Open Text (TSX:OTEX) stock has been a decent long-term investment, delivering total returns of close to 13% per year in the last 10 years. However, the tech stock could be a roller-coaster ride. For example, in late 2022, the stock declined approximately 30% when it announced its plans to acquire Micro Focus. The stock has since recovered from this fall.
Mergers and acquisitions have always been a part of Open Text’s DNA. However, Micro Focus was a relatively large and complex acquisition worth an enterprise value of close to US$6 billion. To get a sense of the size of the acquisition, Open Text’s enterprise value today is about US$18.8 billion.
Other than enhancing Open Text’s capabilities in cyber resilience and informational governance, the management believes Micro Focus will also add capabilities in application development and modernization, advanced analytics, and IT operations. Because of this acquisition, Open Text expanded its addressable market to US$208 billion.
Because of this massive acquisition, Open Text bumped up its debt levels. As of its last reported quarter, which was the fourth quarter of fiscal 2023, the tech company had a net leverage ratio of 3.5 times.
It’s going to take some time to integrate Micro Focus and digest the acquisition. Management targets to reduce the net leverage ratio to less than three times by the end of fiscal 2025. For your reference, before the Micro Focus transaction, Open Text’s net leverage ratio was two times.
Thankfully, Open Text has a track record of generating increasing operating cash flows over time. In the past, it has made countless acquisitions, bumped up its debt, and paid down its debt levels with its reliable cash flows. In fact, the tech company is a free cash flow machine. For example, in fiscal 2023, it used 16% of its operating cash flows for capital investments, leaving free cash flow of US$655 million. This resulted in a payout ratio of almost 40% of free cash flow for its dividend payments in the period.
OTEX Dividend data by YCharts
Sure enough, Open Text is committed to an increasing dividend. It has raised its common stock dividend for 10 consecutive years with an impressive five-year dividend-growth rate of 12.7%. It must have disappointed investors with a dividend hike of only 2.9% last month, as the company focuses on rapid debt reduction. However, management forecasts free cash flow to jump to US$800 to US$900 million in fiscal 2024 (i.e., this fiscal year) and rise potentially to north of US$1.5 billion in fiscal 2026, which would result in higher dividend growth over the next few years. A conservative estimate for its dividend-growth rate would be a similar rate of north of 10% it has experienced in the past.
Valuation-wise, at $54.45 per share, analysts believe the stock trades at a discount of approximately 20%, which could drive price gains of about 24% over the next 12 months. The dividend stock also offers a safe dividend yield of 2.5%. If the management’s forecasts materializes, the stock could double investors’ money in three years! OpenText is worth considering for diversified portfolios in high-risk, long-term accounts.
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* Returns as of 8/16/23
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