Open Text Corp T.OTEX

RBC Upgrade

[retiredcf]

These are US targets and their upside scenario target is raised to US$70.00. GLTA

August 7, 2020

Open Text Corporation 
FY21 outlook appears conservative

Our view: OpenText reported Q4 above expectations on stronger license revenue. However, the company’s FY21 outlook was below consensus, which reflects conservatism regarding sustained COVID-19 macro headwinds. Maintain Outperform, as OpenText has historically created the vast majority of shareholder value through M&A, not organic growth. OpenText currently has capacity to deploy $800MM+ on acquisitions, which would be a catalyst for the stock. Target to $50.

Key points:

• Q4 above expectations. Q4 revenue increased 11% Y/Y to $827MM, above RBC ($814MM) and consensus ($803MM). The upside stems from stronger license revenue ($106MM vs. RBC at $93MM). Due to high margin license revenue and lower costs, adj. EBITDA was $317MM, above RBC/consensus at $264MM/$262MM. $0.80 adj. EPS was ahead of consensus/RBC for $0.61. Notably, Q4 exceeded pre- COVID consensus estimates for $313MM adj. EBITDA and $0.78 adj. EPS (though short of pre-COVID consensus revenue estimate for $856MM).

• FY21 outlook appears conservative. As opposed to withdrawing its annual outlook, OpenText provided a base case outlook for FY21, which appears conservative to us. The company expects FY21 revenue to be flat Y/Y at $3.11B revenue, which is below consensus at $3.33B. The outlook implies negative -8% organic growth, down from -1% FY20. Adj. EBITDA margin guidance for 37-38% implies $1.15-1.18B below consensus at $1.25B.

• Macro, not structural or competitive. Implied negative organic growth stems from lower transactional license revenue and low-margin professional services, primarily as COVID-19 has impacted customer demand in some verticals (e.g. oil & gas, automotive, airlines, etc.). Cloud revenue is expected up low double digits. The headwind does not appear to be structural or competitive, in our view, considering OpenText’s transition to the cloud, product innovation, and strategic partnerships.

• OpenText has created the vast majority of shareholder value through M&A. We estimate that OpenText has averaged 0.8% organic growth over the last 10 years, while FCF/share has expanded 17% compounded and the share price has increased 19% compounded. While FY21 organic growth is a headwind, it is not thesis changing in our view. With leverage now 2.3x net debt / FTM EBITDA Q4, OpenText has the capacity to deploy $800MM+ capital on acquisitions. We estimate that every $800MM capital deployed on acquisitions is 9% accretive to adj. EPS.

• Maintain Outperform, adjusting target from $48.00 to $50.00. We are rolling forward the basis of our price target from CY21e to CY22e. Our revised $50.00 price target is based on 13x CY22e EV/EBITDA (13x CY21e previously), justified below peers at 23x, given OpenText’s lower EBITDA growth (4% vs. peers’ 13%). Our target is adjusted for OpenText’s potential $770MM ($2.86/share) tax liability. OpenText has converted 65% of adj. EBITDA into FCF over the last 5 years