A Member of Pat McKeough’s Inner Circle recently asked for his opinion on a Canadian software specialist that has attracted an activist investor from the U.S.
Open Text has a broad international market for its software, but the activist investor aims to raise the company’s profile with investors in the United States. This activist investor typically prefers collaboration to hostile tactics like proxy fights or lawsuits. Open Text has been able to profit in a highly competitive industry, says Pat, but its growth-by-acquisition strategy adds risk.
Q: Pat: What do you think of Open Text? I also read that it’s the target of an activist investor.
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A: OPEN TEXT (symbol OTEX on Toronto; www.opentext.com) develops, markets, licenses and supports collaboration and enterprise-information-management software for corporate clients. That software stores, finds, and distributes information across corporate intranet and extranet networks as well as the broader Internet.
For its fiscal year ended June 30, 2017, Open Text’s revenue rose 25.6%, to $2.3 billion from $1.8 billion in fiscal 2016. (All figures in U.S. dollars.) Excluding one-time items, earnings per share rose 14.1%, to $2.02 from $1.77.
The company’s revenues and profits have risen steadily over the last five years: in fiscal 2012, revenue was just $1.2 billion and earnings per share were $1.15 (adjusted for a 2-for-1 split in January 2017).
For its fiscal third quarter, ended March 31, 2018, the company’s revenue increased 10.8%, to $685.8 million from $593.1 million a year earlier, with the gains coming largely from cloud services and subscriptions. That missed the consensus estimate of $685.9 million. However, revenue was higher across all of Open Text’s segments. That includes a 28.6% year-over-year gain in customer support, which accounts for 42% of the company’s overall revenue. Earnings per share of $0.54 missed the consensus estimate of $0.62 per share.
The company’s balance sheet is sound, with cash of $476.0 million, or $1.78 a share. Its long-term debt of $2.4 billion U.S. is a manageable 25.2% of the company’s market cap. Open Text spends a high 11% of its revenue on research.
Growth stocks: Activist investor’s plan includes buybacks, dividend hikes, potential acquisition
Blue Harbour Group, a Greenwich, Connecticut, investment firm owns 3.5% of Waterloo, Ontario-based Open Text. That activist investor wants to raise the company’s profile with U.S. investors. Blue Harbour hopes that will help increase the value of its shares. It also believes Open Text is undervalued by as much as 50%.
Blue Harbour’s plan for the company includes share buybacks, dividend increases, and a potential “transformational” acquisition of another software company. It has also broached the possibility of the outright sale of Open Text to a bigger competitor in the software industry.
As an activist investor, Blue Harbour typically aims for collaborative relations with the management and board of any company it targets. That limits any need for hostile tactics such as proxy fights and lawsuits. (Blue Harbour is also one of the biggest shareholders of Adient plc, symbol ADNT on Nasdaq, with 6.2% of that firm’s outstanding shares. Adient is a recommendation of our Spinoffs, Takeovers & Special Situations newsletter.)
Open Text continues to grow by acquisition. This strategy adds risk. As well, the company operates in a very competitive market.
The stock trades at 13.4 times the $2.65 U.S. a share Open Text is forecast to earn for the fiscal year ending June 30, 2018. In May, the company announced that it was raising its dividend by 15%, to $0.1518 a share from $0.1320, with the June 29, 2018 payment. The shares yield 1.7%.
Inner Circle recommendation: Open Text is okay to hold, but only for aggressive investors.
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