Shares of Canadian technical information management company Open Text (TSE: OTEX) (NASDAQ: OTEX) tanked recently. What caused an even more rapid selloff recently was the August 25 announcement that it will acquire Micro Focus International (LSE: MCRO) for ~6 billion dollars. Shares fell about 14% after the announcement and have been falling ever since. The stock is currently down significantly from all-time highs with a Smart Score rating of “Perfect 10”.however, OTEX shares deserve attention.
It should be noted that the reserves of perfect Smart Score ratings are historically superior S&P 500 (SPX), as shown in the figure below.
What makes open-text stocks intriguing?
That’s what makes OTEX stock interesting, whether you like the company or not. These are high-yielding, profitable technology stocks with modest growth that trade at “value stock” levels (8.1x forward earnings, to be exact). Its revenue has grown by an average of 8.8% over the past five years, and revenue growth is expected to be in the mid-to-high single digits for the next two years.
Additionally, the company’s gross margin has grown steadily over the past decade, rising from 71.2% in fiscal 2013 to 75.3% in fiscal 2022 — a sign that rivals aren’t cutting back on profits.
Open Text’s valuation looks cheap
As mentioned earlier, OTEX shares are trading at approximately 8.1 times forward earnings for fiscal 2023 (which ends in June 2023). This is based on EPS estimates of $3.34 for the year. Earnings per share are expected to grow by more than 10% next year, bringing the multiple down to 7.3x. It is undoubtedly cheap.
Note: All figures are in US dollars unless otherwise noted.
However, one should not stop only at salaries. Free cash flow is perhaps the more important metric. Based on just three analyst estimates, OTEX’s free cash flow is expected to be $935 million in FY2023. With a market cap of about $7.2 billion, that translates to a 7.7x price/FCF ratio. Based on these numbers alone, as well as the company’s long-term growth trajectory, OTEX could be a great value for investors.
The large debt owed to Open Text should be considered
While OTEX stock looks cheap based on what we mentioned above, the company also has quite a large amount of debt, which could weigh on its valuation. Compared to a cash position of $1.7 billion, the company has debt of $4.22 billion, giving it a net debt of $2.52 billion (more than a third of its market cap).
However, his debt will soon increase. Micro Focus’ announcement of the acquisition said: “We intend to finance the acquisition with cash on hand, new debt and our existing revolving credit facility.”
Since the acquisition is worth about $6 billion and the company only had about $1.7 billion in cash, you can expect a few billion more dollars in debt. That may be partly why investors didn’t like the acquisition announcement. However, OTEX is very profitable and its debt is currently manageable.
According to analysts, should the open-ended stock be bought?
According to analysts, Open Text shares receive a consensus rating of “Moderate Buy” based on three buys and three holds assigned in the past three months. OTEX’s average share price forecast of C$58.82 implies an upside potential of 59.2%. Analyst price targets range from a high of C$70.73 to a low of C$46.25.
Conclusion: OTEX is a cheap stock to consider
While OTEX has a decent amount of debt on its balance sheet, it’s hard not to see value based on analyst estimates. Perhaps that’s why analysts see upside potential of 59.2% and hence the Smart Score rating of “Perfect 10”. Not many tech stocks trade this “cheap.” If you can get past its recent acquisition and heavy debt, OTEX is a solid stock to consider for the long term.
The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.
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