Fructivore Investments

…but nobody to know what it is. This line was originally chosen to describe a company that was floated alongside the South Sea Bubble in England. And although unfortunately this company seems to be fictitious, there are certainly businesses who could stand to be a little more helpful in describing what products or services they are selling.

And so it is with OpenText, which does the following:

OpenText is an Information Management company that provides software and services that empower digital businesses of all sizes to become more intelligent, connected, secure and responsible….With critical tools and services for connecting and classifying data, OpenText accelerates customers’ ability to deploy Artificial Intelligence (AI), automate work, and strengthen productivity…Our products are fundamentally integrated into the operations and existing software systems of our customers’ businesses, so customers can securely manage the complexity of information flow end-to-end. Through automation and AI, we connect, synthesize and deliver information when and where needed to drive new efficiencies, experiences and insights. We make information more valuable by connecting it to digital business processes, enriching it with insights, protecting and securing it throughout its entire lifecycle and leveraging it to create engaging digital experiences….Our solutions also enable organizations and consumers to secure their information so that they can collaborate with confidence, stay ahead of the regulatory technology curve and identify threats across their endpoints and networks…

And this is in their 10-K, so all of the above is true under penalty of perjury.

The trouble is that if we don’t quite know what a company does, we don’t know if they’re any good at it, or if their competitors might be better at it. Warren Buffett famously claims that he never invests in businesses that he doesn’t understand, which includes high technology. And normally software companies have anemic free cash flows anyway, so a value investor would have no interest in them. My theory is that because writing code is considered an operating expense rather than a capital expenditure (with the exception of a product that is somewhere between commercially viable and fully developed (but not post-development updating or maintenance (which tends to be important for business clients))), the company shows a high return on invested capital (unless there has been an acquisition in which case there is a lot of goodwill on the balance sheet), which attracts a lot of algorithm-minded portfolio managers. Furthermore, as a software company can essentially replicate its product indefinitely at no cost, there is a lottery ticket effect for a company that comes up with the next “disruptive” or “killer” app, as the kids say. Even so, for a larger company in a saturated space such as Microsoft or Alphabet, the odds of developing a product big enough to move the bottom line are quite small.

At any rate, OpenText provides exciting cloud services to businesses, including content management, cybersecurity, automation of applications, and IT operations, and derives its income from cloud services and support contracts. The company is a serial acquirer in the field, having most recently purchased Micro Focus in 2023, a company that provides “technology and services that help customers accelerate digital transformations.” This acquisition was for $5.6 billion, mostly funded by debt, while the company’s current market cap is a mere $7.2 billion at this moment. However, last year OpenText resold a large portion of Micro Focus back to a private equity firm for $2.2 billion and used the proceeds to pay down some of the acquisition debt. So far the acquisition seems to be working out well in terms of free cash flow, which is a rare accomplishment for a merger between two evenly-sized companies, per Damodaran’s Investment Fables.

Turning to the figures, in fiscal year 2024 sales were 5.77 billion, operating earnings were 887 million, plus 808 in depreciation and amortization, minus investing activities of 159, producing operating cash flow of 1536 million. Interest expense was 536 million, leaving $1 billion, or 740 million after estimated taxes, making a reasonable 10% yield of free cash flow. Their fiscal year ends in June for presumably Canadian reasons.

This calculation does not include the $429 million gain on the sale of part of Micro Focus, which OpenText does not consider to be operating even though mergers and acquisitions are part of the company’s core strategy so it may as well be. This stands in positive contrast to Helen of Troy, which considered the sale and leaseback of its premises to be operating even though they’re in the cosmetics and household products business, not the real estate business. At any rate, the gain on sale raises accounting questions; it is surprising that OpenText would be able to turn a 19% profit on assets it held for less than a year, but considering the substantial depreciation and amortization charges that the company takes, it is possible that many of these gains are simply reversals of depreciation charges. Obviously it is in the interest of OpenText to load the divested unit up with as many high priced assets as feasible, to relieve itself of both capital gains and ongoing depreciation charges, but there are limits even to aggressive accounting and I suppose the company should be congratulated for not courting shenanigans.

This figure also does not include the income from the $1.28 billion in cash on OpenText’s balance sheet, which came to $49 million before taxes for the year. Now, on paper, OpenText’s current liabilities exceed its current assets by nearly $400 million, and so not only is there no excess cash available for distribution to the shareholders (which was the happy situation for BorgWarner that many simple-minded editors could not understand), but in theory the company is also going to have to come up with $400 million within the year, so the value of the equity should be reduced by that amount. However, $1.5 billion of OpenText’s current liabilities consist of “deferred revenue.” This category of liability denotes the fact that OpenText’s customers have paid the company up front for services that are to be performed over time, and given the company’s profit margins, even under the worst case scenario of having all of the costs pertaining to this deferred revenue as having yet to be incurred, there should be no additional pressure to come up with more money based on deferred revenues. At any rate, OpenText is in the habit of keeping about $1.2 billion in cash in reserve, so even if it should not be considered available for distribution the income from it should not be ignored.

In 2023 sales were 4.48 billion, operating earnings were 516 million, depreciation was 657 million, capital expenditures 124 million, resulting in 1049. Interest was 364, leaving 685 or $507 after taxes. I should also note that between this fiscal year and 2024 there were charges of nearly $150 million to integrate Micro Focus with OpenText that are in theory nonrecurring but OpenText’s strategy involves frequent acquisitions, though most are not this large.

In 2022 sales were 3.49 billion, operating earnings were 645 million, depreciation was 504 million, capital expenditures came to 93 million, producing 1056. Interest was 151, leaving 905 or 670. There was another acquisition funded by debt in this year.

Year to date 2025, sales are $3.86 billion as compared to $4.41 billion for the first three quarters of 2024, and operating income is $711 million versus $694 million, as expenses are declining faster than sales (which is another promising sign that the Micro Focus acquisition and partial disposition was a good move). Amortization of 480 million and expenditures of 109 produce $1082 in operating cash flow versus $1205 for 2024. However, interest expense was $267 million versus $425 million, leaving $815 versus $780 in pretax free cash flow, or $603 million versus $577 million in after-tax free cash flow, which would be $804 million on a full-year basis.

Interest expense is better covered than before, although the company is still rated BB+ and the outlook is only stable. Unfortunately the gulf between a BB+ bond, which is subinvestment grade, and a BBB- bond, which is investment grade, is roughly as wide as that between Dives and Lazarus, so a credit rating upgrade would be a truly momentous event.

Furthermore the company has made non-trivial amounts of share repurchases this year, so conceivably management sees OpenText as both undervalued and in a state mature enough that its cash needs are predictable enough to allow for repurchases.

So, can we recommend OpenText? Much of the revenue is recurring and the cost of switching IT providers is high enough that companies would not do it lightly. And it is unusual to find a technology company this cheap, although the Software as a Service model is theoretically more difficult to scale than the pure software company model of a company releasing its product into the wild and hoping it finds a habitat and reproduces wildly (if such a model ever existed). Also, the share repurchases suggest the possibility that the company is stabilizing and so even with some opacity as to the company’s operations and competitive niche, OpenText is worthy of consideration for one’s portfolio.

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