Open Text Corporation (TSX: OTEX) enables organizations to gain insight through market-leading information management solutions powered by OpenText Cloud Editions.

Key Highlights

• Recurring revenue provides income stability: The company reported total annual recurring revenues of USD 699.8 million in Q2FY22, a 2.2% increase over pcp. This accounts for 79.8% of the overall revenue. Furthermore, the corporation plans to increase its recurring revenue in a range of 81% to 83% of its total revenue. A higher rate of repeat business indicates high client satisfaction and income stability, both of which are beneficial.

• Acquisition of Zix Corporation: On December 23, 2021, the company announced it completed an acquisition of Zix Corporation, which is a leader in SaaS-based email encryption, threat protection, and compliance cloud solutions for Small and Medium-sized Businesses (SBMs) for the total purchase price of USD 860 million, comprising its cash and debt. This acquisition is expected to enhance the company’s presence across the SBMs segment and would lead to organic growth in the coming quarters.

• Strong profitability margins: The group commands higher margins than the industry median, which indicates higher operational efficiencies. Notably, in Q2 FY22, OTEX reported its EBITDA margin of 37.5%, versus an industry median of 7.9%. Moreover, the company posted operating margin and a net margin of 18.9% and 10.1%, respectively, as compared to the negative industry median of 0.4% and 6.2%.

Source: REFINITIV, Analysis by Kalkine Group

• Trading at discounted valuations: The company’s shares are available at an NTM EV/EBITDA multiple of 10.6x compared to the sector (Software & IT Services) median of 12.0x while on NTM Price to Cash Flow multiple the stock is trading at 11.6x compared to 23.6x. This implies that the shares are trading at a deep discount against the sector. The stock is undervalued on multiple valuation parameters.

Source: REFINITIV, Analysis by Kalkine Group 

Risks associated with investment: The company’s product requires constant up gradation to stay afloat within the industry. Moreover, the arrival of new players would likely lead to increasing competition, reducing pricing power, and loss of clients. An increase in R&D and other input costs would likely put pressure on the company’s margins, which remains a key concern for the group. 

Financial overview of Q2 2022 (In thousands of U.S. dollars)

Source: Company Filing

• In Q2 2022, the company reported total revenues of USD 876.7 million, improved from USD 855.6 million in pcp. The growth was aided by improved income from all its operating segments.
• The cost of sales was slightly higher in the reported period at USD 261.1 against USD 252.5 million in pcp, still, the company posted a higher gross profit at USD 615.6 million compared to USD 603.0 million in pcp.
• On the back of higher operating expenses in the reported period, primarily due to higher sales and marketing expenses along with general expenses, the company’s income from operations fell at USD 192.8 million compared to USD 234.4 million in pcp.
• The company posted net income of USD 88.3 million against a loss of USD 65.4 million in pcp.

Valuation Methodology (Illustrative): EV to Sales

Analysis by Kalkine Group

Stock recommendation

The company witnessed another strong quarter of organic growth, fueled by demand for OpenText Cloud Editions, and even raised its Fiscal 2022 target model to include cloud growth of up to 10% and total revenue growth of up to 4%, which is a huge plus. OpenText now leads the industry in cyber resiliency with a powerful SMB platform for data protection, threat management, email security, and compliance solutions, thanks to the addition of Zix to the group's Security & Protection Cloud.

Furthermore, the company is concentrating on increasing its recurring sales; stronger recurring revenue indicates high client satisfaction and income stability, both of which are important factors. In addition, the company has industry-leading margins on several fronts, indicating its operational efficiency. Therefore, based on the above rationale and valuation, we recommend a “Hold” rating at the closing price of CAD 57.44 as on February 10, 2022.

1-Year Price Chart (as on February 10, 2022). Source: REFINITIV, Analysis by Kalkine Group

*The reference data in this report has been partly sourced from REFINITIV.

Disclaimer

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