Why Open Text Stock (NASDAQ:OTEX) Can Outperform the Market

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Shares of Canadian information technology management company Open Text (EAST: OTEX) (NASDAQ: OTEX) have been tanking lately. What recently sparked an even faster sell-off was the August 25 announcement of the acquisition of Micro Focus International (LSE: MCRO) for ~$6 billion. Shares fell about 14% following that announcement and have been falling ever since. With the stock well below its all-time highs now and with a “Perfect 10” Smart Score rating, however, the OTEX stock is worth considering.

It should be noted that stocks with perfect Smart Score ratings have historically outperformed the S&P 500 (SPX), as shown in the image below.

What makes Open Text Stock intriguing?

Here’s what makes OTEX stocks worthwhile, whether you like the company or not. It is a profitable, high-margin tech stock with modest growth that trades at “equity value” levels (8.1x forward earnings, to be exact). Its revenue has grown at a CAGR of 8.8% over the past five years, and revenue growth is still expected to be in the mid to high single digit range over the next two years.

Additionally, the company’s gross margins have steadily increased over the past decade, from 71.2% in fiscal year 2013 to 75.3% in fiscal year 2022, a sign that competitors do not reduce their profits.

Open Text valuation looks cheap

As mentioned earlier, OTEX stock is trading at around 8.1x forward earnings for fiscal year 2023 (which ends in June 2023). This is based on EPS estimates of $3.34 for the year. The following year, EPS should grow by more than 10%, bringing the multiple down to 7.3x. It is undoubtedly inexpensive.

Note: All figures are in US dollars unless otherwise specified.

However, we shouldn’t stop at revenue alone. Free cash flow is arguably a more important metric. Based on estimates from just three analysts, OTEX’s free cash flow is expected to reach $935 million in fiscal 2023. With a market capitalization of approximately $7.2 billion, this implies a multiple price/FCF of 7.7x. Based on these numbers alone, along with the company’s long-term growth trajectory, OTEX can bring a lot of value to investors.

Open Text’s high debt is something to consider

Although OTEX stock looks cheap based on what we mentioned above, the company also has quite a bit of debt, which can weigh on its valuation multiple. Compared to its cash position of $1.7 billion, the company’s debt stands at $4.22 billion, giving it net debt of $2.52 billion (more than a third of its market capitalization).

However, its debt is about to get heavier. The Micro Focus acquisition announcement states, “We intend to finance the acquisition entirely in cash with existing cash, 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 more billion dollars in debt. That may be part of why investors didn’t like the announcement of the acquisition. Nevertheless, OTEX is very profitable and its debt is currently manageable.

Is Open Text Stock a Buy, Analysts Say?

Analysts say Open Text stock earns a moderate buy consensus rating based on three buy and three hold awards over the past three months. The average OTEX stock 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 worth considering

Although OTEX has decent debt on its balance sheet, it’s hard not to see the value here based on analyst estimates. This may be why analysts see 59.2% upside potential and why it has a “Perfect 10” Smart Score rating. Few tech stocks trade so “cheap”. If you can overcome its recent acquisition and high leverage, then OTEX is a solid stock to consider for the long term.

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