Shares of Open text (OTEX) fell to their 52-week lows, which is not unexpected as many tech names sold off in the past week. In contrast, equities did not experience the same boom higher as well in 2021.

Open Text has a solid track record, largely thanks to a successful deployment strategy. My last take on the company dates back to September 2016, when the company announced its biggest deal yet (at the time) with the $1.6 billion purchase of select Dell/EMC assets. In the meantime, Open Text has continued with its trading strategy to grow the business, but it’s worth asking whether the growth target itself is the right strategy, because total growth here doesn’t translate into a large creating value for shareholders.

old plug

Open Text is a very interesting Canadian software company that helps customers manage unstructured data, known as enterprise information management.

The company grew its sales from half a billion a decade ago (at the time) to $2 billion in revenue in 2016, largely the result of 53 acquisitions made during that ten-year span. years, estimated by myself at a combined total cost of $3 billion. Operating profits have grown from $40 million (10% margins on $400 million in sales in 2006) to $360 million (20% margins on $1.8 billion in sales in 2021).

With an enterprise value of $8.5 billion in 2016, the company has clearly created value through these deals, as additional growth has been secured through the purchase of some HP assets as well as a huge deal $1.6 billion to acquire Dell/EMC’s enterprise content division, including products like Documentum, InfoArchive and LEAP. Valued at just 2.7 times sales, the deal seemed relatively cheap with an immediate increase, even though the deal was relatively large for Open Text to swallow.

As a result of this agreement, I have pegged the pro forma leverage at $2.9 billion, which compares to a pro forma EBITDA figure of $920-950 million, with an effect of lever about 3 times. Open Text’s 122 million shares were trading at $60 before the deal was announced, for a share valuation of $7.3 billion, or an enterprise value of $8.2 billion. before the Dell/EMC agreement. With the own company trading at 4x the sell, it was understandable that investors would appreciate buying the Dell/EMC assets as it was a cheaper relative sell multiple.

Proprietary operations posted adjusted earnings of $3.54 per share in 2016 and GAAP earnings of $2.33 per share. With the Dell/EMC deal, the company would reach $2.5 billion in sales, with a relatively limited increase in the near term, but deleveraging and synergies should be able to drive earnings growth. With shares reaching CAD 65 when the deal was announced, I understood the enthusiasm of investors on the one hand, but the organic growth was not so impressive because the earnings figures were complicated.

What happened?

Fast forward nearly six years in time, the shares are now trading at CAD 56 per share, which looks worse than it is as the stock split on a three-for-two basis in 2017. Even adjusted for this, the stock price returns have been very modest.

Fast forward to August 2020, the company released its results for the fiscal year, which ended in June of that year, the pandemic only impacted the end of the year. Total revenue reached $3.1 billion, approximately 20% higher than the pro forma revenue base in 2016. This is modest growth given continued targeted transactions as growth organic isn’t that impressive, I have to say.

Earnings figures were very complicated as the company showed adjusted earnings of $2.89 per share, but GAAP earnings were two dollars less than that. The vast majority of the variance, around 75%, comes from amortization expense which I’m happy to adjust as the other items are relatively small (including stock-based compensation expense). Adjusted for the stock split, earnings topped $4 per share. With 270 million shares outstanding, it is evident that investors have seen some dilution, used to achieve this growth as these achievements look a little underwhelming.

The shares traded around the CAD 60 mark in the summer of 2020, which translates to a share price of $77 based on the exchange rate of $0.78 and with realistic earnings tending to near $3 per share, valuations are high at 25 times earnings, while the debt burden of $2.5 billion was still high, though manageable with EBITDA trending at $1.1 billion. Leverage remains high despite cash flow conversion as the company continued to be active on the deal front, with the company spending $230m to acquire Guidance Software in 2018, $310m to acquire Liaison Technologies a year later and announcing a $1.3 billion deal for Carbonite in 2020.

Growth continues

Open Text posted continued growth in fiscal 2021, a year in which it remained quiet on the deal front. Full-year sales rose 9% to $3.39 billion, driven by the Carbonite deal, as organic growth was a little lackluster. Adjusted earnings increased fifty cents to $3.39 per share, with GAAP earnings improving slightly to $1.14 per share, again due to large amortization charges. The lack of a transaction resulted in net debt being reduced to less than $2 billion, while adjusted EBITDA further improved to $1.3 billion, resulting in comfortable leverage ratios as shares hit CAD 62 this summer.

First-quarter results were uninspiring with sales up 3.5% as adjusted earnings per share fell six cents to $0.84 per share. In November, the company finally resumed its negotiating efforts by announcing the purchase of Zix in an $860 million deal, the equivalent of 3.5 times sales. Second-quarter results were released in early February, with sales up 2% year-over-year as adjusted earnings fell a similar six cents, now at $0.89 per share.

The 273 million shares are now trading at CAD 56 per share, or $72 per share, supporting an equity valuation of $19.7 billion, or a business valuation of $22.4 billion if l including net debt. This indicates that Zix is ​​really a bolt-on deal, as earnings are likely trending towards $3.40 per share here, or 21-22x earnings, while leverage is manageable at around 2x EBITDA post-l Zix agreement.

Final remarks

The reality is that Open Text has long-term ambitions and although the company is showing fairly stable results, a multiple of 20 to 21 times earnings and 2 times leverage seems reasonable. While long-term M&A ambitions seem solid, the reality is that organic growth has been pretty lackluster. This worked very well when the company was still small and the acquisition prices for small transactions were below multiples, and therefore it was much easier to create value.

On the other hand, investors have seen very little to no returns over the past two years as per-share value creation has been disappointing. Perhaps the focus should be more on growth per share and value creation, rather than growth per se, with organic growth feeling a bit light to get involved here.