OpenText Falls as Growth Hits the Cloud Wall

Image: OpenText.

Among technology companies, OpenText has focused on making the most of the trend toward greater use of cloud-based computing resources and data analytics. Yet even with rising demand for information-management software and services in order to make the best use of cloud-collected data, OpenText's tepid performance in 2015 had shown signs of worry among investors that the company's results might not live up to their expectations when it issued its third-quarter financial report Tuesday afternoon.

What OpenText's results showed is that the company is starting to have trouble sustaining its rapid growth rates, and investors were largely disappointed with what OpenText had to say about its ongoing challenges. Let's look more closely at OpenText's latest quarter to see whether shareholders are right to worry about the company's future.

OpenText's growth comes to a standstillOpenText's fiscal third-quarter results reflected several different challenges. Total revenue climbed just 1%, with the impact of the strong dollar costing the company seven percentage points of sales growth. Similarly, earnings declined more than 20% from year-ago levels, with the $0.66 per share that OpenText posted falling short of what those following the stock had expected to see by more than 25%. Even taking out the impact of currency fluctuations, adjusted earnings of $0.73 per share didn't come close to matching the consensus expectations among investors.

Looking more closely at the results, OpenText's cloud-based revenue wasn't strong enough to boost overall sales substantially. Cloud Services generated a 12% gain in sales despite a five-percentage-point currency headwind, and OpenText's customer-support business also brought in slightly more money this quarter than it did a year ago. Yet declines in revenue from professional services and license fees held back overall sales growth, reflecting the company's transition toward almost exclusively relying on recurring revenue streams for its cash flow.

Interestingly, though, the results didn't keep OpenText from rewarding its shareholders. The company said it would boost its quarterly dividend to $0.20 per share, up by 16% from its previous level of $0.1725. The decision clearly reflects OpenText's confidence that any slowdown in its growth will prove to be temporary.

Certainly, OpenText CEO Mark Barrenchea expressed optimism about the company's future. "We were affected by foreign exchange and customers transitioning to our cloud [as well as] unique items in the quarter, such as acquisitions, litigation costs and others." Barrenchea believes that some of those effects will reverse themselves in future quarters, and he pointed to the fact that OpenText closed 10 deals of more than $1 million in size during the quarter as evidence that the company's growth remains on track.

Image: OpenText.

Will OpenText bounce back?OpenText once again boasted success in its business dealings, with demand coming largely from the financial industry, the public sector, and the services industry. The company added Hasbro and Roche to its list of cloud-services customers, and on-premises customers included a wide range of entities ranging from Dividend Aristocrat Dover to the IT offices for the government of the state of Maine.

At the same time, new capabilities included analytics for business-to-business transactions, a cloud-communications hub, and services for contract management and compliance. The company also celebrated the February victory in a patent-infringement lawsuit, gaining a $5 million damage award from a jury in U.S. federal court.

Still, what spooked investors is the fact that OpenText's growth came to such a quick halt. Even if you believe the currency impacts will dissipate over time, OpenText still faces the same challenge that all high-growth companies do of how to sustain high growth rates as long as possible. This quarter's results show that the company hasn't quite figured everything out yet, despite its long-term strategy.

As a result, OpenText's stock fell sharply, losing 7% of its value in after-hours trading following the announcement. In the long run, though, what OpenText needs to do to recover is simply to find ways to stoke its growth engines and convince investors that it still has what it takes to compete in the cutthroat cloud-computing industry.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Open Text. The Motley Fool owns shares of Open Text. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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