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

The Information Advantage

Open Text Corp 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.

Growth

42

Valuation

90

Quality

58
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Where Are We Now

Updated on: 11/12/2021

Conviction Score

5

OpenText is a business process simplifier with a recurring revenue model, traits love in a business. We would think that this segment would be performing well as organizations move their workloads to the cloud. However, recent results have been sobering, even in OpenText’s cloud segment. We think the valuation today may be too high and would like to see growth pick up.

  • Good, but not great. Cloud revenues were nearly $360 million in the company’s latest report with total revenues of $832 million. These represent growth rates of 4-5% versus the same period last year.

  • OpenText has not performed any acquisitions in fiscal 2021 or 2022 thus far. Growth through acquisitions is part of the company’s strategy, however, we have not any activity on this front as of late.

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.

The Basics

OpenText provides information management services to its clients through cloud-based software. The company serves almost 50,000 customers across over 110 countries. Their revenue structure is broken down into 4 different segments:

  • Cloud Services and Subscriptions

  • Customer Support

  • License

  • Professional Service & Other

OpenText Revenue by Segment (Q1 2022)

Source: OpenText Investor Relations

Oxford Turned into OpenText

In 1987, Timothy Bray worked on behalf of the University of Waterloo, to develop technology to index the Oxford English Dictionary. This is where he met his two colleagues, Frank Tompa and Gaston Gonnet. To index the dictionary, they were using technology called Standardized General Markup Language or SGML. This would later come to be a pivotal part of OpenText’s business.

After leaving the Waterloo project with both colleagues, the trio decided to open a company called OpenText Corporation. They took the technology of search engines from the Oxford English Dictionary project and wanted to do something with it.

During a conference, Timothy Bray heard a speaker talk about the future of search engines and how they would be the next biggest thing. He realized the technology of the Oxford project was very similar, so in 1995, Open Text Corporation released the Open Text Index, one of the first commercial web search engines. This was nearly 2 years before the world was introduced to Google’s search engine.

A few years later, OpenText shifted their focus to enterprise content management. Through the course of 15 years, the company released software to help companies manage their documents and files through OpenText’s Content Suite Platform.

Along the way, the company made acquisitions to expand their software and repository capabilities.

The Ultimate Cloud

OpenText’s main business model is centered around the cloud, or their platform, the Ultimate Cloud, an online information management system for businesses. The platform itself is split up into five different segments, managing a different side of the cloud. To keep the Ultimate Cloud sticky, OpenText releases a new product within one of their segments every 90 days.

The five applications are:

  1. Content

  2. Business Network

  3. Experience

  4. Security & Protection

  5. Developer

Content

This segment focuses on giving businesses the ability to share and collaborate information through the cloud, to allow an entire workforce to be connected, regardless of location. This segment became very useful, as nearly 75% of workforces switched to an online platform due to the pandemic.

In terms of versatility, Content Cloud has software to support all kinds of different industries. There is software deployed to support engineers with managing drawings and project plans, along with software to help companies distribute documents safely with embedded privacy features.

OpenText Content ObjectivesSource: OpenText.com

Business Network

This segment focuses on connecting data with people and systems, while ensuring it is safe and private. The main centrepiece revolves around business integration and analytics. In terms of product line up, Business Network Cloud provides almost 90 different products ranging from supply chain optimization software, consumer analytics, to even a cloud-based messaging platform for businesses to connect with one another.

Open Text Business Network DescriptionSource: OpenText.com

Experience

This segment’s main focus is with consumer management. From customer experience clients to content management, Experience Cloud ensures businesses have all the tools they need to support their consumers all around the world. Their features include Adaptive Media Delivery and Media Management for media distribution, RightFax and Fax2Mail for faxing services, and Magellan, for customer analytics and insights. Just recently OpenText made a push for a more AI-centric Experience Cloud, trying to integrate it into more of their products.

OpenText Experience ObjectivesSource: OpenText.com

Security & Protection

As companies manage millions of incoming and outcoming gigabytes of data, it is important to ensure the data is safe, secure and accessible. Security & Protection Cloud ensures companies have protected information and cyber resilience. In terms of services, this segment provides end-to-end network protection, digital investigation and forensic software, data backup and migration, and finally risk mitigation.

The main goal is to keep a company’s information safe and secure, while also being able to identify and dissolve any threats that may arise.

OpenText Security and Protection ObjectivesSource: OpenText.com

Developer

This segment’s main focus is to support the backbone of any company with technology involved – the developer. Through cloud-based API services, Developer Cloud ensures any company’s developers have access to all the tools they need to get the job done, all in one place. Companies can save on thousands of dollars resorting to this consolidated cloud service. Developers can store and manage data to access, capture and digitize information and even have access to tutorials to learn new topics.

The Move to Cloud

OpenText’s main business of information management was done primarily through licensing. Companies were required to buy a license to use OpenText’s products, either for a one-time fee, or renew the license after a period of time. This was successful at the time, as OpenText would have a consistent user base with majority of revenue coming from licenses, but with the shift in technology, cloud usage became more popular.

Thus, OpenText decided to shift its business to a Software as a Service (SaaS) . They would still keep the same focus with their brand and products but shift the platform in which it is hosted. Now OpenText distributes its services on the cloud, through a recurring fee structure.

OpenText's Transition into SaaS as a graphicSource: OpenText Investor Relations

This can be seen in OpenText’s growth strategy breakdown, as licensing and professional services are on a decline in terms of growth. On the other hand, Cloud, and Customer Support are expected to grow, signifying the success in shifting to a cloud-based service.

Transition to Recurring Revenue

As OpenText has shifted to a SaaS model, it allows for the company to have a consistent inflow of revenue from subscriptions at high profit margins. A substantial portion of OpenText's revenue is classified as Annual Recurring Revenue (ARR). Over time, this number has increased drastically.  

Strong and growing top-line revenues have positive benefits to the company. It allows OpenText to increase their Free Cash Flow, while subsequently increasing their dividend yield.

OpenText Revenue ($M) (Q1 2022)

OpenText Free Cash Flow ($M) (Q1 2022)

OpenText EBITDA ($M) (Q1 2022)

OpenText Dividend Per Share ($) (Q1 2022)

Grow, Acquire, Retain, Repeat

OpenText has a simple model when it comes to growing their company.

The first step in the cycle is to grow their products organically. Their constant push for releasing new products every 90 days allows the company’s brand to expand while being sticky.

OpenText Acquisition Strategy in a graphicSource: OpenText Investor Relations

The next step is expanding their capabilities within each product line through acquisitions. In the last 5 years, OpenText has made pivotal acquisitions to help strengthen different parts of the business. In 2019, OpenText acquired a company focused on data protection and cybersecurity called Carbonite, leading the company to strengthen their pre-existing security & protection unit while also providing more services within the segment.

Finally, the last step in OpenText’s growth strategy is to retain their customers. Their focus on providing quality services to service a variety of businesses is what sets them up for continual growth as it keeps consumers on the platform, allowing for stronger recurring revenues.

Complementing Instead of 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.

For most companies, the reason they need services such as OpenText is for Systems Applications and Products in Data Processing software, or SAP software. This kind of technology is what helps businesses manage their operations and customer relations through data processing.

Now to accomplish that, OpenText and Google Cloud each provide their own service to come together and create one powerful tool. OpenText provides its information management services and on the other side, Google Cloud provides its artificial intelligence and machine learning capabilities, to bring forth a single service that can manage and analyze data. Utilizing both companies’ marquee assets, they can come together and bring forth a product that is useful for SAP.

GoogleHome x OpenText graphicSource: GoogleCloud.com

Risks

OpenText’s main business focuses on cloud-based service, through their transition into a SaaS model, but that may pose a risk towards the other core segments of the business. Customer Service currently accounts for almost half of OpenText's total revenue. It poses the question, how will OpenText continue to grow its Customer Service segment and if there is any growth in that sector for that matter?

The licensing and professional services segment are in decline.

An important part of OpenText’s growth strategy is to make large-scale acquisitions to strengthen or expand a certain area of their business. In the last seven years, they have made four different acquisitions which have had positive impacts on the business.

The concern arises when OpenText makes an acquisition that they either overpaid for or the company does not have any positive impact on OpenText’s business. It is very important, especially for continued growth, for OpenText to acquire companies that can help the company expand their capabilities, rather than limit them.

Investors should keep track of OpenText’s acquisition case studies, studying their cost along with how the company affects the business.

Acquisitions have integration risk when becoming part of a greater offering which is part of OpenText’s strategy. They have a strong history of integration, but it always has risks.

Bottom Line

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. Their versatility in cloud products ensures OpenText can provide for any information management service that a company may need, pushing for a new product release every 90 days. This is what keeps the segment sticky.

The company’s growth strategy is what allows them to be a market leader. OpenText’s simple process of grow, acquire, and retain helps to expand their capabilities while also generating organic growth.

OpenText’s business model to complement other cloud services such as Google Cloud, is a strategic partnership that helps to bring in more consumers to their user base. The product is sticky and customer wins provide recurring revenue and cash flows long-term.

In a world when businesses need organized big data and information management to make informed decisions, OpenText can continue to grow the cloud business while other segments decline and have significant terminal value risk. Acquisitions can contribute meaningfully to their SaaS offering upon successful integration.

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