Is OpenText a buy right now?

Organic growth along with M&A opportunities should be drivers for OpenText (OpenText Stock Quote, Chart, News, Analysts, Financials TSX:OTEX), says Eight Capital analyst Suthan Sukumar, who reviewed the company’s latest quarterly numbers in an update to clients on Friday.

OpenText, an Enterprise Information Management software company headquartered in Waterloo, Ontario, announced its third quarter fiscal 2021 financials on Thursday, posting total revenue up 2.2 per cent year-over-year to $832.9 million and adjusted EBITDA up 14.5 per cent to $297.1 million. Adjusted EPS was also up 23.0 per cent year-over-year to $0.75 per share. (All figures in US dollars.)

“The shift to modern work, digital customer experiences, supply chain retooling and continued economic stimulus are creating positive demand for OpenText Cloud Editions and other services,” said Mark J. Barrenechea, OpenText CEO & CTO, in a press release. “OpenText delivered a robust quarter with organic revenue growth in Annual Recurring Revenues (ARR) and Cloud services and subscriptions, driving Total Growth and profitability across the organization.”

OpenText’s Q3 revenue broke down into $355.8 million in Cloud services and subscriptions, $335.9 million in Customer Support, $76.3 million in Licenses and $64.9 million in Professional services and other sources. The result was a combined 4.4-per-cent uptick in recurring revenues but a 5.9-per-cent drop in License and a decrease of 9.0 per cent in the company’s Professional services segment.

On management’s outlook, OpenText raised its guidance for Cloud growth to 18-20 per cent year-over-year compared to previous guidance in the “high teens,” with accelerated adoption of Cloud Editions for enterprise content management as companies move ahead with digitization and automation. OTEX has also seen further traction in its private cloud business with 75 new G10k customers signing over the fiscal third, while signs of economic recovery across a number of sectors will also be beneficial, according to OpenText.

OTEX’s share price had a rough time in 2020 making up the ground it lost in the early days of the pandemic, finally hitting level in January this year. The stock has been up and down in 2021 but is now up two per cent.

Sukumar sees upside from here. With his report, the analyst has reiterated his “Buy” rating and $58.00 target price for OTEX, which at the time of publication represented a projected 12-month return of 24.7 per cent.

“Open Text reported a stronger set of results in the seasonally weaker FQ3 relative to our/Street expectations. Better cloud performance and a lower decline in license were key factors in the revenue beat, and helped drive an adj. EBITDA/adj. EOS beat despite higher opex, with COVID-19 restrictions loosening,” Sukumar wrote.

Often the company’s seasonally weaker quarter, OpenText’s fiscal third quarter managed to beat analysts’ estimates, nonetheless. The $833-million topline was better than the consensus call for $813 million and Sukumar’s own $818-million forecast, while adjusted EBITDA of $297 million (at a 36-per-cent margin) was also better than the Street’s $275 million and Sukumar’s $271 million. Adjusted EPS of $0.75 per share was above the consensus $0.69 per share and Sukumar’s $0.67 per share.

Sukumar noted that OTEX’s balance sheet remains healthy, supporting M&A activity going forward, with operating cash flow at $63.6 million (down 81 per cent year-over-year) and free cash flow of $50.3 million (down 84 per cent year-over-year), reflecting a $290-million IRS settlement. Adjusted for the IRS payments, Sukumar said operating cash flow and free cash flow would have been up seven per cent and nine per cent, respectively.

By the end of the quarter, OTEX reported cash and equivalents of $1.48 billion for a net debt of $2.11 billion, which compared to cash of $1.50 billion and net debt of $2.09 billion a quarter earlier.

“The company raised its cloud outlook for the year, citing accelerating adoption within the install base for the company’s new Cloud Editions platform, along with recovery in the Business Network segment,” said Sukumar.

“We continue to see upside to organic growth as the company’s new product cycle with CE gains traction, along with increasing M&A optionality given the healthy balance sheet, which suggests potential for larger or a higher pace of acquisitions ahead, in our view,” he wrote.

Comparatively, Sukumar said OTEX remains attractive on valuation, where his target of $58 per share implies a 17x multiple on his 2022 adjusted EPS compared to the broader peer group of higher-growth software companies at 21x.

“We believe continued strong execution will support further multiple expansion,” Sukumar wrote.

The analyst has rejigged his estimates upwards and is now calling for fiscal 2021 (year end June 30) revenue and EBITDA of $3.337 billion and $1.291 billion, respectively, and fiscal 2022 revenue and EBITDA of $3.482 billion and $1.353 billion, respectively.