Is Open Text Stock a Buy for its 3% Dividend Yield?

Open Text Corp. (TSX: OTEX) stock is down almost 10% since 2020. Yet, in this same time period, the company has grown its annual revenue from $3.1 billion to $5.7 billion in fiscal 2024. What is going on with Open Text stock as the company embarks on the largest capital return program in its history?

Open Text and the information management industry

Information is at the heart of everything. The more of it that you have, the better. The better your ability to organize it, analyze it, and derive insights from it, the more valuable it becomes in a business. This is where Open Text comes in. As a high-margin competitor in the information management market, Open Text has made it their business to acquire slow-growing companies. This has allowed the company to increase its presence as well as its competitive positioning.

Importantly, the company’s growth has historically been driven by acquisitions. This enabled Open Text to gain a foothold in its business segments, but it also drove up its debt balance. Today, the company sees significant opportunity to lower costs, increase efficiencies, and drive up its margins. Let’s take a look.

The plan to create shareholder value

In the next few years, management will be focused on growing adjusted earnings before interest, taxes, and depreciation (EBITDA), earnings per share (EPS), and free cash flow. In fiscal 2024, its EBITDA margin came in at 34%. The company expects to increase this to up to 38% by fiscal 2027. This growth will be driven by increasing revenue, leveraging artificial intelligence, and optimizing the workforce.

The problem with Open Text today is that the company’s organic growth rates are low. In fact, this fiscal year, management expects that its organic growth rate will be zero to one percent – hardly anything to get excited about.

So, in response to this, management is working on reducing costs and returning cash to shareholders. Investors have so far not liked this strategy, and the stock got hit again after the company reported weaker-than-expected fourth-quarter results in August. Which brings me back to my initial question – Is Open Text a buy for its 3% dividend yield?

The dividend is increasing at Open Text

First of all, I’d like to highlight that Open Text has a pretty optimistic forecast for its free cash flow generation. This year, management expects free cash flow to come in the range of $575 to $625 million. But things have changed. Acquisitions are no longer the main strategy for Open Text. As such, the company’s plan to deploy this capital is simple – 50% will go toward dividend payments and buybacks. The other 50% will go toward the highest return options of the following: dividends, buybacks, debt reduction, mergers/acquisitions.

In the last five years, Open Text’s dividend has increased by more than 50%. That’s a compound annual growth rate (CAGR) of 8.8%. Looking ahead, the company will be stepping up its dividend payments, meaning this growth will accelerate.

The bottom line

In summary, the company has a renewed focus on growing revenue from its existing business. Within this, Open Text benefits from a large base of recurring revenue (approximately 80% of total revenue is recurring). This, along with cost reductions and increases in efficiency, will drive stable and growing earnings and cash flow for the company. In conclusion, I think that Open Text stock is an inexpensive way to get exposure to increasing dividends and shareholder returns.