OpenText is more than a double, says National Bank

National Bank Financial Markets is staying bullish on Canadian Enterprise Information Management company OpenText (OpenText Stock Quote, Charts, News, Analysts, Financials NASDAQ:OTEX), saying in a Thursday report that OTEX’s recently announced acquisition shouldn’t spook investors.

OpenText shares are down sharply over the past few weeks after the company announced the proposed acquisition of Micro Focus, a UK-based enterprise software company. Pegged at a whopping $6 billion, the deal has drawn criticism as Micro Focus has had declining revenue for years. 

National Bank analyst Richard Tse reported on a lunch taken on Thursday with OpenText management (CEO Mark Barrenechea and CFO Madhu Ranganathan) and investors, where Tse posed a number of questions on the Micro Focus deal. Tse seemed to come away satisfied, as he included in his report a reiterated “Outperform” rating on OTEX and US$60.00 target price, which at the time of the report’s publication represented a projected one-year return of 108.4 per cent.

“[I]nvestors following our research will know OTEX continues to be one of our favourite ‘legacy’ names with a record of robust profitability and recurring cash flow growth,” Tse wrote. “We also see a growing base of recurring revenue through opportunistic acquisitions (like Micro Focus), expanding operating leverage and optionality from organic growth that is not fully reflected in its current stock price.”

Noting that big acquisitions of challenged companies is not a new approach for OpenText, Tse pointed to the case of Documentum, which OpenText acquired and ended up materially enhancing renewal rates on the company’s products. 

The same seems to be the game plan for Micro Focus. When asked by Tse about the negative growth trajectory of Micro Focus’ topline, OTEX management said it expects Micro Focus’ revenue to stabilize by 2023, with product renewals being a focal point.

“OpenText runs a renewal business using a proven playbook it has perfected over 30 years. OpenText operates the renewal process in a centralized manner directly allowing it to control the process around those renewals. Micro Focus customers should benefit from its ability to operate in a private cloud, something it has limited access to,” OpenText said, according to Tse’s report.

Management said it expects the combined OTEX/Micro Focus entity to have adjusted EBITDA margins of between 37 and 39 per cent by 2025, with margins in the short term staying in the 30 per cent range.

As for OpenText’s path forward regarding M&A, Tse related that the company would be concentrating on the integration of Micro Focus for the foreseeable future, although more acquisitions are likely coming, since OTEX is in its DNA an M&A roll-up business.

Ultimately, Tse said he came away from the meeting assured that OpenText did its proper due diligence in vetting Micro Focus.

“No doubt, the obvious question on investors’ minds is whether OpenText diligence-d’ the transaction enough to optimize the risk-to-return profile. The reality of it all is that regardless of the Company’s successful operating track record with M&A, the size of this transaction invariably brings incremental risk,” Tse wrote. 

“That said, what we heard continued to support our analysis that this acquisition will drive incremental equity value in the name with continued defensive attributes (recurring revenue / cash flow), supported by a record of spirited de-levering post acquisitions. Outperform; US$60 target,” he said.