Open Text Corp.
April 8, 2024
THE TD COWEN INSIGHT
We believe OpenText's shares are undervalued, considering OpenText is expected to have lower leverage and potentially higher organic growth, with minimal impact to cash flow, after selling the AMC business.
Event:
We consider the financial profile of OpenText post-AMC divestment.
Impact: SLIGHTLY POSITIVE
Implied valuation of Micro Focus, ex-AMC, seems fair... Micro Focus (MCRO) announced the merger with Hewlett Packard Enterprise's (HPE) software business on September 7, 2016, for gross consideration of ~$8.8bln. Following OpenText's divestment of the Application Modernization and Connectivity (AMC) business, which is essentially legacy MCRO before acquiring the HPE assets, we believe OpenText will have effectively acquired the HPE assets for 5.9x EV/LTM EBITDA, much lower than the 12.1x MCRO paid for them in 2016. The integration challenges MCRO faced with the HPE assets and the resulting valuation compression suggest the HPE assets were worth 4.6x at the time OpenText announced its acquisition of MCRO.
While the implied multiple OpenText paid is slightly higher than this, we believe it is within the range, allowing for some variance, and considering that OpenText has stabilized and integrated MCRO, implying synergies have been realized. More importantly, we believe the divestment significantly improves OpenText's financial profile....Especially considering OpenText's improved financial profile post-divestment. Following the AMC sale, we believe OpenText will have significantly less leverage, providing it the opportunity to accelerate organic growth with minimal impact on cash flow. We estimate pro-forma net debt/EBITDA to be ~2.7x following the AMC sale in Q4/F24, down from 3.7x currently. This should save OpenText ~$158mm in annualized interest costs.
We believe the added balance sheet flexibility also provides OpenText with the optionality to invest in its cloud & AI roadmap to help achieve the 7%-9% cloud organic growth aspirations, and lay out a potential "high growth" acquisition strategy. We estimate that if OpenText levers up to 3.0x to acquire higher growth targets, it could accelerate organic growth by 30bps with a net impact of less than $50mm to its cashflow. Using Descartes as a case study, the higher organic growth could benefit OpenText's valuation multiple, in our view.
Our Investment Thesis
We rate Open Text a BUY given the company's strong acquisitions track record, including the successful Micro Focus integration, de-risked balance sheet post-AMC divestiture, margin expansion, and potential for higher-than-historical organic growth progress supported by accelerated cloud bookings. We believe the potential for an improved macro environment could result in multiple expansion, given Open Text currently trades well below peers and its historical average. We believe the company is on a path to achieve its F2026 aspirations, which include cloud bookings growth of 15%+, organic cloud revenue growth of 7%-9%, and adj. EBITDA margin of 36%-38%. Strong FCF generation also support the potential for small, tuck-in acquisitions to accelerate management's cloud strategy.