Open Text shelves M&A strategy – for now – to focus on stock buybacks and organic growth

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Open Text Corp. OTEX-T stock sank Friday after the company pulled back from its long-held strategy of growing by acquisitions to focus instead on giving more money to shareholders and expanding revenue from its existing businesses.

The Waterloo, Ont-based information management software vendor said in May it would spend half of its prior year’s free cash flows on dividends and buying back shares – announcing a US$250-million repurchase program at the time – and allocate the other half for mergers and acquisitions of cloud-based businesses.

But when Open Text announced fourth-quarter fiscal results late Thursday, it stated the half of free cash flow previously earmarked for M&A would now be allocated to the highest return of capital across dividends, buybacks, debt reduction or M&A.

And for now, the best return comes from purchasing Open Text stock, chief executive officer Mark Barrenechea said. The company announced a fresh US$300-million share repurchase program Thursday and increased its annual dividend by 5 per cent. The company expects to return US$570-million to shareholders in the 2025 fiscal year that started July 1 through dividends and buybacks, the highest amount in its history.

“As we look into 2025, we think the best use of our additional capital is to buy ourselves,” Mr. Barrenechea said. “M&A remains part of our strategy. We’re just applying the capital to ourselves in fiscal 2025.” Asked for more details on when or if Open Text would return to its acquiring ways, he replied that delivering on his goals for the year of delivering mid-single digit organic revenue growth from Open Text’s cloud business and buying back stock “is my singular focus right now. Call me in six months.”

Open Text, the fifth-most-valuable technology company on the Toronto Stock Exchange with a market capitalization of about $11.3-billion, reported results for the quarter ended June 30 that came in below expectations. It posted revenue of US$1.36-billion, down 8.6 per cent year over year owing largely to a rare divestiture, adjusted operating earnings of US$445-million, and net income of $248-million.

Open Text shares closed Friday at $39.51, down 6.5 per cent, amid a broad-based market selloff. That’s the same level where Open Text stock traded eight summers ago. Going into Friday, the stock traded at 7.5 times the ratio of enterprise value to projected operating earnings, down from its typical ratio of 11 to 12 times.

National Bank Financial analyst Richard Tse downgraded his rating on the stock to “sector perform” from “outperform,” describing Open Text’s retreat from its growth-by-acquisition strategy to favour internal revenue growth as a “hard pivot” that would be challenging to pull off.

Open Text has traditionally grown by buying other slow-growing or declining enterprise software businesses and delivering little or no “organic growth,” or revenue expansion from existing businesses. But the company has also managed to generate solid cash flows by delivering high operating profit margins. It earned a 34-per-cent operating profit margin in fiscal 2024, with a goal of reaching the high 30s within two years. The company cut 1,200 jobs in July, which will translate into a $200-million savings, although it plans to hire back 800 people in sales, professional services and engineering.

But Open Text’s acquisition story hit some challenges after it bought Britain’s Micro Focus International PLC for US$5.8-billion in early 2023 during a period of higher interest rates. To help pay off debt accumulated for the purchase, Open Text sold Micro Focus’s mainframe computer unit to Rocket Softwarwe Inc. for US$2.3-billion in cash before taxes and fees – its first divestiture in memory. It used US$2-bilion of the proceeds to reduce debt in its fourth quarter. That cut Open Text’s leverage ratio to 2.85 times, which still limits its deal-making ability until the ratio falls further, Mr. Tse said.

With its acquisition story on the shelf for now, Mr. Barrenechea is talking up the organic growth his cloud business can deliver. He said that business can grow organically by up to 5 per cent this year, rising to as much as 9 per cent two years later. But cloud accounted for less than a third of Open Text’s overall revenues last fiscal year, and revenues in the rest of the business fell. The company forecasts overall organic growth of zero to 1 per cent this year.

The increased focus on Open Text’s meagre organic grow is “a key challenge for the stock,” BMO Capital Markets analyst Thanos Moschopoulos said. “Organic growth will have to show some acceleration in order for the stock to work.” But Open Text has little choice for now as “their balance sheet and current stock valuation make it challenging for them to executive on accretive M&A.”