OpenText is a solid buy, says National Bank

National Bank of Canada analyst Richard Tse still thinks OpenText (OpenText Stock Quote, Chart, News, Analysts, Financials NASDAQ:OTEX) is an obvious investment choice, maintaining an “Outperform” rating and $60/share target price for a one-year return of 48.8 per cent in an update to clients on Wednesday.

Founded in 1991 and headquartered in Waterloo, Ont., OpenText has information management software and solutions and primarily competing in the Enterprise Information Management (EIM) space, where its software supports the collaboration, sharing, storing and retrieving of information.

Tse’s latest analysis comes after OpenText reported its financial results for the third quarter of its 2022 fiscal year, which Tse noted to be in line with expectations.

“Looking ahead, while organic growth offers some potential option value, we believe the Company will return to its acquisition-led growth strategy given the downward rerating in valuations across the sector over the past six months,” Tse said. “Bottom line, we continue to like OTEX for its defensive attributes (strong FCF generation, recurring revenue), financial discipline to drive profitability, and record of (and potential for) materially accretive acquisitions with growing optionality from organic growth.”

OpenText’s financial quarter was headlined by $882.3 million in revenue, coming in slightly ahead of the $874.2 million projected by National Bank and relatively in line with the $884 million consensus estimate, while also representing a 5.9 per cent year-over-year increase, which gets bumped up to eight per cent on a constant currency basis. (All figures in US dollars.)

As part of the company’s fifth consecutive quarter with organic revenue growth, Cloud Services were up 13 per cent (14.3 per cent constant currency) to $401.9 million, while license revenue provided a slight beat at $80.6 million compared to the National Bank estimate of $76.3 million.

“If you’ve been following our research, you’ll recall our view that OpenText’s shift to Cloud has opened up an opportunity to expand into SMB, adding potential upside to organic growth,” Tse said.

Meanwhile, the company’s adjusted EBITDA came in at $284.5 million for a slight beat in relation to the $276.9 million, providing a slight margin beat at 32.2 per cent compared to the 31.7 per cent estimate from National Bank.

Tse also singled out the company’s M&A pipeline as being open for business following its acquisition of Zix, part of the company’s SMB expansion and already reaping leverage benefits in terms of its liquidity.

“Customers are seeking information-led transformations and this is reflective in the strength of our cloud bookings,” said Mark J. Barrenechea, OpenText CEO & CTO in the company’s May 4 press release. “We are seeing the results of our efforts as we help our customers to digitize, transform and grow. OpenText brings a complete and integrated suite of Information Management solutions to customers of all sizes, while providing the layers of defense needed to help organizations secure their users, end points, and networks in the face of ever-increasing cyber threats and ransomware. As we approach the end of the fiscal year, we remain on track to meet our targets and aspirations.”

With the release of the most recent results, Tse has made slight revisions to his financial estimates, minimally tweaking his 2022 revenue projection from $3.53 billion to $3.5 billion, with the revised figure still representing a year-over-year increase of 3.5 per cent. Looking ahead to 2023, Tse slightly lowered his projection from $3.77 billion to $3.7 billion for a potential year-over-year increase of 5.7 per cent.

From a valuation perspective, Tse forecasts minimal movement in the company’s EV/Sales multiple from the reported 4x in 2021 to a projected 3.9x in 2022, then to a projected 3.7x in 2023.

Tse also slightly reduced his adjusted EBITDA projections going forward, lowering his 2022 estimate from $1.29 billion to $1.26 billion for an implied margin of 36.1 per cent, down from the 38.8 per cent implied margin from 2021. Looking ahead to 2023, Tse lowered his adjusted EBITDA estimate from $1.41 billion to $1.38 billion, implying a slightly wider margin of 37.2 per cent.

In terms of valuation, Tse projects a rise in the company’s EV/EBITDA multiple in 2022 from 10.4x to 10.8x, then dropping to a projected 9.9x in 2023.

Overall, Tse continues to believe in what OpenText is capable of moving forward.

“With the market sentiment favouring profitability and cash flow, OTEX offers those compelling defensive attributes,” Tse said. “We see a growing base of recurring revenue through opportunistic acquisitions, expanding operating leverage and optionality from organic growth that is not fully reflected in its current stock price.”

OpenText’s stock price is down 17.2 per cent since the start of 2022. After a brief jump to $60.84/share on January 31, the stock has dropped off to a 2022 low of $48.90 today, part of a 5.4 per cent drop today alone.