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Get Four
|  | OCTOBER 7, 2003
 FOCUS STOCK By Scott Kessler A Good Story for Open Text [Page 2 of 2] SAVVY ACQUIRER. We believe Livelink is distinguished from competing products because it's built for the Internet (with resulting advantages in scalability) and is easy to install and customize (which could contribute to a quicker return on investment for customers). Open Text also offers consulting, training, and technical-support services to enhance the easy implementation of its software. We also anticipate that Open Text will continue to successfully pursue acquisitions to broaden its technology base, enhance its product offerings, and strengthen its sales and customer-support capabilities. It has proven to be a savvy acquirer and effective integrator of smaller companies over the past few years, in our opinion. Many attractive opportunities are still available for purchase, in our view, given the fragmentation of its markets and notable operational and regulatory challenges faced by some of its competitors. Gauss Interprise is a good example of that, in our opinion. Its appeal included its Web-content and business-process management technology and 1,100 clients, including carmaker BMW and newspaper USA Today. However, Gauss had been losing money and burning through cash, causing customer concerns. We recently valued the pending acquisition at only about half our estimate of the German company's 2003 sales, which is a significant discount from the average of its peers, which include Interwoven (IWOV; S&P rank 3 STARS, hold; $3), Stellent (STEL; $9), and Vignette (VIGN; $2). In our view, this transaction would not only enhance Open Text's solutions and customer base but also be accretive to earnings in relatively short order. STEEP DISCOUNT. Standard & Poor's Core Earnings estimates for Open Text are $1.01 for fiscal 2004 (ending June) and $1.36 for fiscal 2005. These forecasts reflect estimated stock-option expense under accounting standard SFAS 123 of $8.9 million in fiscal 2004 and $9.6 million in fiscal 2005. We expect the impact of stock options as a percentage of net income to continue to decline. The company doesn't maintain a defined-benefit plan, so it has no pension-related expenses. Despite the promise of ECM solutions and Open Text's recent quarterly results, which have been encouraging, in our opinion, the stock trades at steep discounts to its competitors, as well as the S&P 1500 Internet Software & Services and S&P 1500 Software industry indexes. We anticipate that Open Text will be able to post revenue increases averaging 20% annually over the next three years. Despite modeling for a higher corporate tax rate in fiscal 2004 and 2005, we conservatively anticipate that EPS gains will be at least on par with this revenue growth projection due to notable expected margin expansion and only modest growth in the number of shares outstanding. TWO TARGETS. Based upon our adjusted calendar year 2003 EPS estimate (which excludes amortization of acquired intangibles and investment gains or losses) of $1.40, Open Text recently had a price-earnings ratio of 26 and a p-e-to-growth rate (PEG) ratio of 1.3. In comparison, recent averages for the other ECM companies we cover, Documentum (DCTM; 3 STARS; $21), FileNet (FILE; 4 STARS, accumulate; $20) and Interwoven, were 75 for p-e and 3.6 for PEG. The S&P 1500 Internet Software & Services Industry recently had a p-e of 68 and a PEG of 2.1. The S&P 1500 Software Industry recently had a p-e of 27 and PEG of 2.1. If Open Text traded at the recent PEG ratios of the S&P 1500 Internet Software & Services and S&P 1500 Software Industries, which happened to be the same, its stock price would be $59. Our discounted cash-flow (DCF) model's assumptions include weighted average cost of capital of 14.7% and growth trending down gradually from 39% in fiscal 2004 to 24% in fiscal 2008. Based on our DCF analysis, the stock's intrinsic value is around $47 per share. Based upon relative and intrinsic analyses, weighing our DCF conclusions more heavily, our 12-month target price for the stock is $50. We expect the shares to materially outperform the S&P 500 over the next 12 months. RISKS REMAIN. We believe the stock trades at a substantial discount to its competitors, peers, and our target price in part because Open Text is based in Canada and isn't heavily followed in the U.S. However, we think its p-e multiple will expand as it continues to execute its business plan and achieve or even exceed its operating targets, and gains recognition for doing so. Our projections, target price, and investment opinion entail risks. In our view, they include the following possible scenarios: disappointing or nonexistent economic growth in the U.S. and abroad, weaker-than-expected demand for Open Text's offerings due to a lower rate of recovery in technology spending, increasing competition in the form of development or acquisitions from much larger companies, such as IBM (IBM ) and Microsoft (MSFT ), and failure to effectively integrate recent acquisitions.
 Analyst Kessler follows Internet software & services and Internet retail stocks for Standard & Poor's Equity Research Services All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. Standard & Poor's Regulatory Disclosure Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc.
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