me wrap up. BPM got stronger with Cordys. Information Exchange will strengthen with GXS. Our EIM platform is about to get stronger with Red Oxygen. When you look at our growing technology strength, that includes a soon refreshed EIM platform, a combined global trading grid, enabling over $16 billion transactions a year, a cloud based managed services business, paired with an install base of near 80,000 customers and 550,000 trading partners, passionately driven by 8000 employees strong with our financial operating model; the future of OpenText never looked brighter. I look forward to welcoming GXS employees, customers, and partners to OpenText in the near future.

Again, we’ll not be taking questions today related to financials, operations or integration. With that let me open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question today will come from Scott Penner with TD Securities. Please go ahead.

Scott Penner - TD Securities

Just wondering whether you can comment at all just on the sources of synergy for the transaction? It looks like you've acquired basically a pretty stable business with a good customer base, that's been there for a number of years in many cases. Is the goal here over the next years to sell OpenText software into this base? I'm just sort of wondering what you can provide on that?

Mark Barrenechea

We have pretty informative deck under the Investor section of our website. So I’d encourage everyone to go take a look at that. Scott, I'll emphasize Page 4 in the deck, which is strategic rationale. The first is we like the scale that it will bring to Information Exchange by adding new services with GSX market leading B2B integration platform. Second, being able to get more scale and expertise and managed hosting, which we call Cloud services, we see a fair amount of adjacency, where we can cross sell neutrally adjacent product into each of our installed base, as well as extending buying centers for both businesses. So, those are some of the sort of business synergies on go-to-market that we’re anticipating.

Operator

Your next question will come from Paul Steep with Scotia Capital. Please go ahead.

Paul Steep - Scotia Capital

Mark, maybe you can just comment -- my rough math here be that now roughly 36% of the revenue, if I'm not wrong look more transactional in nature. Can you maybe talk about where the shifts or how this sort of positions OpenText to more significantly play within customers and how heavy is the weighting now to maybe more logistics or trade finance, just in terms of what the new OpenText looks like?

Mark Barrenechea

I think a few elements, there is no doubt that kind of base of recurring revenue will be up with this combination or late towards financial services and manufacturing about, discreet in processing - the process manufacturing will be increased. So our weight will be increased there. And I’d really kind of think about the recurring revenues, the stability of our occurring revenues and jointly between two businesses as part of what we find very attractive.

I also like the fact that we’re going to extend our buying centers, and again I’d point to the deck that we posted on Slide 5, where we look at our EIM pillars plus EIM buyers to now include supply chain procurement and connecting us better with EIM trading partners and a real extended community, more extended community through EIM.

And look with the internet of all things, we feel it’s important to have platform together here, close to $16 billion transactions going through the trading grid and with the internet of things and more transactions like this, we think we’re positioned well for the future.

Paul Steep - Scotia Capital

Just one clarification before I pass it along that I think is important. On the recurring side, Mark, is the tie in more based on any firm contracts with customers or is it more, you are so deeply integrated that those customers are basically tied in?

Mark Barrenechea

Well, I think it’s a nature of both businesses. You look at our recurring revenues and GSX recurring revenues; I think it’s the nature of the business that ultimately is contractual.

Operator

Your next question will come from Kris Thompson with National Bank Financial. Please go ahead.

Kris Thompson - National Bank Financial

Mark, who are the main competitors? Does SAP play in this space and how is that going to impact your relationship with SAP?

Mark Barrenechea

I’d look at our main competitor really here as IBM. I look across EIM, whether it’d be ECM, CEM, DPM, discovery and Information Exchange. I would raise IBM sort of as our focal point to go compete against and we believe we’re going to go compete very effectively against EIM, especially with Red Oxygen and larger functional blocks, deeper integration across our many suites. So we look towards IBM as being our focal point for the company and then that focus is a very good thing.

In relation to SAP they are a strong, strategic partnerships. I am hopeful that our relation with GSX will bring us closer together as companies. We value the relationship that we have built over the last decade highly, and I suspect this will bring us closer, further apart.

Kris Thompson - National Bank Financial

Just the last one from me. Maybe Paul, for your assumptions for getting neutral or slightly accretive in 2014, what should we use for interest rate, maybe 3% and income tax rate so we can model that out?

Paul McFeeters

Certainly interest rates, you can look at the term loan B markets, but if you want to talk all in rates, that's probably not a bad proxy. And yes, a little too early to comment on tax rate until we get closed in the operations. So I will defer that question to when we pull through transactions.

Operator

Your next question comes from Thanos Moschopoulos with BMO Capital Markets. Please go ahead.

Thanos Moschopoulos - BMO Capital Markets

Congratulations on the acquisition. Paul, maybe a follow-up to the last question. When you talk about bringing the asset up to OpenText targeted model, do you mean from a both an EBITDA and a net margin perspective?

Paul McFeeters

I mean from a net margin perspective, which is essentially EBITDA but we'll leave the D in.

Thanos Moschopoulos - BMO Capital Markets

Although this seems like it was already a very profitable business. So it would seem like there's probably not a lot you need to do there necessarily?

Paul McFeeters

Yes, clearly, we’re starting off with a reasonable operating margin to begin with; correct it’s a high transaction business as Mark has indicated. So that's why we're just extending a little bit to timeframe to our typical timeframe. But I would say within -- between first and second year we're comfortable within our target operating model.

Thanos Moschopoulos - BMO Capital Markets

Okay. It looks like the revenue base has been very stable and so should it be safe for us to assume that that stability should remain the case over the next year rather than a typical decline you would typically see following an acquisition?

Paul McFeeters

Yes Thanos, we don't want to comment on the business at this point. We'll certainly come back once we close the transaction to comment more on operations and target model.

Thanos Moschopoulos - BMO Capital Markets

And just one last one from me. Mark, can you comment on the go to market? Was this primarily a direct sale? Was it a channel sale? And then under OpenText, will you have sort of an overlay sales force or will that be primarily through your existing sales force channels?

Mark Barrenechea

Thanos thanks for the question. GSX is primarily a direct sales model. So a majority of their revenues go direct. EasyLink, it's not just similar on EasyLink, but where some of our volume business goes through partners. I'm looking at certainly bringing the two businesses together. They are very complementary, we see them naturally fitting together and sort of working as a market unit together, but we'll get more details on that post close.

Operator

Your next question will come from Paul Treiber with RBC Capital Markets. Please go ahead.

Paul Treiber - RBC Capital Markets

With GSX and EasyLink, it seems like you'll be the largest provider in the B2B transaction space above IBM. Are there any antitrust ramifications?

Paul McFeeters

The deal is subject to customary closing conditions, as well as antitrust review in the U.S. We think the issues will be -- if any, very small and don't really anticipate a different than normal closing than we have experienced in past transactions. These are very complicated areas, but we're not anticipating anything unusual as from previous acquisitions we have completed.

Paul Treiber - RBC Capital Markets

And then, what's the degree of customer overlap between GSX and EasyLink and then do you anticipate any negative revenue synergies?

Paul McFeeters

So again Paul, we're not going to get into kind of the combined financials right now. But we actually look at the products in the installed to be rather complementary. On the EasyLink side the strength of EasyLink is fax and notification. Clearly it’s an EDI business there, but it’s primarily standards based and it's a much smaller component of the EasyLink business. GSX is majority EDI with some notifications within the business. So we think the customers are complementary for fax and EDI. And all those messaging services from ACH, fax, EDI, soon secure email. So technology complementary EasyLink strong on fax, GSX strong on EDI and to an extent, we do have a same customer where typically one of us is selling EDI, the other one is selling fax.

Paul Treiber - RBC Capital Markets

Just one last one. Should we expect or is it reasonable to expect GSX to be brought into Red Oxygen within the one or two-year timeframe that you are outlining for the integration?

Paul McFeeters

Good question. I would say more details to follow. Certainly we see opportunity to integrate our vendor and voice management components, our capture, a document management in the cloud leveraging managed services, but those particular details we’ll save to post closure but certainly the areas of governance capture document management, managed services are part of our strategic thesis. With the two up products and technology should be able to work well together.

Operator

Your next question will come from Steven Li with Raymond James. Please go ahead.

Steven Li - Raymond James

A few questions from me. Paul on the onboarding, given the already waiting at about high 20s EBITDA margin, why really take two years to onboard to your model or am I missing something here?

Paul McFeeters

I think what you’re missing Steven is depreciation. The depreciations range $37 million a year. We leave depreciation into our adjusted operating margin. So you are going to have to adjust for that. That’s a big difference between EBITDA margin and our adjusted operating margin. So if you factor that into the calculation, I think you’ll see that on a comparable basis on adjusted margin, it is in the 17% - 18% range.

Steven Li - Raymond James

And Paul on the stable revenues, I haven’t been able to find any but do you know if there was an acquisition by GSX in the last 12-18 months?

Paul McFeeters

I think in their 10-K I think they know what was in that time frame, might be a little bit lower than that. So details on this…..

Steven Li - Raymond James

This was 2011…

Paul McFeeters

Maybe, then that probably in the last year or two, I’d have to look but it’s in the 10-K and in our information circular but off the top of my head I don’t know if there is a significant in the last 12 to 18 months.

Steven Li - Raymond James

And then one last one from me. How much cash and debt will you have post the transaction?

Paul McFeeters

Well, right now what I can comment on is our cash at the end of the last quarter was 491 and we’re putting 265 plus with the deal cost will be on top of that. So you would deduct that also from our cash balance. And then of course closing about 90 days, you would anticipate the additional increase in operating cash for this quarter.

Steven Li - Raymond James

And did you say the cost of a new debt, how much it was Paul?

Paul McFeeters

Well, not specifying it but it’s term loan B. So if you look at our rating, current ratings in the term loan B market, the range is kind of LIBOR plus 225-250 LIBOR base about 75, maybe some amortization of cost on top of that. So all in, the amortize maybe 3 to 3.25 but we haven’t marketed the transaction and we do have committed funding but that’s kind of the estimate I would look at with today’s market.

Steven Li - Raymond James

Okay, great and then one last one before I pass the line, how would you break down the revenues transaction PS and license percentage?

Paul McFeeters

Steve, you can go and take a look at their published financials but I would sort of breakout roughly their messaging services and this is just based on their stated numbers 50-40-10. So 50% messaging services, 40 managed services, 10% software.

Operator

Your next question will come from Richard Tse with Cormark Securities. Please go ahead.

Richard Tse - Cormark Securities

Can you give us some context in terms of how this whole transaction came about? Were they being shopped around, like did you pursue them? A bit of context there?

Paul McFeeters

Richard thank you for the question. Well, look when we on-boarded EasyLink, and as we got to understand the business, the EasyLink business much better, we very much liked the space and its contribution strategically to the company and obviously to our financial model as well. And GSX was in the process earlier, sort of late spring early summer and we participated in that process. So I’d say it started with EasyLink for us, getting to the market intimately, obviously validating our strategic rationale for bringing EasyLink on, validating our financial case and with GSX in the process, we entered that process through the summer and here we are today.

Richard Tse - Cormark Securities

And then I’m not terribly familiar with the markets that they operate altogether. Obviously there are many different markets, but could you give us a sense of what their share would be either in whole or each of the segments? And then who the sort of next two competitors behind them would be?

Paul McFeeters

The markets roughly we look at Gartner Data, the size of the B2B integration markets, roughly 6 billion. So they are a bit under 10% of the total market. Nearest competitors would be companies like IBM, Sterling Commerce, Liaison, Informatica for some of the B2B analytics [indiscernible] for some of the transactional pieces.

Operator

And that does conclude our question-and-answer period. I’ll now turn the call back over to Mark Barrenechea.

Mark Barrenechea

Thank you everyone for joining us today, very much appreciate it and we look forward to seeing you all at Enterprise World later in November. That concludes today’s call.

Operator

Ladies and gentlemen, that does conclude our conference call for today. We thank you for your participation. You may now disconnect your lines.

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