OpenText Logo
OpenText Corporation (OTEX) Stock | NASDAQ: OTEX | TSX: OTEX.TO

Covered by Stratosphere

The Information Advantage

OpenText Corporation (OpenText) grew out of a technology project involving the Oxford English Dictionary at Canada's University of Waterloo in the mid-1980s. Its software allows clients to archive, aggregate, retrieve, and search unstructured information (such as documents, e-mail, presentations). The company is based in Ontario, Canada.

Stratosphere Score

7

Growth

4

Valuation

10

Quality

6

Margins

9

Dividend

8

Balance Sheet

6

Investment Thesis

  1. OpenText's shift into cloud-based services for information management has had a proven track record of success and continues to bring in strong recurring revenues.

  2. OpenText provides sticky information management software that are deeply engrained in large enterprise's technology stack.

  3. The business has demonstrated strong capability in making large acquisitions to grow the business in secular trends such as cloud and cyber-security.

  4. Many business segments are in structural decline, however the cloud segment is expected to grow at high teen figures with strong margins and recurring revenue.

  5. Instead of competing against big cloud competitors, such as Google Cloud, Azure, and Amazon Web Services (AWS), OpenText uses its cloud infrastructure to complement these services.

Key Company Metrics

A set of metrics we constantly keep updated to monitor the investment thesis.

Competitive Advantages

Complementing, Not Competing

Instead of competing against big cloud competitors, such as Google Cloud, Azure, and Amazon Web Services ("AWS"), OpenText uses its cloud infrastructure to complement these services.

Many companies need OpenText's services for Systems Applications and Products in Data Processing software, or SAP software. SAP software helps businesses manage their operations and customer relations through processing swaths of data to get a comprehensive view of their customers and operations.

OpenText strategically partnered with Google Cloud to create one powerful tool. Google and OpenText have come together to bring forth a unified service that can powerfully manage and analyze data by leveraging OpenText's information management expertise with Google Cloud's artificial intelligence and machine learning capabilities. While it would be difficult to have OpenText's information management systems scale on their own cloud platform, the robustness of the Google Cloud platform allows OpenText to scale with companies of any size. There are essentially no limitations in terms of data storage, deployments, or workloads. Google Cloud opens up a world of opportunities in this regard.

OpenText takes a similar approach with other major cloud providers, like AWS and Azure. Instead of competing with these cloud providers - which would likely be an out-of-reach feat - OpenText sits on top of these cloud platforms, boosting the value proposition of its services. Global enterprises are swiftly migrating workloads to the cloud, and OpenText's cloud-native applications can seamlessly ride this wave.

OpenText's partnership structure also allows it to compete against much larger technology behemoths in the same industry - IBM, Adobe, and Veeva, among others.

Cloud-Native Platform

Like many software businesses, OpenText's main business (information management) was sold primarily through licensing. Companies were required to purchase a license to use OpenText's products either through a lifetime, one-time fee, or a renewable license. This worked historically as major software providers used a similar approach. However, licensing in general began to fall out of favour as the revenues were more cyclical and prone to volatility, and software piracy was a legitimate concern for many software providers as well. On top of that, cloud usage has been rising dramatically over the last decade or so, which cultivated a new way of doing business in the software world - eliminating perpetual licenses in favour of software-as-a-service ("SaaS").

OpenText had decided to shift its business to the SaaS model as well, a move that was pervasive in the software sphere. The company would still keep the same focus on its products and brand but shift the platform in which the products are hosted. Today, OpenText distributes its services on the cloud using a recurring fee SaaS model.

This shift was important for one main reason - every company was "locking in" future cash flows through subscriptions and contracts to make more money and more accurately predict research & development expenses to continue competing in the market. The software industry is highly fragmented with many nuanced offerings. Research & development, therefore, is a paramount expenditure, and is expected to eat up roughly 12-14% of OpenText's revenues.

This shift was arguably a necessary one, and it fortunately came with many benefits. The company is seeing its subscription-based services increase while its licensing offerings decline.

OpenText's main business model is centered around its cloud platform, the Ultimate Cloud, an online information management system for businesses. The platform itself is split up into five segments, each managing a certain facet of "information management". To keep the Ultimate Cloud sticky, OpenText releases a new product within one of its segments every 90 days.

The five applications are:

  • Content

  • Business Network

  • Experience

  • Security & Protection

  • Developer

OpenText 2022 Guidance

Opportunities Ahead

  • Grow, acquire, retain, repeat. OpenText employs a relatively simple to spur growth. The company's main focus in on organic growth. With the shift to SaaS, OpenText has more predictable cash flows while the licensing services modestly decline. As these services get smaller, more investment dollars from the rising SaaS revenues can be put towards just that - SaaS. OpenText can continue to leverage its partnerships and develop new products every 3 months to expand its value proposition while also remaining relevant among its customers. As long as the products remain sticky, OpenText can also continue to acquire businesses to boost its value proposition when developing a certain product or feature in-house is too expensive. The company has completed over 10 "material" acquisitions since 2016, and we believe the pipeline of new acquisition targets should be robust enough to continue growing this way.

  • The cloud continues to have a long runway. It is imperative to have deep relationships with the most influential tech brands as they roll out cloud advancements. OpenText is likely too small to tackle these issues on their own. Continued partnerships with the Big 3 cloud providers, SAP, Oracle, Salesforce, and many other large technology companies should allow OpenText to grow with the rising tide.

  • OpenText is focused on further penetrating the G10K (i.e., the Global 10,000 companies). OpenText's installed customer base includes companies of this calibre. Developing products that allows cross-selling and integration opportunities makes things easier for these clients. Ultimately, the focus on this cohort of customers - who are a significant source of revenue to OpenText - should result in growing cash flow generation.

Risks

Low Growth Profile

While OpenText has done well transitioning its products into the SaaS model, the company's growth has been underwhelming. OpenText's cloud revenue is the only main contributor to the 3-4% growth expected in 2022.

In 2022, OpenText expects its cloud business to grow between 8-10%. While these are respectable growth rates, they do not line up with the growth rates that other industry players are experiencing. Therefore, it appears OpenText is losing overall share to its larger competitors.

However, there is a mitigating factor - OpenText trades at a much cheaper valuation than many of its peers.

Declining Segments

OpenText's licensing and professional services segments are seeing constant / declining growth rates.

While these are smaller segments that do not contribute much to the revenue pie, they still exist and sap the income statement of resources that could have otherwise been used to boost advancements in Cloud and Customer Support.

We believe a risk with OpenText is that the company is not being aggressive enough in its strategy, allowing some customers to continue paying for services that are not moving the needle.

We would prefer to see OpenText transition these customers into the SaaS model, look into selling these units (if at all possible), or redirect financial resources away from these weaker segments.

Acquisitions

An important part of OpenText's growth strategy is to make large-scale acquisitions to strengthen or expand a certain area of its business. In the last seven years, the serial acquirer has made four acquisitions that have had positive impacts on the business.

While some of these acquisitions were successful, OpenText may be faced with some challenges when seeking and purchasing acquisition targets:

  • OpenText is not widely known as an ultra-premier SaaS provider. Many targets may seek to be acquired by some of OpenText's competitors instead, who could realize synergies quicker and scale the joint businesses faster.

  • OpenText has certain business segments that are hardly growing. This may make it difficult to attract targets who may be seeking for a partnership or equity position in the joint company. It may not be attractive to these owners to sell their business(es) to a company that moves "slower" than its competition.

  • The boost from historical acquisitions are unclear. Despite integrating some strong companies, the company is still growing slowly. While we cannot see the deal-by-deal results post-acquisition, the slow growth on the top line could be indicative of weaker-than-expected post-acquisition impacts. OpenText might be overpaying for its acquisitions, miscalculating opportunities, or both.

If the company continues to see weak growth, it may land itself into a vicious cycle - low growth leads to pressured acquisitions, which will likely end up not helping OpenText as much as the company thought it would, which could lead to even lower (or negative) growth.

We believe investors should tread carefully despite OpenText's optically cheap valuation multiples.

Join our stock investing newsletter

Investing articles and ideas in your inbox

We won't send you spam. Unsubscribe at any time.