Claim Membership Credit
OpenText (TSX:OTEX) stock lost $7.16 per share or 14.75% of its market value following the Canadian technology giant’s release of quarterly financial results. The $11.3 billion information management company lost almost $2 billion in market value in a single trading session on Friday despite meeting earnings expectations. The devil was in its issued guidance.
Why did OpenText stock fall?
OpenText reported 16.3% growth in third-quarter fiscal 2024 revenue to a record $1.45 billion, and its adjusted diluted earnings per share of $0.94 were in line with market expectations. Investors were concerned by management’s preliminary guidance for the fiscal year 2025 (which begins in July) and the company’s moved aspirations for 2027.
The tech stock adjusted its prior adjusted earnings before interest, taxes, depreciation, and amortization (adjusted EBITDA) margin for 2024 from 36% to 37% of revenue to 33.5% to 34.5%. It reduced its free cash flow outlook for the current year from $825 million-$900 million to a lower range between $725 million to $800 million. The adjustments could partly reflect a recently concluded sale of a cash-rich mainframe business to Rocket Software for under $2.3 billion.
However, OpenText pushed out of its prior cloud bookings and other key medium-term aspirations a year further from 2026 to 2027. Revenue run rates of $5.7 billion to $5.9 billion are now achievable in fiscal year 2027, not earlier. The “delay” applies to cash flow run rates and adjusted EBITDA margins, too. Why? Because the company is witnessing larger but longer contract commitments in the cloud computing market. Snatching customers from competitors could take longer to achieve. This spooks growth-oriented investors hopeful about the company’s rapid adoption of artificial intelligence (AI) to re-engineer revenue and earnings growth.
What else should investors know about OTEX stock today?
OpenText’s sale of a slow-growth but cash-rich mainframe business takes away a cash flow-generating asset. That said, the divestiture helped reduce company debt by $2 billion this month and reset its leverage profile to achieve a more financially flexible balance sheet.
The sale of a slow-growth, cash-rich business makes OTEX look like a shrinking business over the next 12 months. Revenue-growth rates will be negative due to higher comparable quarterly earnings over the next four quarterly earnings reports. However, OpenText is still growing, organically, though too slowly for some, and the business should expand through acquisitions of cloud businesses shortly.
The market estimates OTEX will lose 7.6% of its revenue year over year in fiscal year 2025, which begins in July 2024. Revenue should shrink at an increased magnitude from 5.7% during this quarter to June 2024 before a 10.5% year-over-year revenue drop in the final quarter of this calendar year.
Should you buy the dip?
Investors willing to patiently wait for OpenText to fully capitalize on a cloud services-led growth opportunity could buy OTEX stock at today’s cheap valuations and sit out the storm for future gains. The business’s double-digit growth rates in AI-enhanced cloud computing offerings, its intention to continue investing in the cloud segment, a strong cash flow generation capacity, and a more investor-friendly capital-budgeting policy could help unlock positive total returns on the tech stock over the next decade.
OpenText has updated its capital budget to allocate 50% of its available cash flow towards share repurchases and growing dividends, up from 30% a quarter ago. Recurring share buybacks could reduce the number of outstanding shares, grow earnings per share, and enhance OpenText’s return on equity by reducing its equity base.
The recent drop in OTEX stock price is a buying opportunity the company could capitalize on to amplify the impact of its stock repurchase budget.
Moreover, sustained free cash flow generation supports strong dividend growth rates for passive-income growth. Dividend-growth rates around 10% could be achievable over the next two to three years. The current OTEX stock quarterly dividend yields 3.3% annually.
Shares are significantly cheaper today. OpenText stock trades at forward price-to-earnings multiple of 8.3, which is lower than a five-year average multiple of 12.4. New investors pay $8.30 for each dollar of annual earnings, down from an average of $12.40 per dollar of OpenText’s future annual earnings.
