In the world of tech giants, some have become household names for investors. Others, though large and fast-growing, miss that attention, for better or for worse.
OpenText Corporation (OTEX, Financial) fits within the latter group. Since its inception as a search engine-type company in 1991, it has become something of a giant itself. It operates in the Enterprise Information Management industry, with annual revenue of more than $1.6 billion and capable of going head-to-head with names such as IBM (IBM, Financial) and Hewlett Packard (HPQ).
Source: OpenText Investor Presentation, September 2014
It came to our attention from its appearance on the Undervalued Predictable screener at GuruFocus; it gets a 4.5-Star predictability rating (very good), and its Discount Cash Value is 38% above its recent price.
History
1991: A four-person consulting group is spun off from a University of Waterloo (Canada) project to index the Oxford English Dictionary
1991: OpenText incorporates
1992: A Japanese company begins distributing its products
1993: Expands into the U.S.A. and Switzerland
1994: OpenText 4 search engine released
1995: Sees potential for intranets (internal networks); Oracle integrates OpenText technology; its Latitude Web Server allows Yahoo! to search all words on all web sites; makes two significant acquisitions - Latitude Web Server later becomes Livelink Web Server, the foundation for its core products
1996: Initial Public Offering
2007: Strengthens relationship with SAP
2011: Total revenue exceeds $1 billion for first time
2012: Mark Barrenechea appointed President and Chief Executive Officer
1995 - 2014: 48 acquisitions in 20 years, according to a September 3, 2014 Investor Presentation (Other history based on information at the company website and Wikipedia.org).
Takeaway: A well-established organization that reached $1 billion in revenue in its first 20 years, with much of its growth attributable to acquisitions.
The Business
OpenText is a software company that operates in the field of Enterprise Information Management (EIM). Think of EIM as a catch-all category for companies that provide various kinds of infrastructure for business information, data, and tools.
For OTEX, this includes five distinct groups of services:
- Enterprise Content Management (ECM), which includes records management, archiving, and email services
- Business Process Management (BPM), including software for analyzing and optimizing business processes
- Customer Experience Management (CEM), includes software that integrates internal and external content to enhance the ‘customer experience’
- Information Exchange (iX), "...a set of offerings that facilitate efficient, secure, and compliant exchange of information inside and outside the enterprise."
- Discovery, which includes the indexing, navigation, and retrieval of information in databases (for a fuller description of these segments, see the 10-K Report for 2014).
As of June 30, 2014 it employed about 8,000, including 2,000 in cloud services, 1,900 in product development and 1,400 in sales and marketing.
Revenues
The company segments revenue into four streams:
- license
- customer support
- professional service and other
- cloud services
For fiscal 2014, which ended on June 30, OpenText took in $1.625-billion in revenues. The following excerpt from the 10-K shows how much each segment contributed to the total:
Geographically, the biggest contribution comes from the United States; it provided $726-million of the $1.625 billion earned in fiscal 2014. The other major contributors are: United Kingdom, Germany, and Canada.
No individual customer accounts for more than 10% of revenue.
Competition
Both narrowly-focused and broad-solutions providers compete for EIM dollars. The big competitors include IBM, EMC Corporation (EMC, Financial), Hewlett-Packard, and Adobe (ADBE, Financial).
The company lists competitive factors this way, and in this order in its 10-K: "...(i) vendor and product reputation; (ii) product quality, performance and price; (iii) the availability of software products on multiple platforms; (iv) product scalability; (v) product integration with other enterprise applications; (vi) software functionality and features; (vii) software ease of use; (viii) the quality of professional services, customer support services and training; and (ix) the ability to address specific customer business problems."
To help maintain its competitive position, OTEX invests significantly in Research & Development and makes acquisitions.
It has developed strategic alliances and partnerships with other major players, including SAP (SAP), Microsoft Corporation (MSFT), Oracle Corporation (ORCL), Accenture plc (ACN), and Deloitte Consulting LLC.
Takeaways: OpenText offers a broad range of software and technical services to customers in the Enterprise Information Management category. It competes with some major technology companies, and has strategic alliances with others. Its revenues come from four different streams (the largest of which is customer support), and from some 140 countries (the biggest revenue contributor is the United States).
Growth Plan
As we noted in the History section, this company has grown mainly through acquisitions, spending $3.4 billion over the past 20 years to buy 48 firms. According to its Investor Presentation, "Acquisitions are core to our business model." It adds it has $3 billion in ‘gross acquisition capacity’ for the next five years. That would suggest its aggressive growth will continue over the next half decade.
For fiscal 2015 (which began July 1, 2041), OTEX outlines its overall plan this way (in its Investor Presentation):
Takeaways: OpenText plans to continue with its ambitious growth plan; a plan that depends heavily on acquisitions, as well as internal growth initiatives.
Management
President & Chief Executive Officer: Mark J. Barrenechea has held these positions since January 2012; previously, he was President, CEO, and a Director of Silicon Graphics International (SGI), and prior to that held senior management positions at CA. Inc (formerly Computer Associates International, Inc. (CA). Mr. Barrenechea is also a Director of OpenText.
Chief Financial Officer: John Doolittle has held the CFO position since last month (September 2014); previously he held the same position at Mattamy Homes and Nortel Networks.
Executive Chairman of the Board: P. Thomas Jenkins has served as a Director since 1994 and Chairman since 1998; from 2005 to 2013 he was President & CEO of OpenText. He is an electrical engineer, and has served in technical and managerial functions at several tech companies.
Board Members: areas of expertise and/or experience include hardware and software management, software services, telecommunications, software engineering, finance, and law.
OpenText receives a good score, 3/10 from ISS Governance. ISS QuickScore ratings range from 1 to 10, with 1 being the best available, and 10 the worst. OTEX receives one red flag, for Board Practices, and two green flags, for Use of Equity and Equity Risk Mitigation.
Takeaways: Although the CEO and CFO are relatively new to their posts, the company’s leadership and governance team otherwise presents as stable and diverse.
Ownership
Gurus: OTEX is held by just two of the investors followed by GuruFocus, Jim Simons (Trades, Portfolio) with 410,208 shares, and John Hussman (Trades, Portfolio) with 221,000 shares. http://www.gurufocus.com/gurutrades/OTEX
Institutions: According to nasdaq.com’s Ownership Summary, 218 institutional investors own 82,458,551 shares, which represents just under 68% of shares outstanding. Institutions include pension funds, mutual funds, banks, insurance companies, hedge funds, and other professionally managed pools. http://www.nasdaq.com/symbol/otex/institutional-holdings
Short Interests: GuruFocus assess short interests in OpenText at 4.39%, and shows that number in historical context, in the following chart:
Insiders: OpenText’s 10-K Report for 2014 shows Chairman P. Thomas Jenkins holding just over 1.9 million shares (1.55% of shares outstanding), while the current CEO, Mark J. Barrenechea, owned 302,000 shares. And, the company also reports it has formal share ownership guidelines which specify the CEO/President must own shares valued at 4 times his/her annual salary, while other senior managers must own 1 times, and non-management directors must own shares valued at 3 times their annual retainers. http://investors.opentext.com/financials.cfm
Takeaways: Gurus are light on OTEX stock, but institutions hold a respectable 68% of shares outstanding; guidelines also ensure managers and directors must commit to meeting corporate targets.
OTEX by the Numbers
Financial Strength
OpenText scores a 6/10 for Financial Strength and 8/10 for Growth & Profitability at GuruFocus:
Weighing down the financial strength score is a decreasing Cash to Debt ratio, a number which has declined for the past four fiscal years. While the company is about average for its industry (Global Software - Application) on this metric, it scores poorly against its own history. Its Equity to Assets ratio also has been trending down for the same four years.
On the other hand, its Free Cash Flow has grown rapidly over roughly the same period: 24.4% per year over the past five years and 22.10% per year over the past 10 years. As the following GuruFocus chart shows, Free Cash Flow has more than doubled since 2009:
Takeaways: Although OTEX scores poorly on the Cash to Debt and Equity to Assets ratios, we are not concerned about its debt load. Its debt reflects the industry average, and it shows strength in its Free Cash Flow.
Valuations
OpenText comes up in the Undervalued Predictable screener because it meets the criteria for those two positives:
Receiving 4.5 out of a possible 5 stars means OTEX is considered a good prospect. GuruFocus backtesting has found the average 4.5-Star stock gains 10.6% per year, while only 10% of stocks are in a loss position if held for 10 years.
The valuation piece of the screener comes from comparing a recent price against its Discount Cash Flow (note this valuation uses different criteria than the Discounted Cash Flow calculator on the Menu bar - go to the Undervalued Predictable results page, and click on this line: "What are Undervalued Predictable Companies? Click to Show / Hide")
As the image above shows, OTEX has an $88 target, while its recent price was $54.83 - that’s 38% below the Discount Cash Flow value.
OpenText currently has a 32 P/E, and as the following chart shows, this puts it in about the middle of the range it’s established over the past five years:
Takeaways: The criteria within the Undervalued Predictable screener tell us this stock trades below its Discount Cash Value; at the same time, the high predictability rating tells us this company should deliver consistently strong earnings growth and is unlikely to leave investors with a capital loss.
Opportunities & Risks
In its September 2014 Investor Presentation, OpenText describes EIM as "...a large, growing and relevant $20.9b market." It says this growth, and its own growth, are driven by digitalization, compliance requirements, security needs, cloud computing, mobility, and new business processes.
As a player in that market, the company says it has scale and momentum, with $1.625 billion in sales, 8,000 employees, and distribution (sales and marketing) in 40 countries.
As we’ve seen above, it has strategic relationships with several big IT firms, including SAP, Oracle, and Microsoft.
OpenText has a history of acquiring and integrating companies that expand its range or depth, as well as $3 billion available for new buys in the next five years.
And, it is capable of internal growth as well. In its most recent fiscal year it spent $176.8 million on research and development.
At the same time, OpenText operates in a highly competitive and risky environment.
It faces competition from companies that also have scale and momentum, including IBM. It also must contend with small, sharply-focused competitors that may be more nimble or have superior technology.
Disruptive technologies are a constant concern for tech companies; it’s the double-edged sword of the industry.
In its 10-K Report, OpenText reports the length of the sales cycle can fluctuate significantly, thereby affecting quarter-to-quarter reporting of license revenues.
It also depends heavily on third-party distributors and partners for its income, and its revenues could be hit if they reduce their sales efforts.
Product development is "long, expensive and uncertain" - so, investments in research and development this year may not produce a return in years to come, if at all. In addition, patents often become bones of contention between and among tech companies. (Opportunities and Risks based on information provided in OTEX’ 10-K Report and Investor Presentation (September 2014)).
Outlook
Overall, OpenText has a history of strong and rapid growth through both acquisitions and organic growth.
Can it continue to grow both rapidly and profitably? History suggests it can: GuruFocus puts its average EBITDA per Share Growth Rate at 22.10% per year over the past five years, 21.50% per year over the past 10 years. Earnings per Share have grown at nearly the same rate, 24.3% in the past five years.
Conclusions
OpenText should be considered by investors looking for short- and long-term capital appreciation.
With a dividend yield of less than 2%, it won’t be a fit for income investors. But, it will fit for investors who want a stock with above average growth prospects and above average predictability.
