Why Open Text Will Be A Major Player In The Software Industry

Jun. 25, 2019 10:49 PM ETOpen Text Corporation (OTEX), OTEX:CA3 Comments6 Likes
Michael Litarowich profile picture
Michael Litarowich
55 Followers

Summary

  • Diversified product offerings and revenue segments.
  • A CEO who has brought this company to new heights under his watch.
  • Open Text has strong fundamentals that speak to the sustained growth.
  • Its market share is growing, and Open Text has an advantage over the big brand names with its EIM software.

Editor's note: Seeking Alpha is proud to welcome Michael Litarowich as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA Essential. Click here to find out more »

Editor's note: Seeking Alpha is proud to welcome Michael Litarowich as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA Essential. Click here to find out more »

For many investors, Open Text (NASDAQ:OTEX) has largely flown under the radar, and for good reason. This article will largely discuss why the underlying fundamentals for this company, and its growing presence in the Enterprise Information Management software business, could take it to new heights in the coming years.

Overview

Open Text’s primary specialization is its Enterprise Information Management (EIM) software. The software enhances supply chain analytics, structures data series, provides cloud services, implements artificial intelligence to analyze underlying business trends, and much more. The company is considered by many to be the leader in the EIM space, due in part to the 29 acquisitions it has completed in the last 18 years, dating back to 2003. All software offered by Open Text falls under the revenue segment of “licenses” and accounted for 15.56% of the company's total revenue in 2018.

Open Text provides supplementary services related to its EIM software that includes consultations, learning the program, optimizing assets, and more. These professional services are what help clients integrate and implement the EIM software into their businesses. Once businesses purchase the software, they can then receive further support on maximizing the benefits from it. The professional services segment made up about 11.23% of all revenues in 2018.

Another source of revenue is from Open Text’s cloud services. The primary functions of its cloud services are securing data, transferring data between different platforms, and providing security eliminating the need for data storage hardware. The cloud services were 29.44% of total revenue for 2018.

Lastly, the most profitable revenue segment is the customer support provided with the products. This is a yearly subscription service and provides insurance if anything goes wrong with any of the products or services, and Open Text will provide all support necessary to ensure operation. This customer support includes various software upgrades, online support, functionality issues, product information, and more. The customer support segment made up 43.77% of the total revenue in 2018.

Overall, cloud services and customer support are what drive the revenue growth of the business. The bread and butter for this company has been its ability to provide a unique product to clients and provide exceptional support to ensure the products are integrated properly and efficiently. Revenue has grown by about 16% on average over the past 5 years, and has ramped up to 25.59% in 2017 and 22.88% in 2018.

Company Management

In 2012, Open Text hired a new CEO by the name of Mark Barrenechea. When he was brought on as CEO, he was diagnosed with cancer, but that did not affect the business operations, which speaks volumes on how he handles adversity. Shareholders started seeing instant returns when he took over the company, and this chart from the 2018 annual report illustrates this point.

Source 1: Open Text 2018 Annual Report

Shareholder returns have more than doubled during his time in office, staying on pace with other major indexes. When Mark Barrenechea joined the company, its enterprise value was $2,128,945. As of 2018, the enterprise value is $11,462,711, increasing more than 5 times over under his watch.

Underlying Fundamentals

The fundamental analysis is what really makes Open Text shine and is why I am bullish in the long term. Over the trailing twelve months (TTM) ended March 31, 2019, it is trading at a multiple of 39.37 times earnings. Looking at the closet comparable public companies, you can see the Open Text stands out among the rest.

Source 2: Pitchbook.com

The majority of the companies on this list have no price-to-earnings because they have negative earnings, with some having negative earnings for consecutive years. The closest true competitor to Open Text is Box (BOX) and it too is not a profitable company. According to CSIMarket.com, the industry average P/E ratio for companies in the software industry is 31.29, which puts Open Text at the sweet spot right near the average.

Another metric that speaks to Open Text’s profitability is their operating margins. In the TTM ended March 31, 2019, the company has an EBITDA margin of 35.70%, well above the industry average of 27%. This margin has grown every year since 2012, which can be attributed to the consistent acquisitions made by the company as well as its increasing client base. Open Text has a much lower cost of sales because most of its assets can be reused several times and most expenses come from payroll. As with all companies operating in the software industry, operations are not as capital-intensive as those in retail.

The net profit margin is, and has been, on the low side, with the most recent number being 9.58% over the TTM. The company's operating expenses have been growing very fast because of the increased number of clients using the software, and this is something to keep an eye on in the future. The majority of the "selling and marketing" line item expense is from payroll and commissions to employees. We will need to look for cost cutting in R&D and SG&A in future reports, which will indicate increased profitability in the future.

Balance Sheet

It is always important to analyze companies from several different angles, and one approach I like is using the Uniform Adjusted Financial Reporting Standards (UAFRS). A firm that specializes in using this reporting method is Valens Research. I will not explain how UAFRS is performed, but the concept is that it removes a lot of the GAAP and non-GAAP accounting methods from the numbers on the annual report and represents a more accurate number.

Looking at return on assets, there is an incredibly large difference in the reported number in the annual statements and the number after UAFRS.

Source 3: Valens Research

Using UAFRS to achieve an adjusted ROA number shows a company that is utilizing its assets much more effectively than using as-reported numbers. This signals to us that Open Text is providing quality services that clients keep returning to use. Since 2007, we have seen remarkable consistency in this ability. Open Text has been expanding its products and services over the years, and there is no evidence that this will slow down anytime soon.

The overall strength of the company is evident from its operating metrics, profitability metrics, and multiples. Zooming in more on the balance sheet, I want to point out the "deferred revenue" line item. This has been the fastest-growing liability on the balance sheet and relates to cloud services and customer support agreements. As a result, this has an increasing effect on the company’s enterprise value, giving it additional cash up-front that allows it to service debt obligations and growth opportunities.

The current capital structure is about 60% debt and 40% equity. In 2013, Open Text’s closing debt balance was $565 million, and that has more than quadrupled up to $2.620 billion in 2018. This was a major shift in the capital structure of the company, which was about 44% debt and 56% equity. This shift lowered its weighted average cost of capital and was one of the catalysts that saw the stock price more than double from 2013 to 2018.

The continued efforts towards maximizing return on invested capital and lowering its costs of obtaining capital has been fueling the accelerating growth since 2013. We’ve seen the balance sheet grow every single year, and have seen increasing strength in operating metrics. Looking forward, the company has maintained a steady cash balance that should continue to service all debt obligations and fuel expansion. Consistently high margins have been a catalyst towards increasing the cash balance all the way to the bottom line.

What’s Next

Looking forward, I think we will see a lot of the same from Open Text. The company will keep adding to its existing software and services by way of acquisitions and getting rid of potential competitors in the process. As it stands now, the Enterprise Management software market is expected to be worth $213.43 billion by 2020 with a compound annual growth rate of 7.4%. With that growth rate, we can estimate the total market size for 2018 was around $183.01 billion. Based on reported revenue for Open Text in 2018, the calculated market share is 1.5% for the entire enterprise application software market.

The increasing use of cloud services among businesses has seen Open Text’s cloud revenue grow every year. Looking forward, it is reasonable to assume the company’s cloud services will continue to grow as it adds to this through acquisitions and research & development. Mark Barrenechea has completed two acquisitions in 2019 to go along with the 15 acquisitions completed during his tenure. He states in an interview with Bloomberg that he has been looking for genuine assets from the acquisitions and integrating them to create a “powerhouse cloud platform.”

With all this being said, the key drivers are going to be the growing cloud platform and customer support offered to its clients. Aside from announcing more M&A activity, the company has been quiet on plans moving forward. Open Text is very aware of what its strengths are and what it needs to do to continue this growth moving forward. I think these initiatives include expanding its portfolio of large clients, scaling internationally, improving its cloud software, possibly through a large acquisition, and growing its existing service offerings.

The major risks to the growth of Open Text is going to be large competitors such as Amazon (AMZN) and Microsoft (MSFT) in the cloud space. These two companies, along with others, are established and are growing fast, as well as gaining market share in cloud services. The threat comes in the form of brand names as well, because Open Text is a much less-known name in the technology sector.

I believe that Open Text is going to compete with the Microsofts and Amazons of today through its EIM software and customer support. The company’s platform allows for easy integration of its cloud services, and as its business clientele grows, so will its cloud services. If Open Text can continue to effectively leverage its EIM software going forward, then I believe its other services will grow because of the satisfaction of current clients.

Overall Analysis

For a recap, I have presented the products and services Open Text offers, a comparison between similar public companies, and the underlying profitability metrics. I am bullish on Open Text in the long term because of its ability to show consistently high fundamentals. The P/E ratio is in line with industry averages and above that of its peers. Several comparable public companies that operate in the EIM software space have consistently negative net income and are not returning capital to shareholders, and Open Text is one of the few that does.

Open Text has been extremely active in acquiring other companies, and there are no signs that suggest this will stop anytime soon. This has allowed the company to quickly expand its product offerings and enhance the capabilities of its existing software. Its asset growth has benefited from this as well, increasing the enterprise value over time. The adjusted ROA number shows us a more accurate representation of how effectively the company is using its assets to generate profits.

It is reasonable to see the stock price double over the next 5 years. Open Text is part of a booming industry that is still in its infancy. The strength and growth of the company’s balance sheet should eliminate worries about additional stock offerings, servicing debt, or losing enterprise value. Barring any major recessions, we should see this expansion continue and growing market share for the company.

As the Enterprise Information Management software industry grows, Open Text will be at the forefront with a very established business. Cloud services are growing at a torrid pace, and Open Text has the advantage of having an established cloud platform. The CEO has pushed this company to new heights since he came on board in 2012 and is a stalwart on the management team. Open Text will be a major player in the technology sector in the future, and I hope this article sheds some light as to why.

This article was written by

Michael Litarowich profile picture
55 Followers
I am a graduate with a Masters in Finance and write articles for Seeking Alpha because of my love for research. I enjoy performing due diligence on my investments and will share some of my ideas here! I follow most industries to stay up to date on current conditions and to diversify my investments. I enjoy build financial models on various companies to see how my numbers come up against the professionals in the industry.
Follow

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Recommended For You

Comments (3)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.