Summary
#1 As businesses grow fast, they are looking for a way to manage their information.
#2 Big data management and security are at the center of many companies’ concerns.
#3 OTEX is a leader in Enterprise Information Management (EIM) systems.
Investing Thesis
Big data, cloud. and security. Those are three keywords you are not done hearing about. As we evolve through an era of consolidation; businesses grow larger every second. Managing growth is one thing, but dealing with the enormous amount of data this growth is bringing inside each company is part of Hercules labors. Enterprise Information Management (EIM) systems have been developed to manage this issue. OpenText (OTEX.TO) happens to be one of the leaders in this emerging business. Let’s take a deeper look at how OTEX manages its way through the cloud.
Business Model Explained to a 12 Years Old
Imagine you have a business. A big one. Imagine that your business employs 100 people and keeps growing. Each day, you receive tons of information about your products, sales, employees, expenses, contracts, etc. This information is piling up faster than your revenue and you end up with mountains of useless and unreadable reports on your desk. You need a solution that will receive, integrate and digest this data for you. This is what we call Enterprise Information Management (EIM) system. EIM helps managers making better decisions by organizing the information in a way that you can access it rapidly, understand it and trust it.
OTEX is a leader in the EIM industry. It helps over 100,000 customers to share, store, retrieve and analyze their company’s information. Open Text is Canada’s largest enterprise software company.
Revenues
Source: Ycharts
As the need for EIM grows OTEX surfs the wave-like a pro. Management brilliantly combines partnerships and growth by acquisitions to ensure strong quarters one after the other.
Since its creation in 1991, the company has successfully performed 58 mergers & acquisitions. Open Text revenue is not only diversified across 100,000 clients, but also with 41% of their sales coming outside Americas. Through the usage of the cloud technology, OTEX is now able to multiply its products offering to the very same clients:
Earnings
Source: Ycharts
Don’t get fooled by the impressive EPS jump in 2017, this was all about a one-time tax benefit tied to the company’s internal reorganization. Following fast-growing company’s earnings isn’t really a good idea. EPS isn’t a good reflection of what the business is doing. Lots of money is being invested in R&D along with acquisitions. Focusing on its revenue growth perspectives makes more sense at this stage.
Dividend Perspectives
Growth-oriented companies in the techno industry are rarely focused on sharing their profits with their shareholders. OTEX has changed its mind back in 2013 when it pays its first dividend.
Source: Ycharts
As you can see in the graph below, the dividend seems to fluctuate over time. This is because OTEX trades on both the TSE and the U.S. Market (NYSE) under the same symbol. Its dividend payments are announced in USD:
Source: Ycharts
The company successfully increased its dividend by 76% through 5 consecutive dividend increases. There wasn’t a special dividend paid in 2014, the graph only shows a false distortion created by the stock split in February.
Source: ycharts
OTEX management aims at a 20% payout ratio based on cash from operation for the upcoming years. As the company continues its quest for growth, you can expect a double-digit dividend growth policy for several years to come.
OTEX meets my 7 dividend growth investing principles.
Potential Risks
Open Text evolves in a rapidly changing environment. It is continuously one iteration away from becoming obsolete as technology evolves very fast. There are also several competitors in this field lurking to grab OTEX clients. Many of them are larger U.S. companies with additional resources. While Open Text has built a strong name and there is a switching cost for any clients who wish to move to another EIM, it is not impossible that OTEX stop being the flavor of the month at one point.
The second risk I see is that OTEX is condemned to grow by more acquisitions in the future. With several transactions under its belt, it doesn’t seem like a problem. However, this could lead to hectic quarters.
Valuation
At this point of the analysis, I could say that I’m intrigued by OTEX, but I’m still not sure I would put my money on it. Let’s see what the market has to say about OTEX valuation:
Source: Ycharts
By looking at the past 10 years of PE history, it is still difficult to determine a trend. The company’s valuation clearly depends on their short-term growth perspective prior or following an acquisition.
In order to have a better idea of OTEX fair value, I used a double stage dividend discount model. I think management can continue with an aggressive dividend growth policy for the next decade. I also require a 10% return rate due to its sector volatility.
| Input Descriptions for 15-Cell Matrix | INPUTS | |||
| Enter Recent Annual Dividend Payment: | $0.66 | |||
| Enter Expected Dividend Growth Rate Years 1-10: | 12.00% | |||
| Enter Expected Terminal Dividend Growth Rate: | 7.00% | |||
| Enter Discount Rate: | 10.00% | |||
| Discount Rate (Horizontal) | ||||
| Margin of Safety | 9.00% | 10.00% | 11.00% | |
| 20% Premium | $64.81 | $42.58 | $31.50 | |
| 10% Premium | $59.41 | $39.03 | $28.87 | |
| Intrinsic Value | $54.01 | $35.49 | $26.25 | |
| 10% Discount | $48.61 | $31.94 | $23.62 | |
| 20% Discount | $43.21 | $28.39 | $21.00 | |
Please read the Dividend Discount Model limitations to fully understand my calculations.
Unfortunately, the bulk of OTEX value lies in its growth perspectives and not within its real numbers. In other words; OTEX is overvalued. The DDM is often difficult to use for smaller yielding stocks. At 1.50%, we can’t really consider OTEX as the strong dividend payer.
Final Thoughts
I think OTEX future will be bright and the company will continue to thrive in the EIM business. However, it doesn’t include all requirements to be part of my personal dividend growth portfolio. I may wait until the company slows down on growth by acquisitions and distribute a larger share of its profit as dividend.
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Disclaimer: I am not long OTEX in my Dividend Stocks Rock portfolios.
