Company Description

OpenText was founded in 1991 and currently employs about 5,000 people. It is the leader in digital content management which enables organizations to grow their businesses, lower costs of operations, and reduce information governance and security related risks. OTEX is a relatively small company with a dominant share of the ECM (Enterprise Content management) market, which essentially provides records, emails and archive management.  Its primary competitors are:  IBM, EMC, Microsoft, Autonomy (acquired by HP) and Oracle, although some of these also act as key channel partners.

Recently the company has turned its focus to Enterprise Information Management (EIM), which they claim is the “Deep Web,” where 96% of digital content is kept inside firewalls. (for perspective the public web 4% of digital content or about 8 billion pages of information, the “Deep Web” would have 200 billion pages).  According to the company and other sources this market is currently worth $13bln and growing at around 10%/year.  EIM contains not only ECM where OTEX is a leader but also BPM (Business Process Management), CEM (Web Content Management), Information Exchange (document distribution) and Discovery (search).

OpenText’s business model is based on originating software products and distributing them through direct sales, strategic alliances, system integrators, VARs, distributors, OEM’s and technological alliances.  Their largest strategic alliance is with SAP which continues to add more OTEX sku’s.  The customer base is highly diversified covering all major industries and government departments– and very “sticky”.  Like other enterprise software providers, once established in a company’s infrastructure it’s very difficult and costly to switch.

Geographically they sell about 53% of their products in the America’s, 39% in EMEA and 8% in Asia Pac.  Revenues are split between service (21%), maintenance (54%) and license (24%).  License generates the highest gross margin at 94%, followed by maintenance at 85% and services at 21%.

OTEX has been a serial acquirer since inception and continues to look for purchases to fuel licence and service revenue growth.  Over the last five years OTEX has made 13 acquisitions, growing in size from $100mm (Captaris, November 2008) to their most recent purchase of EasyLink Services for $310mm (July 2012).  In our opinion managements capital allocation track record has been above average (fairly priced deals with no missteps).

Metric Summary

Investment Thesis

Over the past eight years OTEX has punished the recurrently large short base which has once again taken a negative view on the new CEO and a few volatile quarters to rebuild a short position to over 20% of all outstanding shares.  From our perspective this pessimistic short term outlook provides a great opportunity and OTEX’s price looks well below intrinsic value.  This can be verified using discounted after tax cash flows (assuming a very conservative 5% growth rate) or through its after tax cash multiple, where it trades cheap to its peers and recent corporate actions (excluding HP’s enormous purchase of Autonomy at 10x sales).  In our opinion at 10x 2013 after tax cash we are getting a good quality company with a sticky customer base, recurring revenues (calculable downside), while paying nothing for future growth.

OTEX has been a consistent performer, generating a compound annual growth rate in after tax cash of 25% for the past nine years.  It needs no excess capital to grow and has been a good allocator of investor cash.  The company has spent $1.2bln on acquisitions to generate $1.1bln in after tax cash over the last nine years and built a recurring revenue base that is being overlooked by many investors.  Before the EasyLink transaction we conservatively calculate the recurring maintenance revenue base to be worth about $40/share (some analysts have this as high as $50/share) and a run-off maintenance book of about $29/share.  Meaning if the company closed its doors today it would return over half its market cap in the next ten years.  Any doubts on the value of recurring revenue streams can be put to rest by looking at Constellation Software (CSU CN) which has made a very good business out of acquiring books of maintenance.

The relatively new CEO, Mark Barrenechea, has so far been impressive, with more emphasis on organic growth to accompany the acquisition strategy.  To us this makes sense at this stage of OTEX’s development; with a full suite of products there must be some additional revenue to be generated from cross selling.  Consider that OTEX has now in excess of 100mm users and that less than 10% of their customers have more than one OpenText product installed and incremental products range from $15-$20/seat.

Value can also be realized through margin improvement as the company integrates the last three major purchases:  EasyLink, Metastorm and Global 360.  Earlier this year the company was given a wake-up up call on integration (for which the CEO took full responsibility) when they failed to re-align and consolidate the global sales force.  Actions since then indicate the problems have been rectified.

If the market refuses to realize the value of the company there is always the possibility of OTEX being acquired – they are one of the last pure-play ECM vendors with relatively small market cap and a  dominant share of the industry.  They are second only to IBM in the global ECM market with a 17.9% share (IBM 18.2%, EMC 11.6%, Microsoft 5.9%, Autonomy 5.5%, Oracle 5.3%).  They have also recently entered into the cloud business ahead of most other ECM providers.  Not included in our valuation is what OpenText Temp, their cloud offering, could be worth if Dropbox is valued at $4bln(est), Box at $600mm(est) and Jive at $800mln?

Risks

In our view the greatest risk is management execution; they need to prove that the company can grow organically along with making acquisitions.  Second to this are the macro concerns, specifically those affecting their European sales.  Last is the competition in the Cloud market.

• quarterly earnings
• corporate actions (further acquisitons or take-over)