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OpenText Is Private Equity, Not A Software Platform

Jun. 08, 2020 9:44 AM ETOpen Text Corporation (OTEX), OTEX:CA13 Comments
A.C.T. Investing profile picture
A.C.T. Investing


  • At OpenText’s current valuation, investors should consider holding, not buying.
  • The company has an impressive track record of acquisitions and integrations.
  • OpenText has seen negligible organic growth, but the industry has grown substantially in the past five years.
  • Management sells the company as a software platform, but many factors make this hard to believe.

Investment Thesis

OpenText (NASDAQ:OTEX) is perceived as a synergetic software platform, but really it is a private equity firm and should be valued as such. Although this is a well-managed firm whose financial performance is exemplary, its current valuation does not leave much room for growth. Keep an eye on this stock.

Industry Overview

OpenText operates in various enterprise software industries with is Enterprise Information Management (EIM) suite of products. EIM is an umbrella term for software that enables firms to better control and utilize all forms of information. In OpenText's FY2019 annual report:

Our EIM solutions are designed to enable organizations to secure their information so that they can collaborate with confidence, validate endpoints with all machines and the Internet of Things (IoT), stay ahead of the regulatory technology curve, identify threats that cross their networks, leverage discovery with information forensics, and gain insight and action through analytics, artificial intelligence (AI) and automation.

OpenText's EIM software portfolio spans many sub-industries of the enterprise software industry. Below is an overview of the sub-industries in which OpenText operates and its historical and projected growth:

Source: Table by Author using data from IBISWorld

Growth in the enterprise software industries has been strong in the past five years due to increasing complexity of businesses and strong corporate appetite to invest in efficiency-improving products. Large firms have already gained the most sizable benefits of adopting enterprise software, and these high adoption rates will reduce growth moving forward. Industry growth will be driven by new products catering to niche/underserved markets and small- and mid-size business (SMB) adoption as enterprise software becomes more ubiquitous, user friendly and cost effective. Other growth areas include continuing expansion into cloud and mobile platforms, data warehousing, cloud security, automation, predictive analytics and other AI applications.

The industry is characterized by

This article was written by

A.C.T. Investing profile picture
Inspired by famous value investors. I look for obscure companies, traditional value opportunities, or cheap growth opportunities. I hold an HBA from Ivey Business School, Western University in Ontario, Canada.

Analyst’s 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.

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Comments (13)

I know this is an old article but I just read it a few weeks ago. Excellent analysis on organic growth. The article could be better if you break it down further into License/Cloud/Support/Professional but I realize that would be very difficult. It's clear from their reports that they are bleeding License revenue, but growing Cloud at a high rate and Support at a lower rate. You are probably correct that legacy software is struggling. It seems to me that they are basically acquiring new customers via acquisitions to put the on their own cloud and support. That doesn't mean they are private equity, it's a business strategy to simply get larger. Can a cloud/software support company achieve economies of scale? That leads me to my next point - I don't like how you value the company. Just because they have been a serial acquirer does not mean that they are private equity or should be valued as private equity.
A.C.T. Investing profile picture
Tech companies achieve organic growth. I am arguing that OTEX does not deserve tech-level valuations. Because it experiences zero organic growth, we should value it as such.

Margins have not been declining over the analysis period, suggesting that they are not driving any significant value through economies of scale.
@A.C.T. Investing I get what you're saying but growth is growth and the market doesn't care. It probably doesn't make sense to value them as a high growth company, simply because they haven't been one for a few years. That may change though. Right now the stock is at 13x earnings imo which is an ok price for even a company that can do 5 to 10% earnings growth. The thing is, this company can do more. Look at valuations on Constellation and Enghouse.
@BlueChipRick I agree with your point about growth being growth. I also agree with the author that the serial acquisition without synergies or purpose is also concerning. My guess is that they have some products performing better than others. MIght be time for the company to sell off the nonperforming assets and keep the ones that make sense. There is no way all segments are performing exactly the way they were upon acquisition.

I would also say that acquiring so many companies has hopefully allowed them to acquire some talented employees. That might be the most important part. Have they been able to keep their employees. I'm really only familiar with the Carbonite product. The rest I don't know.

But I think I will pass. From my point of view a company unable to grow organically has poor management and is in trouble. It shows a lack of imagination and creativity. My guess is that for a lot of their products they are simply milking the products until they hit end of life in practical terms. All I know is that they should be able to achieve organic growth with a product like Carbonite.
Comprehensive fundamental analysis; excellent historical drill-down to analyze M&A contribution, derivation of organic vs inorganic growth; rigorous valuation analysis and comparative valuation. The qualitative view is equally fully covered. I for one do not believe that future acquisitions will come as easily (and cheaply) as past precedents, in which case the implied growth rate in the current forward multiple is not sustainable. A+ effort.
A.C.T. Investing profile picture
Thank you, and agreed- I think it is trivial to assume that the past will be the same as the future due to the intensifying competition and growing appetite for M&A in the software industry.
Jack R. censored profile picture
didnt say it was fair, i said it was a bargain. 12x is fair for a flat revenue dairy company, a car dealer, a train maker. for one of the few companies that didnt report a profit warning during covid, this is dirt cheap
Jack R. censored profile picture
M&A is an optionality that comes on top for free. returns are declining of course like all M&A returns due to increased competition from private equity in a low interest environment
Jack R. censored profile picture
I really dont understand what you are talking about. You elaborate on complex calculations to value OTEX and at the end you arrive to weird conclusions.

Put it simple:
OTEX is trading at around 12-15x times cash flow or normalized earnings less amortizations.
Add to that their savings plan to reduce I think around 70M per year going forward

For a company that has extremely sticky and revenue recurring products, this is a bargain.

Whatever external growth they can deliver through M&A comes on top, and they have an impressive track record doing this.
A.C.T. Investing profile picture
@Jack R. I used rigorous calculations to find the base-case-valuation that myself and others can feel confident about. I can then incorporate the qualitative discussion more convincingly once I have done this. This is better than just a simple discussion or valuation, in my opinion.

Management has a clear financial incentive to market their company as a software platform- what I have tried to highlight in this article is that they are not. Their return on M&A is declining. The industry is fiercely competitive. Their product mix is not synergetic. Because of these factors, they should not receive the lofty valuations that software companies do.

I agree that OTEX's 12-15x cash flow valuation, as you have said, is fair. But I do not want to initiate a position in a company at a fair price. I want to initiate at a great price.

Great company, and I do acknowledge that my conclusion is quite conservative. I hope you learned something from my perspective!
KR1527 profile picture
I like OpenText but it does seem expensive here ...
Ludo5312 profile picture
An interesting perspective! That PE has been very kind to my pension fund...
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