Open Text Corporation

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Open Text is a leading provider of information management software and services, enabling organizations to digitize workflows, improve productivity, and derive insights from their unstructured data.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview and Moat Analysis Open Text operates in the Information Management (IM) sector, a space increasingly crucial for organizations seeking to navigate the complexities of digital transformation. Its core business revolves around providing software solutions that facilitate content management, collaboration, data analytics, and workflow automation. The company’s customer base is diverse, ranging from large global corporations to small and medium-sized businesses.

Open Text’s moat is moderately wide, earning a rating of 3/5. Their moat is primarily based on high switching costs and, to a lesser extent, network effects associated with its embedded software in client workflows. Here’s a breakdown:

  • Switching Costs: A key component of Open Text’s business is providing mission-critical software to large enterprises. Switching costs arise from the disruption, cost, and risk associated with changing software providers when these products are deeply integrated into daily operations. Migration and implementation, especially with complex solutions are painful, time-consuming, and expensive; the company has created “stickiness” because its software becomes deeply embedded within client operations. This makes customers far less likely to abandon Open Text’s products, translating to predictable recurring revenue streams.
  • Network Effects: While not the primary driver, Open Text also benefits somewhat from network effects. The more data that is aggregated in its platform, the more insights and analytics are generated, leading to more value for its customers. Data analytics and insights are powerful because once a good data infrastructure has been established in a company, migrating to another product is hard and costful, due to lost of proprietary insights and processes. However, since each company is a separate system, the benefit of others is not directly felt by all, which limits the network effect.
  • Brand: Open Text has a strong, well-known brand in the information management space, built on its over three decades of experience in the field. It regularly appears on the leader section of the Gartner magic quadrant. This gives the company credibility and makes their products more trustworthy.

  • Scale: Open Text is a well-established player in its area, with revenue in the billions of USD, meaning that they have enormous amounts of data and R&D to create new features, compared to smaller rivals. Their scale advantage gives them the ability to produce better software that smaller companies cannot.

    • Counterarguments to the moat are primarily the competition which is becoming stronger, especially in the cloud computing segment. Although this poses a risk, many companies that use Open Text have hybrid or on premise systems and are not fully in the cloud.

The company recently stated that their “Cloud” business is currently a tailwind. Cloud is also their fastest growing sector and the area they will be focusing on the future.

Business Resilience and Potential Risks Open Text operates in a rapidly changing technological landscape. Its moat has potential to be eroded by both internal and external factors.

  • Competition from both large (Microsoft, Google, Adobe) and specialized cloud-based platforms could limit the company’s pricing power and market share.
  • Technology shifts related to the internet, software, data and AI pose a threat to its established business models. If Open Text is unable to innovate and develop new cutting-edge tech and product offerings, there is a risk its solutions might be seen as outdated and become obsolete.
  • Acquisition risks: While acquisitions are a core part of Open Text’s growth strategy, if they are not integrated successfully, or are acquired for high premiums (overpaying), the company may destroy its value through goodwill impairments and poor returns.

Financial Resilience: The company has a proven track record, is profitable and cash generative, and is actively reducing debt. - It has a strong cash position of over $1.5 billion. - The debt is manageable as well, with management aiming for a low debt/EBITDA ratio, and is under management control. - Overall, while the company faces challenges, it is also quite resilient to these issues due to its strong financials, size, and customer retention.

Detailed Explanation of the Business

  • Revenue Distribution:
    • Open Text generates revenues through three main segments.
      • Cloud Services and Subscriptions: which is the most prominent revenue source, accounting for $1.3 billion revenue in 2022; this segment is subscription revenues of their products (software/services).
      • Customer Support: accounting for $1.47 billion in revenue; which is money related to client support and maintenance.
      • Professional Service and Other: $1.0 billion; which is money earned from training, customization, and consultation.

Approximately 80% of the revenues are recurring, which shows the stickiness and reliability of the business. In 2022, Open Text generated over $3.9 billion in total revenue.

  • Trends in the Industry:
    • The Information Management sector is seeing an increase in digital transformation, driving demand for tools that can manage, analyze, and secure data.
    • The shift to cloud-based platforms for information management is accelerating, with increased demand for SaaS (Software as a Service) solutions.
    • AI and Machine learning are becoming increasingly prevalent in document and data management, due to their efficiency at automating many tasks and bringing valuable insights.
  • Margins: Open Text has gross margins that are over 70%, and net margins around 10% which shows the overall profitability of the company. However, as mentioned before, management is targeting a more focused cloud-based strategy, which they expect will lead to margins over 20-30% over time as costs associated with legacy systems fall down, which will increase net margins.
  • Competitive Landscape: The competitive landscape for information management is extremely fragmented and includes very large players like Microsoft and Google, to mid size companies like Adobe and Workday, and also countless smaller specialized players.
  • What Makes Open Text Different?: The main difference for Open Text is its main focus, which is helping large enterprises manage and organize complex document and data management in a hybrid system or on premise infrastructure. They claim to be leaders in this field, which makes them more secure against competition from new or smaller players.
  • Other relevant points: -Open Text is a very acquisitive company, acquiring many companies throughout the years. These companies are either related to their core business or are for expansion.

-Management has recently shifted focus to profitability instead of growth and they are actively working towards cutting down costs and deleveraging the balance sheet. - The company offers integration with multiple services that are common for business use (e.g Microsoft, Google, Oracle). This makes it easier for clients to seamlessly work with Open Text.

Financial Analysis

  • Revenue: Open Text has grown its revenue consistently in the last decade, driven mainly by acquisitions. Cloud and subscription revenues are growing and now make up the majority of the revenues, which means a recurring revenue stream, and thus more predictable income in the future.
  • Profitability: Operating margins are healthy (around 20%) but have decreased as the company is allocating more resources towards R&D and marketing. With more focus being put into the cloud segment in the future, this should bring further profitability.
  • Balance Sheet: The company has a significant amount of cash. It has around $1.5 billion cash, and is working towards deleveraging debt.
    • Total debt is around $6 billion, however most of this debt is for long term and not near-term obligations.
    • Goodwill has been steadily increasing over time, but is being controlled by management.
  • Cash Flows: Cash flow from operations has been generally positive, although negative in 2021. However, the company had free cash flow of over $1 billion, and the company consistently makes efforts to reduce short-term liabilities and debts, making the cash position of the company better.
    • A lot of acquisitions are done for cash+equity which means in some years the cash position is low.
    • In the latest quarter, management showed a commitment towards using free cash flow to paying off debt, which should improve the balance sheet going forward.
  • Capital Structure: The company has a high leverage ratio because of their history of acquiring many companies. They are actively working on deleveraging their balance sheet and using cash to reduce debt. Management is aiming for 2.0x debt-EBITDA.
  • Recent Concerns: The market is not as excited by their acquisition plans, partly due to the high leverage and also because acquisitions make the financial statements very complicated and sometimes, hard to analyze, and they also need to spend resources integrating the new companies into their main portfolio.

Understandability Rating: 3/5 Open Text has a moderately complex business model with multiple product offerings and diverse revenue streams. Although its strategy and products are easy to understand on a basic level, valuing them and understanding all the facets of the financial statements can be hard. Because it has very wide reach in various technologies, it is hard to get familiarized with all their products and the market they operate in, which can increase the complexity of the company.

  • The acquisition heavy strategy also increases complexity.
  • Their financial reports are long and need quite some knowledge of accounting to fully understand.

Balance Sheet Health Rating: 4/5 Open Text has a healthy balance sheet. They have a solid cash position, a good portion of long term debt, and no worries about upcoming liquidity crises. Management is also focused on reducing debts, meaning the financial position of the company should get even better in the near future.

  • Company has $1.5 billion cash.
  • Debt/EBITDA is around 3.4x, management is aiming for 2.0x.
  • Strong positive free cash flows.
  • Majority of debt is long term and not short term.