Canadian enterprise information management software giant OpenText (TSX:OTEX) has struggled to retain investors’ interest over the past year, with its stock price declining 18% despite the company’s efforts to integrate artificial intelligence (AI) into its product portfolio. Management is upbeat about the company’s prospects for the second half of its financial year 2025, which ends in June next year. However, a key question arises from the technology stock’s investor base: Where could OpenText stock be a year from now?
It’s one of a few Canadian tech stocks that could easily have passed as an AI stock trade with potential to generate positive returns for 2024. Yet, OpenText stock grossly underperformed the market during a time when several global AI stocks richly rewarded their investors. With falling interest rates, expanding AI adoption rates, and increasing competition in the enterprise software space, the next 12 months could be an interesting, yet challenging time, for OpenText’s share price.
A mature business lacking organic growth
OpenText, a mature business, has seen little to no organic growth in recent years, with some marginal sales declines during some quarters. For example, organic revenue shrank by 1.8% year-over-year to US$1.3 billion during the most recent quarter that ended in September. The business is struggling to find decent growth, investors are concerned, and OpenText’s stock has given up nearly all of its 90% capital gain temporarily achieved over the past decade.
While OpenText has a reputation as a disciplined acquirer, using mergers and acquisitions to expand its product portfolio and customer base, its recent divestment of a high-margin AMC business recently acquired with Micro Focus suggests the company is now focused on enhancing its financial flexibility while returning capital to shareholders.
The company is returning a record US$570 million to shareholders this year through share repurchases and growing dividends. While share buybacks reduce outstanding shares and can prop up OpenText’s stock price, they also signal a mature business with limited revenue and earnings growth prospects.
Faced with a limited investment opportunities set, a declining business’s management would rather give back capital to shareholders so they can deploy it somewhere else for more lucrative returns than attempt to reinvest the cash flow into internal projects with lacklustre return profiles.
If OpenText continues to generate positive free cash flow during the next year (and it most likely will), the company will most likely continue to return more capital to shareholders through share repurchases rather than reinvest it in projects with low returns – unless AI products revive demand growth.
That said, something is cooking within OpenText’s product portfolio.
Positive signs for OpenText stock
On a positive note, OpenText’s cloud contract durations are expanding to four years or longer on new deals, and the company has improved its cost containment and efficiency, leading to a higher adjusted earnings before interest, taxes, depreciation, and amortization (adjusted EBITDA) margin of 35%. Additionally, after signing on 20 customers for AI-related products during the past quarter, the company expects a strong second half of fiscal year 2025 as it rolls out the Titanium X project’s new AI-powered offerings.
OpenText could grow its sales traction next year as its developers polish up new AI agents while demand growth gathers momentum.
Challenges remain
However, management’s revenue guidance for the Fiscal Year 2025 implies only 1% potential annual growth to between US$5.3 billion and US$5.4 billion. Insiders remain cautious and conservative in their numerical projections. New AI product offerings may potentially fail to lift the business into a new growth mode during the next 12 months.
The company faces strong competition in its core markets with the likes of a Copilot-powered Microsoft, DropBox, and other enterprise content solutions providers offering a significant challenge to its flagship products.
Investor takeaway
Generative AI has been a focus for OpenText, but the company’s organic revenue growth has yet to take off. While management is optimistic, the next 12 months may see OpenText stock trading sideways as investors assess the company’s progress in profitably growing its sales. Some investors may opt to sell OTEX stock for tax loss harvesting.
That said, a return to positive organic revenue growth could propel OTEX stock to double-digit gains in the next year. In the meantime, new investors holding the stock will benefit from a healthy 3.6% dividend yield.
