OpenText is trading at a big discount, says Eight Capital

Eight Capital analyst Adhir Kadve is feeling bullish about Canadian software company OpenText (OpenText Corp Stock Quote, Charts, News, Analysts, Financials NASDAQ:OTEX), saying in a new report that investors should take advantage of the currently attractive entry point.

OpenText fell out of favour last year when the company announced the proposed acquisition of UK-based Micro Focus, a $5.8 billion deal that just closed in January. Questions were raised about the viability of the asset, one which has recently had trouble growing revenue, and concerns were that OTEX was saddling itself with a difficult, long-term project in reviving Micro Focus.

Shares fell from just under $40 — already well off the $54 highs of mid-2021 — to as low as $26 this past September. And while the stock has made up some of that ground more recently, Kadve thinks the upside potential is significant.

In his coverage resumption on Monday, Kadve asserted a “Buy” rating on OTEX and 12-month target price of $45.00, which at the time of publication represented a projected return of 27.6 per cent.

On the Micro Focus deal, Kadve said OpenText has plenty of experience in integrating big acquisitions and has laid out a well-defined plan to stabilize and return Micro Focus to growth, improved EBITDA and free cash flow generation and a de-leveraging of its balance sheet.

“With OpenText closing the Micro Focus transaction on January 31st, we can’t help but notice that investors remain overly pessimistic about the acquisition discounting OpenText’s experience with acquisitions and thus its ability to successfully integrate the asset.,” Kadve wrote.

“In our view, OpenText’s successful track record of integrating prior acquisitions should not be ignored and drives our confidence in the company’s ability to execute,” he said.

Kadve argued that OTEX presents investors with a defensively-minded name supported by strong annual recurring revenue (over 80 per cent of its revenues), profitability (EBITDA margins in the mid-to-high 30 per cent range) and free cash flow generation (OpenText generated about $780 million in trailing 12 months free cash flow. On top of that, Kadve noted OpenText’s dividend, which currently has a yield of 2.7 per cent. 

“In our view, this is an enviable financial profile with strong defensive characteristics,” Kadve said.

By the numbers, Kadve is projecting full fiscal 2023 (year end June 30) revenue and EBITDA of $4,381 million and $1,422 million, respectively, and fiscal 2024 revenue and EBITDA of $5,889 million and $2,171 million, respectively. (All figures in US dollars.)

In terms of valuation, Kadve said OTEX is currently trading at about 8.0x calendar 2024 EV/EBITDA, which he calls a significant discount to the company’s enterprise software peers at 13.5x. Kadve’s $45 target is based on a 9x 2024 EV/EBITDA multiple.