OTEX - Open Text Corporation (OTEX) Presents at Nasdaq 49th Investor Conference (Transcript)
2023-12-05 10:52:02 ET
Open Text Corporation (OTEX)
Nasdaq 49th Investor Conference
December 05, 2023 08:00 AM ET
Company Participants
Madhu Ranganathan - Chief Financial Officer
Presentation
Unidentified Company Representative
All right, well, good afternoon. Hope everyone enjoyed lunch and the panel presentation. We are kicking things back on again with OpenText, and we're pleased to have Chief Financial Officer, Madhu Ranganathan.
Madhu, thank you for joining us again at the NASDAQ conference.
Madhu Ranganathan
Yes, thank you for having us. It's great to be at NASDAQ in London.
Question-and-Answer Session
Q - Unidentified Analyst
Awesome. So just to give you a sense, OpenText is now almost a $6 billion business, serving 120,000 enterprises on and 150 million users. And so Madhu, given the scale of the business for investors, new to the OpenText story, what is the pain point that OpenText is solving for your customers and how would you describe the core opportunity that company's pursuing?
Madhu Ranganathan
Yes, sounds great. And it's a great place to start. Think of OpenText as we are focused on the singular powerful concept of information management at scale in the cloud and AI. With the Micro Focus acquisition, we truly have the most comprehensive information management platform in the industry. And to address Sanjit's point and the pain points, I'll talk about what do we do? We build software and we build software to power and protect information and ranging from content management to business networks, we call it that, gears towards industrial, commercial, automotive, supply chain, cybersecurity, right? And IT operations management, application automation, and of course, AI and analytics, kind of the full kind of the full spectrum.
Now what we do is all sorts of information, content, documents, email, video, archives, all of that. And the exciting opportunity ahead is intersecting Gen AI through all of that. Now with respect to pain points, think of customers have very, very complex work streams and the data and the information sprawl has never been more complex. So where we really intersect with our software is, there's a lot of talk about AI and data warehousing, but we come much before that in terms of organizing data, storing data, protecting data, analyzing data so that you can in fact apply the data warehousing in AI and that's really where we come in.
So I would say the pain points are really the data sprawl, the information sprawl. It's still unfathomable how much of unstructured data is out there for a company like OpenText to apply its software. And where the evolution happens, it's really getting into the Gen AI capabilities as well.
Unidentified Analyst
Great. Yes, you can't have an AI strategy without a data strategy clearly. Seethe Company made some news on its earnings call and which was a very solid quarter. But I think what caught my eyes around this strategic shift from a less reliance on M&A, which has been a focus to renewed commitment to driving organic growth. Can you talk to us a little bit about the motivation behind the shift in strategy, and what does that mean for M&A going forward? Like, will you not do any M&A or is it just going to be a different size and type of M&A?
Madhu Ranganathan
Yes, absolutely. I will say we're a 32-year young company and to just kick it off, I'll say, as a technology company at scale, we're always going to do acquisitions, right? So that's kind of the leading statement there. So for the last 32 years, the framework of information management has clearly been built through in acquisitions. We've also had a couple unique approaches to M&A. We have been -- as you can call it, a value-based acquirer. You do not see us pay very, very high multiples on businesses. And we also believe in getting the businesses in acquiring, integrating, and getting them to the levels of profitability that OpenText has that sort of has been kind of the full M&A model.
Now, with Micro Focus acquisition, we are near 6 billion in revenue, but we also have to -- we can also operate in a $200 billion TAM. Now, previous to Micro Focus, we were about 9,000 billion. So, we have a $200 billion TAM, and at near 6 billion, it is very clear that we do not need more TAM, we could grow into this TAM. And there are plenty of areas for us to unlock. And this is not an overnight strategy Sanjit. And that's something I do want to clarify. This is in a multi-year added, and of course the size and scale of the TAM allows us to make this pivot.
But there are two very important aspects that lead into this. One is obviously R&D and innovation. We are at 14% to 16% of revenues in R&D that is also reflective of 40% of our workforce, of 25,000 employees involved in R&D and innovation, and our go-to market engine, we believe at the size and scale of OpenText is like none other, which is -- we probably have the strongest direct Salesforce team, and we have a very strong partner network from the SAPs of the world to Google and AWS and to many, many other partner channel.
Now, the investments we've made in M&A, our next sort of value unlocker is going to be organic growth. So, so again, we are going to lead in with organic growth. We can talk about the divestiture. The divestiture is going to allow us to deliver earlier than we anticipated. That means we return to capital flexibility. The muscle memory of M&A does not go away, but we will lead in with organic growth and M&A will definitely be in the picture. But the next 30 years, so to speak, of OpenText is built upon the framework of M&A that we did, and plenty of value areas on unlock for organic growth.
Unidentified Analyst
Great. Let's talk about that divestiture. So in the last couple weeks you've announced the divestiture of the application modernization and connectivity business to rocket software. Are you guys are going to get 2.27 billion in cash? Can you describe what this business was? How large was it in terms of revenue and EBITDA? And why did the team make the decision to divest?
Madhu Ranganathan
I'd want to start with the why first and then we can work our way back to your other very, very valid points. Look, when we acquired Micro Focus, we did not have an intention to divest. We acquired the entire business and the intent was to keep the entire business. This is AMC, right, application modernization and connectivity. It's the COBOL and the mainframe business. And we did get an inbound call and as we diligence the inbound call, a few things came to light. One is you'll hear us talk a lot about our cloud journey. AMC was all non-cloud or off-cloud, which actually also meant that in our product roadmap, which is very aggressive product roadmap, AMC was the farthest in our cloud roadmap to be able to cloudify and just by DNA, AMC is also a very self-contained unit.
So again, when you think about divestitures and carve outs, we want to make sure it is carve-outable in a very successful manner. And by nature of everything I described about AMC, rocket software is a great home for AMC. And they have invested into cloud and hybrid since that is the bread and butter of their business and AMC would do very well there. For us, if we were to cloudify AMC earlier than we had planned, it would mean we would not be able to clarify other products and solutions. And there's a very important aspect here. AMC's 500 million in revenue, 275 million in EBITDA, but it was also a flattish business, right? So, we had chosen to put our roadmap into more of the growthy areas of our products and solutions. And it absolutely made sense to do this divestiture.
We expect to close it by June, and you're right, it's about 2.275 billion. And last but not least, it's going to allow us to delever, which is about three quarters earlier, to get to below three times in our net leverage ratio than we had planned. And most importantly, the focus and the opportunity for us to release the resources, the mindshare starting from our CEO and CTO to the architects to cloud and AI opportunities just seem too large to not consider, and we are delighted to be able to do this.
Unidentified Analyst
Yes, it sounds like a transaction makes a lot of sense. And just to follow up, and I think you addressed it in your answer, it sounds like with the proceeds, you'll be using it for debt pay down.
Madhu Ranganathan
Yes. I mean, a hundred percent is going to be focused on debt pay down if I could just expand the answer that OpenText has taken a pretty holistic view on capital allocation. Meaning, like historically, we have a 20% trailing 12 month cash flows, free cash flows on dividend. Now we are, when we return to capital flexibility, able to add buybacks into the mix. And as you rightly asked earlier, M&As will always be in the mix. And this is a strong free cash flow business. Yes, some cash flows is going out of the business with AMC, but we still are going to be at the low twenties in terms of free cash flow to revenue only to grow. So, the full stack capital allocation is something I think will be the, I think we'll be ready to implement.
Unidentified Analyst
Excellent. Let's talk a little bit about, Micro Focus. In August, 2022, the Company purchased Micro Focus for about $6 billion. Can you give us some progress updates since making the acquisition, what has been completed with respect to the integration and what remains ahead? We'll talk about the top line growth in terms of Micro Focus in a bit, but just in terms of the blocking tackling of integration, what's been done and what's left to do?
Madhu Ranganathan
Yes. Well, first of all the Micro Focus acquisition brings me personally, operationally to the UK more often than I used to. And we have a strong workforce in Reading, and I'm going to be there tomorrow. So, we went after Micro Focus integration like none other because it was a transformative deal. And also, we had to bridge the gap between the market's reaction to it versus where we believed, the value could be sort of gathered from the asset. And what do I mean by that? We went off at what has been completed, corporate integration, product integration, sales integration, product roadmap, and customers all done.
We spoke about renewals in our last earnings call, which is about 65% of the business we acquired from Micro Focus. And they were at low 80s in terms of the of their renewal rate and getting them to the high 80s, which is the goal for this fiscal year, June, and getting them into the mid-90s, which is really the OpenText standard, is really the journey that we are very well on. And we spoke about it at our earnings call as well. And I will say micro focus is predominantly off cloud, very nascent in the cloud and getting some of their key products like voltage and fortify into our aggressive cloud roadmap, and we've been able to do that as well.
And the last thing we can get to AI, when you're ready, two of the micro focus crown jewel products are going to be part of our AI solution and we couldn't be more delighted to do so, 2.3 billion is their baseline of revenue we expect to organically grow from that base in fiscal ‘24. And the last, but not least, I'll tell you that, we can get them to 36% to 38% adjusted EBITDA in fiscal ‘24, which is also about six months earlier than we had planned. So all in all, we are very pleased with where we are.
Unidentified Analyst
So let's turn the conversation into what we talked to at the top of the call in terms of driving organic growth. And how do we achieve that? So as a company, you've laid out some multi-year targets. In 2026, I think you guys are targeting AR growth to go from 1.2%, which is roughly where it is today -- to sorry, 2% to 4% by that time. So maybe just starting at the high level, we'll go into the individual businesses in a second, but what are the basic pillars to get you to that acceleration?
Madhu Ranganathan
Yes, so we have the materials in our investor deck, but really the first place to start is cloud, and the cloud bookings growth we've spoken about at 15% annual cloud bookings growth. And for those of you who are newer to the OpenText story, I'll share that our cloud revenues was zero about eight years ago, right. So, I mean, it has been an amazing journey in the cloud. So the fiscal ‘26 aspirations include 7% to 9% organic cloud revenue growth, which is the biggest and the leading growth driver for the overall 2% to 4%.
Now, cloud organic growth rate has been trending steadily up in our most recent fiscal year we did about 4%. And then when you think about the next two to three years, getting to the 7% to 9% is going to be the leading driver. Our customer support install base is a very solid market install base, and that runs about flat to low single digits in growth. We optimize for gross margins about 91%. So that's what gets you to the 2% to 4% ARR organic growth.
We call out licenses flat. We've chosen to be in the license business more as a customer deployment choice, right. So when you do the math there as well, we get to the 2% to 4% growth, but starting at the top of the stack for us, the ultimate destination is cloud, 80% of R&D goes into the cloud. So I say the starting point is 15% cloud bookings growth, and we work our way from there into cloud revenue growth and to the overall 2% to 4%.
Unidentified Analyst
And so if we look at core OpenText ex-Micro Focus, can you frame up the opportunity to accelerate growth by driving more conversion to SaaS and greater adoption of the cloud portfolio? As you answer that, is there any sort of uplift that the Company sees when a customer goes from off cloud to your cloud products and cloud portfolio? What does that uplift look like?
Madhu Ranganathan
Yes, so I'll say, one of the important distinctions of OpenText's journey to the cloud is we did not take the approach of the maintenance being the base that we have to cannibalize out of or substitute out of, right? So the greenfield new opportunities for us for cloud has been very strong and continues to be very strong. So when we speak about the 15% cloud bookings Sanjit, like, none of that is expected to come out of maintenance like cannibalization, right? Again across our pillars, we see the pipeline and the opportunities to do so.
Now, the OpenText Cloud, we are the largest private cloud provider, so we continue to see growth in that. Particularly as you intersect AI for a large enterprises, they'd rather stand it up in the private cloud than they would in a, than they would in a public cloud. We have a lot of opportunities in the SaaS, right? We went after complex cloud businesses that will continue, but many of our products and solutions are moving from the on-prem to the SaaS version. And we see a lot of growth in there now.
Now, content is going to be a leading cloud growth driver, and right next to it is going to be cybersecurity like products as well. And when we talk about the Micro Focus intersection, value edge smacks is the service management tool that Micro Focus did not have a chance to cloudify fortify, all of that is going to be part of the cloud journey. And keep in mind we call it Titanium, that's our R&D project of how much we drive into the cloud. 80% of R&D investments are directed to the cloud.
Titanium was driven for OpenText clarification. Now, Titanium X is driven for Micro Focus clarification. And when we talk about cloud is getting up products to public cloud parity, because many of our customers have already made the decision about their cloud home, whether it's Google or AWS or Microsoft. And our job is to provide the products and solutions agnostic of the cloud parity, right? Those are the areas where the cloud solutions come into play.
Unidentified Analyst
Yes. As part of that growth strategy, obviously AI is going to be play a role in that, in that better growth story over time. Can you give investors the reason why OpenText will be an AI winner? What data assets does the Company possess that'll allow you to effectively monetize your AI ambitions?
Madhu Ranganathan
Yes, absolutely. So the 32 year history we have, it has been all about working with and working on customer's data. So to start off with the customer's data is not our product, but we have visibility, access to the customer data, and as we can all appreciate, and there's no AI -- excuse me, and there's no AI without data, right? So let's start right there. We sit on 75,000 enterprise customers who've been with us for a very long time, and we get access to the data to offer our products and solutions. And the number two things, Sanjit is, it's kind of missed to this AI hype in our view, which is we today have the product portfolio ready.
It's our product, our technology to go do this AI, I mean like AI journey and that's what we call the Aviator. It comes together with a Micro Focus idle product, the Vertica product, which is the vectorization of the database, as well as our own analytics tool called the Magellan. So at the start of this AI hype, we know went about it very systematically and we were able to pull this together as Aviator. Now if you recall me mentioning the different pillars we were, we kind of splashed this Aviator across our pillars.
So we are offering the AI, the AI solution to sit across every, every single pillar is sitting on trillions of data, whether that's content or transactions. So that's really the approach we're taking at OpenText's world, we rolled out our general availability product, so this Aviator is going to be released in December and we rolled out pricing, we call purchase your wings, which is the initial pilot phase of what the customers want to think about as use cases, which again, what we are seeing is sits across every sector we operate, setting up an Aviator persona along with the kind of the real life, whether it's claims or whether it's HR or whether it's tech support, right That's really the approach we're taking.
Unidentified Analyst
Awesome. And you sort of addressed it in your answer, but just to put a pin in it, which products do you see as the most significant contributors near-term, and what do you see as the biggest long-term AI opportunity for the Company to monetize?
Madhu Ranganathan
Yes. So the near term AI opportunities is going to arise out of search, it's going to arise out of IoT. And when you think about the long term, I'd encourage us to think about in two aspects, there's this hype asking, what is your AI revenue, right? There's going to be a lot of pull in effect for OpenText where our customers who have -- who are ready to move into AI also realize that they have to work through this unstructured content and they have to get the content organized or get ready for AI. And that's where the core OpenText cloud solutions come into play.
We called out in the context of the 15% bookings growth, we called out 20% near-term in our second quarter, which is December quarter. It'll have some AI contribution in it, but I do think the long term is going to be a pull-in opportunity for our cloud solutions, as well as AI, and the AI curve could be slower to kind of begin, and we'll call it out as we see it. We -- in the numbers you asked, and I shared on fiscal ‘26, it does not include AI at the moment, and we'll just call out as we see it.
Unidentified Analyst
Is there with across the product really -- is it like the content management side that's probably most obvious near term versus other parts of the world?
Madhu Ranganathan
Yes. The content management and the search side is ripe for that, but that does include a lot more of the pull-in effect as well with respect to where there's more unstructured data. Customers want to get ready very fast, which would mean purchasing our core content management solutions. And we do see, as I said, IoT as a key opportunity as well.
Unidentified Analyst
On the last earnings call, you mentioned that Micro Focus would return to organic growth by the end of fiscal year ‘24. Looking longer term towards your 2026 targets, what are the specific things that companies doing to accelerate organic grow that Micro Focus?
Madhu Ranganathan
Yes, so one of the challenges of Micro Focus that was well, sort of seen from the market perspective that we were well aware too is their continued customer churn. So, we will return Micro Focus organic growth. And recall my comment about 65% of the business we bought was support and maintenance. So we right away had to address the maintenance in the renewals piece, a couple sort of strategic aspects and more operational aspects.
From a strategic aspect, as many of us who've been in software for a long time, the customers are looking for the future direction of the product roadmap. And right or wrong, the Micro Focus customers did not get a lot of love and visibility on the future roadmap. And Mark, a CEO of the team, means like addressed that first as soon as couple months into the close. We went in front of all the Micro Focus customers spoke about the current product roadmap, what we could do in the future.
As we know in software renewals, that renewal doesn't happen for that product. It happens for the vision of the future product. So that had to be addressed sort of right away. Now, the blocking and tackling is some philosophies around in a renewals management and our philosophy has to be centralized. We don't outsource renewals. Micro Focus had it decentralized also had it outsourced. So, we pulled everything in within two months.
Now their low 80s renewal rates, we see a path to high 80s in fiscal ‘24, and we see a path to the OpenText standards of mid 90s in the next one to two years. So that's going to be a major driver for returning to organic growth. Now our philosophy is every one of the Micro Focus products has to grow. Now I spoke about AMC that was sort of flattish and we have an opportunity there, but aside from that, all other products have an opportunity to grow.
Now, cloud was non-existent or nascent for Micro Focus. Their customers are looking for a private cloud roadmap for a general cloud roadmap we provided that. So step by step, we will be cloudifying the Micro Focus products, that is also accretive to growth, right. So those are sort of the big drivers. But I will say the foundational aspect of what needs to be done it has been set, right.
Unidentified Analyst
Excellent. This is my first CFO specific question.
Madhu Ranganathan
Alright.
Unidentified Analyst
But let's sort of lay out the total return framework you plan to deliver to shareholders across, if we think of the key inputs here, revenue growth, margin expansion, share of purchases and dividends. And what does that sort of sum up to that investors can expect over the next three or four years?
Madhu Ranganathan
Yes, so maybe not directly answering and I will do that. Look, we are very clear that today we're not getting full value for what we have done and for what we have out there. And specifically, I mean, our fiscal ‘26 aspirations, and there's a little bit of a history or a journey there, which is all good, putting the negative pieces and Micro Focus in the rear view mirror through the strength of our integration, the strength of us posting the numbers, that's been priority one. And I believe we've done very well on that.
And over time, we will put that in the rear view mirror. The leverage was top of mind from an investor perspective, right. And we do have a solid path there in addition to our normal repayment to get to accelerated delever. So I will say with that the capital allocation framework, if you think about it on a three-legged stool, with M&A has been a big aspect of the capital allocation and dividends, we've been a 10 year plus dividend issuer. We expect to continue to maintain it, share buybacks we've done some not so programmatically.
And with the June expected close of AMC and the big bang delever, we do expect buyback to be back on the table from a return to shareholder perspective. Yes, so those are kind of the three big like levers we have. But coming back to the model of OpenText for software companies, we've chosen to be very profitable, strong cash flows. And now, I believe our organic growth rate will catch up to the expectations of where this addressable market and the product innovation can come together. So that's really where we believe that the convergence of what we've done and what we can do, to where the share prices trading and the valuation is, we do, we expect that to converge.
Unidentified Analyst
Awesome. And just to follow up on that going back to the total from the revenue growth standpoint. We're looking I think sort of turning two to 4%. EBITDA margins from today to 2026, where does that -- where is, where are you starting from and where, where does that go to? And then in terms of the dividend piece, what's the policy in terms of free cash flow allocation?
Madhu Ranganathan
Yes, sure thing. So from a growth perspective, I'll probably reiterate, that the starting point is a cloud bookings growth. That's the 15%. And the cloud revenue organic growth is seven to 9%. And again, when you look at customer support at flat to low single digit growth, that's where the math of the 2% to 4% comes in. I did want to clarify that. So from a dividend and buyback perspective, we are looking at 30%. So we've been at 20% trailing 12 month free cash flows for dividend. We are putting another 10% buyback. That's certainly not the cap.
If we believe our stock is a better buy than doing an M&A. I mean, our choices are going to be very clear, with the AMC kind of the potential divestiture, our EBITDA range is 36% to 38%. It was previously 38% to 40%. We are bringing it down just the pure math of AMC. And I'll remind us that we still haven't baked in AI revenues and the productivity coming out of it. And as we get to the closing of the divestiture, we'll certainly come out with sort of the better math on that.
Unidentified Analyst
Yes. And it's also a key point that you're not necessarily baking in any sort of AI interest monitors and monetization into the forecast. I guess, my last question is just in this as a CFO in this higher rate environment, how has the change -- how has that changed your perspective on how you allocate capital to the business with these higher rates between the interest that you're getting on cash versus debt pay down versus the funding needs of the business?
Madhu Ranganathan
Yes, so two things. Again, back to the AMC divestiture, about $150 million annually is going to come off of the interest burden and the cash flow burden from the divestiture. Pre that very cognizant of raising interest rates at an average of 6%, we had committed to $175 million repayment. So definitely that's sort of in top of mind. But your question about allocating investments within the operating model is a very important one.
And I will say OpenText is very distinctive in the sense we could do 36% to 38% adjusted EBITDA margin after allocating 14% to 16% to R&D. And the 14% to 16%, we have to consider that as 40% of our workforce. That's 10,000 out of 25,000 people around the globe doing R&D and innovation. And we're also doing 16% to 18% for sales and marketing. So, I believe CFO perspective, it's a very well allocated, very well invested model. And we get a lot of mileage out of this in terms of the growth rates we talked about.
Unidentified Analyst
Awesome. Well, Madhu, thank you so much for coming to NASDAQ and walking us through all the things that are happening in the OpenText. I really appreciate it.
Madhu Ranganathan
Thank you to NASDAQ and thank you as well. Thank you all.
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Open Text Corporation (OTEX) Presents at Nasdaq 49th Investor Conference (Transcript)