open text corporation

Open Text Corporation 13 July 2007

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Traded onAIM, London Stock Exchange

Regulated and authorised by

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Initiation Report

NASDAQ Common Stock

BUY

Ticker: OTEX Target price: US$24.69

Current price: US$22.17

Fundamental research indicates an 11% upside in the price of the NASDAQ common stock for the coming 6-24 months. The company reports in US dollars, which is its major trading currency. As a result, the impact of currency movements on the NASDAQ common stock is assumed to be neutral. We have calculated the target price based on fundamental factors using the weighted average of target prices obtained by using DCF and comparative valuation methodologies. The technical condition of the NASDAQ common stock suggests a HOLD.

We rate the NASDAQ common stock a BUY based on fundamental factors, with a 6-24 month target price of US$24.69.

Canadian Stock

HOLD

Ticker: OTC.TO Target price: C$23.21 Current price: C$23.32

The Canadian stock is expected to remain flat over the next 6-24 months as the 11% fundamental upside is offset by approximately 11 percentage points downside attributable purely to the anticipated appreciation of the Canadian dollar against the US dollar over the same period.

We rate the Canadian stock a HOLD, with a 6–24 month target price of C$23.21.

Report summary Open Text Corporation (Open Text) is an application software company concentrated primarily in the Enterprise Content Management (ECM) domain, in which it holds a strong market position, providing ECM solutions to large corporations. Headquartered in Canada, Open Text has operations spread across Australia, North America, Europe, Asia and Latin America, managed through 52 offices. It currently employs a workforce of over 2000 personnel. The company’s flagship product, LiveLink, is a web-based content management solution and offers integrated Business Process Management (BPM) capabilities. Over the past 4 years, Open Text has grown inorganically through several acquisitions, the largest of these being the acquisition of Hummingbird Ltd. (Hummingbird) in October 2006 for US$412.5 mn. Open Text has successfully partnered with leading players in the application software industry such as SAP AG (SAP), Oracle Corporation (Oracle) and Microsoft Corporation (Microsoft), by integrating LiveLink with their products, enabling users to continue working on their preferred applications. Despite concerns that Open Text could face problems in integrating its various acquisitions, the company has created the broadest ECM suite available in the market and, amongst its peers, comes closest to the description of a fully integrated ECM services provider. Based on the growing demand for ECM products, primarily as a result of heightened concerns over compliance requirements, which can be effectively managed using ECM suites, we expect Open Text to maintain its dominant position in the ECM market. Based on these factors our outlook for the stock is positive.

Stringent corporate compliance norms to fuel growth for Open Text

Investment horizonThis report addresses the needs of strategic investors with a long term investment horizon of 6-24 months. We will soon provide, from time to time, a short term view for this stock, generally 7-60 days, for readers who have a short trading horizon.

Supervisor: Arindam Pal Analyst: Aishwarya Narayanan Editor: Heloise Capon Global Research Director: Satish Betadpur, CFA Next news due: FY 2007 results, 30 August 2007


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Currency impact for US investors The company reports in US dollars, which is its major trading currency. Earnings forecasts are therefore also expressed in US dollars. Although the company has costs as well as revenues in other currencies, we assume that the net risk is minimized through implementation of effective hedging strategies. As a result, the impact of currency movements on the price of the NASDAQ common stock is assumed to be neutral. Where specific currency risks are identified these risks will be highlighted in the report.

Currency impact on the Canadian stock The impact by itself of the anticipated currency movements on the Canadian stock (now C$23.32), without considering changes in the share price, is broadly negative and is expected to be:

Over 6 months: C$22.61 Over 12 months: C$23.94 Over 24 months: C$20.84

Investment Thesis

Company overview

Open Text, founded in June 1991 and headquartered in Canada, is currently the world’s largest independent provider of ECM software and solutions. The company introduced its flagship product LiveLink (initially known as Latitude Web Server), a web-based document management product which was the first of its type, in 1995. The product was well received as it effectively capitalized on the Web’s potential for content management. In 1995 the company also achieved several major contract wins, integrating its technology with that of leading players in the application software domain, such as Oracle and Microsoft. The company went public in 1996 and continued to expand its customer base. Since 2003 Open Text has pursued a strategy of rapid inorganic growth, acquiring a number of independent software firms, including Gauss Interprise AG (Gauss), Eloquent Inc. (Eloquent), Corechange Inc. (Corechange) and DOMEA e-Government (which comprises SER eGovernment Deutschland GmbH and SER Solutions Software GmbH ), all of which were acquired in 2003. However, the largest acquisition in 2003 was that of Munich-based IXOS Software AG (IXOS), a software vendor, which had provided archiving software to enable users to manage data compatible with SAP solutions, for 15 years. In 2003, the company also developed strategic alliances with Adobe Systems Inc. and Ricoh Co. Ltd. and entered into a joint venture with BearingPoint Inc., a leading business consulting firm, to provide a world wide training portal for the US Army. The company made two acquisitions in 2004, Artesia Technologies Inc. (Artesia) and Vista Plus Suite from Quest Software Inc. (Quest) and acquired Optura Inc. in 2005. The acquisition program continued in 2006, when Open Text acquired Hummingbird, and later Momentum Inc. in early 2007. At a cost of US$412.5 mn, Hummingbird is by far the largest of the acquisitions made by Open Text and it has strengthened its product portfolio considerably. As a result of this well-planned growth strategy, Open Text is now able to provide solutions for multiple industry verticals such as energy, media, manufacturing, financial services, telecommunications, insurance, legal, pharmaceutical and life sciences as well as governmental organizations. Open Text’s solutions encompass business applications such as Compliance and Governance, Email Management, Corporate Services, Information Systems and Technology, Manufacturing and Operations and Procurement.

Open Text is the world’s largest independent provider of ECM software and solutions

Open Text’s largest acquisition to date has been that of Hummingbird for US$412.5 mn in October 2006


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Date Company acquired Terms Business description

Feb-03 Corechange Inc. US$3.6 mn Provider of portal infrastructure software

Mar-03 Eloquent Inc. US$6.7 mn Provider of "sales-readiness" solutions

Oct-03 Gauss Interprise AG US$9.8 mn Web Content Management vendor

Oct-03 IXOS Software AG US$237 mnIntegrated document management and archiving solutions provider

Oct-03 DOMEA e-Government US$11.4 mn Vendor of e-Government solutions

Aug-04 Artesia Technologies Inc. US$5.8 mnProvider of Digital Asset Management for the media and entertainment industry

Sep-04 Vista Plus Suite US$23.7 mnVista Plus Suite acquired from Quest Software Inc. Captures and stores business criticial information from ERP systems

Feb-05 Optura Inc. US$3.7 mn Vendor of Business Process optimisation software

Oct-06 Hummingbird Ltd. US$412.5 mn Provider of ECM solutions

Mar-07 Momentum, Inc. US$4.7 mn Provider of IT solutions for US Government agencies

Source: Company data

Open Text Acquisitions: 2003 to July 2007

Business overview

Open Text classifies its top-line into three principal revenue streams (segments) – License and Networking, Customer Support and Services. License and Networking revenues consist of fees earned from software licenses sold to customers, which are one-off charges. This segment contributed 30% of the company’s total revenues in FY 2006. Customer Support revenues consist of charges for maintenance and customer support agreements which allow customers to receive technical support, enhancements and upgrades for the company’s products as and when they are available. In FY 2006, the Customer Support segment contributed 46% of total revenues. Service revenues derive from consulting contracts and contracts to provide training and integration services, whereby Open Text’s ECM product can be integrated with a customer’s existing applications. The Services segment contributed 24% to total revenues in FY 2006.

The company has a presence across five continents and classifies its geographical segments under North America, Europe and Other, where the last segment primarily consists of Australia and Asia. North America and Europe accounted for the highest shares (48.3% and 46.2%, respectively) of the company’s total revenues in FY 2006. The remaining 5.5% was accounted for by Australia, Japan, and the Middle East (Asia).

Through its various acquisitions, Open Text has achieved the expertise to deliver solutions which are customized for each of the many industry verticals to which it caters. Furthermore, Open Text has successfully partnered with prominent enterprise software players such as Oracle, Microsoft and SAP, through its global partner program, to ensure Open Text products are compatible with the customers’ existing systems. According to the terms of this program, the company’s partners develop, validate and deliver Open Text-based solutions, giving a distinct advantage to Open Text over its competitors as the partnerships are with the majority of the leading players in the Operating System (OS) domain. The most recent example of the company’s product compatibility is Open Text’s Hummingbird Connectivity 2007 suite, which is certified as compatible with Microsoft’s latest operating system, Windows Vista. This program has enabled Open Text to significantly widen its customer base as it allows users to easily integrate ECM with current applications.

License revenues accounted for approximately 30% of Open Text’s total revenue in FY 2006

In FY 2006, North America and Europe accounted for 48.3% and 46.2% of total revenues respectively


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FY 2006: Revenues by business segment (%) FY 2006: Global revenue mix (%)

29.9%

46.2%

23.8%

Licence and Networking Customer Support Services

48.3%

46.2%

5.5%

North America Europe Other


Products and suites

LiveLink ECM – Open Text’s flagship product:

LiveLink is a leading content management and collaboration software suite for global organizations. It enables users to maintain auditable trails of records and encourages efficiency by streamlining processes. LiveLink serves multiple industry verticals and objectives within a company by bringing together content, collaboration and process technologies. Business solutions are customized for each client and can be scaled and extended to integrate with other solutions across the enterprise, thus protecting existing investments in technology. Some of LiveLink’s principal product features are:

Archiving and Imaging: These products enable organizations to manage the physical storage of all content, without impacting the way users work with content. These products can also be integrated with third party applications.

Business Process Management: These products enable organizations to create, modify and manage business processes of any complexity and allow business process managers to manage workflows without heavy dependence on IT resources.

Document Management and Collaboration: These ECM products enable teams of users to share their knowledge on projects and collaborate in a virtual enviroment. Document management services captures information and make it securely available to other users as and when they require.

Digital Asset Management: Allows effective management of digital assets and serves as the single access point for all digital media files and underlying information.

E-mail Management: Open Text’s e-mail products enable compliancy compatible archiving and records management, allowing organizations to store and retrieve e-mail content whilst ensuring regulatory compliance. It eliminates the requirement to delete content in order to meet storage requirements.

Web Content Management (WCM): Global organizations require the management of corporate information over a long period of time and for the benefit of multiple audiences through websites, intranets and portals. Open Text’s RedDot WCM product enables delivery of content to audiences from any source using the Web and eliminates bottlenecks in Web publishing.

LiveLink ECM is Open Text’s flagship product suite which offers a variety of features

LiveLink based solutions can be customized and offer scalability and easy integration with a client’s existing systems


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FY 2003- FY 2006: Revenues by segment (in US$ mn) FY 2003- FY 2006: Revenues by segment (%)

76 122 137 12363

109179 189

39

61

9899

0

100

200

300

400

500

FY 2003 FY 2004 FY 2005 FY 2006

Licence and Networking Customer Support Service

`

43% 42% 33% 30%

36% 37%43% 46%

21% 21% 24% 24%

0%

20%

40%

60%

80%

100%

FY 2003 FY 2004 FY 2005 FY 2006

Licence and Networking Customer Support Service


Hummingbird Connectivity Suite:

The connectivity suite is a single, consolidated solution that allows organizations to securely integrate different legacy IT-infrastructure with desktop products, thus enabling them to meet corporate governance and business continuity requirements. This product suite also offers solutions for remote document access, allowing remote users to access critical and confidential applications with maximum security. According to global market research and analysis firm, IDC Inc. (IDC). Hummingbird’s flagship connectivity software, Exceed, held 71.5% market share in the server connectivity software market between 1999-2004. Open Text now views the connectivity business as a mature cash generating business and believes that it has potential to enhance its profitability.

Industry overview

According to the IDC, the market for ECM software grew almost 13% y-o-y in 2006. The year 2006 was also marked by vendor consolidations and several high profile acquisitions such as IBM’s acquisition of FileNet Corporation (FileNet) and Oracle’s acquisition of Stellent, Inc. (Stellent). The IDC forecasts this market to continue to grow at a CAGR of 13% per annum between 2006-2011, generating annual revenues of approximately US$3.9 bn. With information volumes growing and companies facing greater competitive pressures to be more responsive and efficient, there is now increasing demand for ECM, as a technology required to address compliance and process efficiency needs. Furthermore, the potential for the ECM market to expand into currently under-served geographies and market verticals, adds to the overall positive growth outlook for the industry. This leads us to believe that IDC’s forecasted growth figure is achievable.

Competition and consolidation in the ECM industry:

The ECM market, which has historically been characterized by fragmentation, has experienced several vendor consolidations and acquisitions over the recent past. Since the 1980s, IBM has been the acknowledged market leader in ECM. However, EMC Corporation’s (EMC) acquisition of content management heavyweight, Documentum Inc. in 2003, followed by that of Captiva Software Corporation, led to EMC assuming the market leader position in the ECM industry. However, IBM’s acquisition of FileNet in 2006 has re-established the company as the leading player in this market, with Open Text, as a result of the Hummingbird acquisition, taking the second position. In the EMEA (Europe, Middle East and Africa) region, the combined Open Text -- Hummingbird entity now has 28% market share, positioning the company as the market leader in the region, according to a recent study conducted by Gartner Dataquest, Inc. Other independent vendors of note in the industry are Interwoven Inc. (Interwoven) and Vignette Corporation (Vignette), which are likely to be prime takeover targets for larger multiple-product vendors in the future.

The ECM industry has been marked by vendor consolidation and several acquisitions over the last few years

Hummingbird’s connectivity software, Exceed, held 71.5% market share, from 1999-2004


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ECM Market Share (3Q 07)

24.90%

20.20%

13.10%

3.50%

2.60%

1.60%

6.30%

4.50%

4.10%

IBM FileNet (IBM Corporation)

Open Text Corporation

EMC Corporation

Interwoven, Inc

Vignette Corporation

Stellent, Inc

Mobius Management Systems, Inc

Hyland Software, Inc

Microsoft Corporation

Source: Company data, Investor Presentation, 3Q 07

Open Text’s peer group and close competitors:

IBM FileNet (IBM): IBM is an information technology (IT) company that provides business, technology and consulting services. Its recent acquisition of FileNet has established the combined entity as the largest ECM provider in the space. FileNet enjoys a strong presence in the financial services and banking verticals.

EMC: EMC is a leading developer and provider of information infrastructure technology and solutions which cater to the information repository needs of organizations of all sizes around the world. The company’s main segments are information storage, content management and archiving, information security and virtual infrastructure.

Microsoft: Microsoft is the largest player in the software industry. Microsoft’s Windows OS is the most widely used in the world and the company is endeavoring to add value to its core Windows product through offerings in areas such as ECM. Microsoft recently launched the Microsoft Office SharePoint Server 2007 product which offers ECM solutions such as document management, records management and WCM. Microsoft’s principal advantage in this space is its ability to capitalize on its core products’ large market share, by bundling ECM solutions with these core products.

Interwoven: Interwoven is an independent ECM vendor which specializes in legal and compliance related content management software. The company’s target client group consists of law firms and corporate legal departments.

Vignette: Vignette is an independent ECM provider which offers Web content management, documents and records management and document imaging functionalities.

Hyland Software, Inc. (Hyland): Hyland engages in developing and marketing ECM software in North America, Latin America, Europe and Japan. The company offers a product suite named OnBase, which is ECM software offering document imaging and BPM functionalities.

Mobius Management Systems, Inc. (Mobius): This company provides solutions for records and content management. It offers a suite of products named ViewDirect TCM that meets various enterprise requirements for managing content. It is currently a subsidiary of Allen Systems Group, Inc.

Open Text enjoys the second largest market share globally in the ECM market

IBM is the current market leader in the ECM industry with 24.9% of market share globally


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Industry outlook

The global ECM market is expected to continue to expand as small and mid-sized companies also enter the market for enterprise-wide ECM implementations, following the adoption of stricter compliance norms, globally, and the ever-increasing volume of information which requires classification. In terms of geographical distribution of demand, the Asia Pacific excluding Japan (APEJ) region is currently under-served in terms of ECM implementations and offers significant potential for growth. With a CAGR of 13% predicted for the next five years, the outlook for the industry is positive. Further consolidations, combined with the ability to offer differentiated products, will determine the acquisition of market share by current players.

Peer comparison

Following the recent wave of consolidation in the industry and subsequent divergence in product offerings, Open Text is not directly comparable with its peers. For the larger players in the industry such as IBM and Microsoft, ECM software comprises minimal share of their product portfolios. As far as the smaller players are concerned, only Open Text enjoys a significant market share in the ECM market. However, in our peer group we have considered both the larger players and the smaller pure-play independent ECM vendors. IBM is currently the market leader in the ECM industry, followed by Open Text. Although Microsoft commands a minuscule market share currently, it poses a significant threat to Open Text following the adoption of a strategy to bundle ECM products with its market leading legacy OS applications. In terms of top-line performance in FY 2006, Open Text registered a decline of 1.3% y-o-y, well below its peer group average of 6.7% y-o-y growth. The decline was led by a drop in license revenues. However, the company reported a strong y-o-y growth of 54.6% in revenues in 3Q 07, following the acquisition of Hummingbird in the second quarter. Open Text’s operating margin in FY 2006, adjusted1 for non-recurring items was reported at 9.51%, as opposed to a peer group average of 17.02%. However, the peer average for independent vendors only (namely, ECM, Interwoven and Vignette) was 7.3%. Open Text registered a strong 77.2% y-o-y growth in adjusted EPS, compared to the peer group average growth of 16.3% y-o-y. We have not considered Interwoven’s growth in adjusted1 operating margin and EPS in the peer group average, as the company incurred losses in FY 2005 from which it turned around in FY 2006. Going forward, we believe Open Text’s top-line will benefit from the Hummingbird acquisition (as is already evident from the performances of the two completed consolidated quarters after acquisition), enabling the company to grow at a CAGR of just over 13% between the years FY 2006-FY 2011, in line with the growth rate predicted for the ECM industry over the same period.

Peer Comparison Table - FY 2006


EMC Corporation

IBM Corporation

Microsoft Corporation

Interwoven Inc

Vignette Corporation

Industry Average

Market capitalization (in US$ bn) 1.07 37.63 156.55 285.76 0.62 0.54 N/A

Employees 1,894 31,100 366,486 71,000 744 670 N/ARevenue (in US$ mn) 410 11,155 91,423 44,282 194 198 N/A

y-o-y growth (%) (1.27%) 15.43% 0.31% 11.29% 10.86% 3.62% 6.71%

Operating profit (in US$ mn)* 39 1,804 13,963 18,010 4 7 N/A

y-o-y growth (%) 41.87% 14.06% 6.27% 6.37% 612.50% 2200.00% 453.71%Operating margin* (%) 9.51% 16.18% 15.27% 40.67% (0.01%) 3.48% 17.02%EPS* (US$) 0.53 0.54 6.06 1.20 0.07 0.41 N/A

y-o-y growth (%) 77.22% 14.26% 23.42% 6.40% 393.33% (39.77%) 16.31%*Excluding non-recurring itemsNote: Fiscal year end for Open Text and Microsoft is 30 June 2006, and 31 December 2006 for the remaining companiesSource: Company data

Microsoft is a potential threat to Open Text following adoption of strategy to bundle ECM with OS products

Potential product differentiation and consolidation will determine market leadership in the ECM space


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3Q 07 results update

Top-line registers robust growth post-acquisition

The company’s revenues registered a 54.6% y-o-y growth to US$156.1 mn in 3Q 07 driven largely by a 72.0% y-o-y increase in Customer Support revenues, which stood at US$79 mn, contributing 50.7% to the company’s total revenues. License and Networking revenues grew 51.4% y-o-y to US$43 mn and accounted for 27.6% of total revenues. Service revenues stood at US$34 mn, registering a growth of 28.0% y-o-y and contributed 21.8% to the total revenues. This healthy growth can be attributed to the wider customer base that Open Text has obtained following the Hummingbird acquisition. Customer support revenues came from existing customers as well as from new license sales. Operating profit was reported at US$13.5 mn, registering a y-o-y increase of 24.5%. Operating profit adjusted1 for non-recurring restructuring charges stood at US$14.4 mn, registering a y-o-y growth of 39.7%, which was led by growth in revenues as well as a reduction in operating expenses y-o-y. Operating profit margin was reported at 8.7%, registering a decline of 210 bps y-o-y. Adjusted1 operating profit margin stood at 9.2%, registering a decline of 100 bps y-o-y. The decline in operating margin is attributable to a y-o-y increase in amortization expenses, resulting from amortization of intangibles relating to acquisitions made in the previous fiscal year as well as that of the Hummingbird acquisition in the current year. Adjusted EBITDA was US$35.9 mn, reporting a y-o-y growth of 79.0%, while adjusted EBITDA margin increased by 313 bps y-o-y, driven by increased revenues. Net profit was reported at US$3.9 mn, registering a decline of 47.4%, due to interest charges of US$7.6 mn on the Hummingbird acquisition term loan. Net income, adjusted for non-recurring foreign exchange gains/losses, declined 11.1% y-o-y to US$4.6 mn, while adjusted net margin declined 219 bps y-o-y to 3%. Adjusted EPS declined to US$0.09 per share in 3Q 07 from US$0.10 per share in 3Q 06.

Operating cash flow was strong

Cash flow from operations in 3Q 07 stood at US$41.3 mn, compared to US$28.7 mn in the corresponding quarter last year, registering a 44.1% y-o-y growth. Net cash and cash equivalents stood at US$159.7 mn at the end of 3Q 07, compared to US$107.4 mn at the end of 3Q 06, an increase of 32.8% y-o-y. In 2Q 07, the company raised debt through a term loan amounting to US$390 mn in order to partially fund the Hummingbird acquisition. As a result, the company’s debt-to-capital ratio on its balance sheet stood at 44.5% at the end of 3Q 07.

FY 2006 performance was not impressive

FY 2006 results disappointed due to slowdown in Licence revenues

Open Text reported revenues of US$409.6 mn in FY 2006, registering a 1.3% y-o-y decline, primarily due to a 10.3% y-o-y decline in License and Networking revenues to US$122.5 mn. Service revenues also declined 1.5% y-o-y to US$97.63 mn, while revenues from Customer Support stood at US$189.42, registering growth of 5.7% y-o-y. The company cites structural re-alignment in global sales force as the reason for this drop in License and Networking revenues as the company focused on streamlining operations for future profitability.

Adjusted operating profit registered 41.9% y-o-y growth in FY 2006

Open Text’s operating profit was reported at US$13.0 mn in FY 2006, registering a decline of 55.8% y-o-y. The decline was led by significant restructuring charges which were reported at US$26.2 mn, compared to a recovery of US$1.7 mn in FY 2005. Operating profit adjusted1 for non-recurring restructuring charges increased by 41.9% to US$39.1 mn, reflecting improving cost efficiencies as R&D and SG&A costs declined as a percentage of revenues in FY 2006. Reported net income stood at US$5.0 mn in FY 2006, registering a decline of 75.6% y-o-y due to a higher tax rate of 42.4%, compared to 25.2% in FY 2005. Adjusted net income increased by 69.9% y-o-y to US$26.4 mn on the back of higher adjusted operating profit. Adjusted net margin increased by 270 bps to 6.4%. Reported EPS declined 74.5% to US$0.10 per share, while adjusted EPS increased 77.2% to US$0.53 per share in FY 2006.

Open Text’s top-line declined 1.3% y-o-y in FY 2006 as operating performance improved due to cost efficiencies

Hummingbird acquisition provided a much needed boost to Open Text’s top-line in 3Q 07

Cash flow from operations in 3Q 07 registered a 44.1% y-o-y growth


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Stringent compliance requirements to be the primary growth driver

Information Lifecycle Management (ILM) is designed to manage the flow of information and data from creation and initial storage to obsolescence and deletion. ILM has gained importance following the implementation of compliance laws such as the Sarbanes-Oxley Act of 2002 in the US, which mandate strict records compliance. We believe that ECM players will continue to benefit from the Sarbanes-Oxley compliance drive as well as from compliance requirements mandated by laws globally. Compliance demands affect an entire company, necessitating enterprise-wide policies and an integrated information management system to enable it. ILM enables a user to create content and store it until the end of its lifecycle. Most regulations are information intensive and impose strict mandates as to how information should be managed. Companies with operations in Europe are subject to the provisions of the European Commission’s Directive on Data Protection. According to this directive, organizations have to meet minimum adequacy standards relating to privacy. Similarly the Sarbanes-Oxley legislation imposes tougher standards for accounting practices for companies with operations in the US. As a result of this stringent regulatory environment, demand for ECM for compliance purposes is gaining ground as it enables organizations to provide compliance and corporate governance in an efficient and cost effective manner. Open Text’s solutions allow corporations to manage operations in a more transparent manner by ensuring that all content is safe, searchable and readily accessible. Open Text’s partnerships with leading OS providers such as Microsoft, ensures that content can be managed irrespective of which application it is produced on. We believe the company is well positioned to capitalize on this requirement.

Growing incidence of corporate litigation to be a key driver

An ever growing global corporate marketplace is increasing the scope of regulations as well as the degree of corporate risk. Not only are regulations demanding but any infringement invites strict penalties, resulting in prolonged legal battles in many cases. As is the prerequisite with any litigation, corporate litigation also necessitates conclusive data backed evidence. As a result, organizations now require efficient and effective technology for managing content more than ever before. The starting point is to identify records and content which are business records, after which these records have to be classified, stored and managed accordingly. An organization can be litigation-ready only when it can successfully combine automated and intelligent record classification to extract meaningful and important information from records. ECM is seen as the most cost-effective solution to the problem as it helps manage content lifecycle in accordance with regulatory requirements. Open Text’s content management solutions provide clients with an integrated product offering developed to support activities through the information lifecycle.

Requirement for products that differentiate

In terms of product offering and functionality, there is very little to choose between ECM vendors in the market today. Most vendors have concentrated on combining unstructured and structured data to facilitate tasks such as claims or forms processing in combination with Enterprise Resource Planning (ERP). Only a product that is appreciably different and adds certain value-added functionalities can offer a vendor an edge over the others. Interwoven recently took a step in this direction by offering a product aimed at Segmentation and Analytics, which allows companies to track the behavior of different customers who visit their website and accordingly categorize them and target each segment with customized offers. This functionality also helps to identify if a particular site is poorly designed so that appropriate action can be taken. We believe that following the acquisition of Hummingbird, Open Text has the potential to diversify effectively, using Hummingbird’s connectivity products.

Hummingbird acquisition results in larger market share, but significant product overlap

The ECM industry has been left with only three pure-play independent vendors of note – Open Text, Interwoven and Vignette. Of these, the chances that the latter two will be acquired by a larger multi-product vendor are high. Following its Hummingbird acquisition Open Text may have been successful in pulling itself out of the list of potential acquisition targets. However, the acquisition also poses some new challenges for Open Text going forward, which the company will have to manage effectively in order to survive in the highly competitive ECM industry. While Open Text’s acquisition of Hummingbird has established the company as the largest independent vendor of ECM software, it has also brought with it a slew of overlapping products. Open Text and Hummingbird previously offered competing ECM technologies, which now require significant product integration work. Open Text supports three

Compliance and litigation are seen as the main growth drivers for the ECM industry

Hummingbird’s connectivity suite offers an opportunity for diversification to Open Text’s existing portfolio

Product overlap may cannibalize market share and reduce synergies from the Hummingbird acquisition


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products for Web Content Management (WCM) – Open Text, Gauss and Obtree. Hummingbird has now added a fourth – Red Dot. Product overlaps also exist in the Records Management and Document Management products. Therefore, the actual gain in market share for Open Text from this acquisition could be less than it appears. Another consequent risk is that of Hummingbird customer migration to third party vendors due to concern over lack of support for their platform. Disturbingly, Management has also suspended guidance for the quarters following the acquisition citing lack of clarity. However, we expect the synergies from this acquisition to only be marginally negatively impacted by product overlaps and its effect on market share.

The Hummingbird acquisition may adversely affect profitability in the short term

Open Text acquired all of Hummingbird’s outstanding shares in October 2006, in an all cash deal worth US$412.5 mn, which was funded in part by a term-loan of US$390 mn. The resultant interest arising from this term loan will materially impact the company’s bottom-line. The size of the acquisition and challenges from integration could pose a challenge for Open Text Management and affect the company’s operations. Nevertheless, the Hummingbird acquisition represents an excellent opportunity to expand Open Text’s existing product portfolio and will help contribute significantly to the company’s top-line as well as profitability if it can be integrated with the company’s existing operations effectively.

Financial Projections

Revenue and earnings growth

Growth in revenues: We expect Open Text’s revenues to grow by 42.5% y-o-y to US$583.6 mn in FY 2007. This expectation is largely driven by the strong inorganic growth registered by the company in the second and third quarters of this year, following the Hummingbird acquisition, and we expect this growth to continue into the last quarter as well. We expect revenues from Licence and Networking to contribute US$172.2 mn or 29.5% to total revenues, growing at 40.6% y-o-y. Revenues from Customer Support are estimated to be US$280.7 mn or 48.1% of total revenues, growing at 48.2 y-o-y, while those from the Service segment are expected to be US$130.7 mn or 22.4% of total revenues, growing at 33.8% y-o-y. In FY 2008, we expect the company to grow a healthy 13.5% y-o-y aided by one quarter’s inorganic growth from the Hummingbird acquisition. Going forward, we expect Open Text’s revenues to grow at an organic growth rate of approximately 5% up to FY 2011. Accordingly, our estimates suggest a CAGR of 13.4% in total revenues through the period FY 2006-FY 2011, which is in line with the ECM industry’s projected CAGR of 13% over the same period. Over our projection horizon of FY 2007-FY 2016, we have estimated a CAGR of 8.7% for Open Text.

Margins: We expect expansion in reported operating margin for Open Text in FY 2007, as non-recurring restructuring charges have been lower in the three reported quarters of FY 2007. We forecast an improvement over FY 2006 operating margin of 468 bps, resulting in an operating margin of 7.9% in FY 2007. Adjusted1 operating margin (excluding restructuring expenses) for FY 2007 is expected at 8.8%, a decrease of 81 bps over 9.6% in FY 2006. The estimated decline is due to an increase in amortization expenses of acquired intangibles relating to the Hummingbird acquisition in FY 2007. Amortization is estimated at 4.2% of revenues in FY 2007 as opposed to 2.3% of revenues in FY 2006. Adjusted operating margin for FY 2008 has been estimated at 9.1% considering a margin expansion assumption of 124 bps. FY 2007 estimates are based on the robust results in the first three reported quarters and on an expected strong performance in 4Q 07. Cost savings are expected in General and Administrative expenses as the company experiences further synergies from the Hummingbird acquisition in FY 2008. Accordingly, we have reflected this as a declining percentage of total revenues. We have estimated a margin improvement from 9.6% in FY 2006 to 20.5% in FY 2016.

Earnings: Net income in FY 2007 is estimated at US$15.9 mn, more than three times that in FY 2006, which was US$5.0 mn, registering a growth of 219.1% y-o-y. The increase is mainly due to an outflow of US$4.8 mn in FY 2006 in the form of Other Losses as opposed to a projected inflow of US$0.6 mn in FY 2007. Net income in FY 2008 is estimated at US$18.7 mn. Adjusted1 net income for FY 2007 is estimated at US$21.7 mn, a decline of 17.6% y-o-y over US$26.4 mn in FY 2006, resulting from the increased amortization expenses. Adjusted net income margin is estimated at 3.7% for FY 2007, down 271 bps from FY 2006. Over our projected horizon we expect adjusted net margin to improve from 6.4% in FY 2006 to 12.8% in FY 2016, despite interest outflows on the term loan undertaken to fund

Hummingbird acquisition could adversely impact earnings in the short term

FY 2007 revenues estimated to grow 42.5% y-o-y, driven by Hummingbird acquisition

Reported net income estimated at more than three times that in FY 2006

Adjusted operating profit margin expected to expand from 9.6% to 20.5% over the period FY2006- FY2016


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the Hummingbird acquisition. These outflows are expected to continue until FY 2013. The company has provided guidance for complete amortization of acquired intangibles until FY 2011, which we have modeled into our estimates. The reason for margin expansion, despite these two heavy outflows, is the significant savings in costs expected due to acquisition synergies. Adjusted diluted EPS is expected to register a CAGR of 12.7% through the period 2006-2011. It is estimated at US$0.43 in FY 2007 and US$0.38 in FY 2008 compared to US$0.53 in FY 2006. Over our projected horizon of FY 2006-FY 2016, we expect adjusted diluted EPS to exhibit a CAGR of 16.7%. Reported diluted EPS stood at US$0.10 in FY 2006 and is estimated at US$0.31 in FY 2007. Non-GAAP2 net income and EPS are projected to increase from US$76.6 mn and US$1.52 in FY 2007 to US$95.3 mn and US$1.96 in FY 2009.

Adjusted operating (%) and net margin (%) (FY 2006A-FY 2011E)

0.00%

4.00%

8.00%

12.00%

16.00%

FY 2006 A FY 2007 E FY 2008 E FY 2009 E FY 2010 E FY 2011 E

Adjusted operating margin Adjusted net margin

Source: IIIR estimates, Company data

Open Text has announced a share repurchase program: Open Text has adopted a proposed repurchase program to potentially repurchase up to an aggregate of 2,494,053 common shares over the next twelve months, which represents 5% of the issued and outstanding shares. As of April 2007, Open Text had 49,881,068 issued and outstanding common shares. This repurchase program commenced in May 2007 and will continue for the next twelve months. We have accordingly modeled this into our estimates.

Stock price movement

Open Text’s NASDAQ common stock broadly outperformed the NASDAQ composite index over the past year. However, it has shown a slight decline since May 2007. The company’s stock has appreciated by 65.0%, compared to the 31.5% appreciation in the NASDAQ composite index in the corresponding period. The Canadian stock appreciated by 53.7% compared to a 28.4% appreciation registered by the index in the corresponding period.

Open Text’s NASDAQ common stock has appreciated 65% over the past year


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Stock price movement

-15%

0%

15%

30%

45%

60%

75%

07-06 09-06 11-06 01-07 03-07 05-07 07-07

OTEX NASDAQ

-15%

0%

15%

30%

45%

60%

75%

07-06 09-06 11-06 01-07 03-07 05-07 07-07

OTC.TO OTEX

Source: Bloomberg

Valuation

To value Open Text in this report we have used the Discounted Cash Flow (DCF) valuation and comparative valuation based on Price-to-sales (P/S) and Price-Earnings-Growth (PEG) multiple methods considering FY 2009 sales and earnings estimates. The DCF method values the stream of future cash flows discounted to the present day using the company’s Weighted Average Cost of Capital (WACC), and as such is a good measure of the company’s value in absolute terms. Comparative valuation using P/S and PEG helps us to compare the company’s operating performance with its peers. The P/S method helps us compare the sales growth of peer companies, while the PEG multiple method is particularly helpful in valuing companies based on their future growth potential, providing a useful tool to assess the value investors are likely to assign to the stock over the investment horizon.

Comparative valuation

If we consider the P/S multiples, Open Text is currently trading at a multiple of 2.14x, which represents a discount of 25% to the current peer group average of 2.84x. Historically, the stock has traded in a TTM range of 1.54x to 2.48x, at an average of 2.08x. We expect Open Text to report strong growth in margins as it realizes synergies from the Hummingbird acquisition and top-line growth that is in line with the projected industry CAGR from FY 2006 to FY 2011. In order to reflect this, we have assigned a target P/S multiple of 1.80x, to value the NASDAQ common stock, which is lower than the current multiple as we expect sales to increase significantly but higher than its forward multiple of 1.49x. Employing this target multiple on the FY 2009 sales estimate of US$695.2 mn, we arrive at a target price of US$25.73 per share.

Considering P/E multiples, Open Text is currently trading at a P/E multiple of 19.59x trailing 12-month EPS, which is at a 25% discount to its current peer group average multiple of 26.12x. Historically, the stock has traded at a TTM average P/E of 17.75x, which represents a discount of 29% to the peer group TTM average multiple of 25.16x. We expect Open Text’s long term earnings growth rate (next 5-year CAGR) to be at 13.37%, giving us a current PEG multiple of 0.99x, compared to an average of 1.33x for its peer group. To value the NASDAQ common stock in this report, we have assigned a PEG multiple of 0.70x, which is lower than the current multiple but higher than the forward multiple. Applying this multiple to our estimated FY 2009 non-GAAP EPS of US$1.96, we arrive at a target price of US$27.01 per share.

Based on a P/S multiple of 1.80x, the NASDAQ common stock is valued at US$25.73

Based on a PEG multiple of 0.70x, the NASDAQ common stock is valued at US$27.01


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Company 3 yr trading range TTM trading

range

TTM P/S

average

Current P/S Forward

FY 2009 P/SOpen Text Corporation 1.39 - 4.44 1.54 - 2.48 2.08 2.14 1.49EMC Corporation 2.22 - 4.55 2.22 - 3.48 2.76 3.17 2.50Interwoven Inc 1.65 - 3.26 1.94 - 3.26 2.57 3.16 N/AVignette Corporation 1.67 - 3.15 1.84 - 3.15 2.51 2.90 N/APeer group average 2.48 2.84 2.01

Comparative valuation : P/S approach

Source: Bloomberg, IIIR estimates

Current PEG

Open Text Corporation 13.53 - 34.72 13.53 - 21.35 17.75 19.59 30.77 13.37 1.47EMC Corporation 16.93 - 46.31 16.93 - 29.44 22.14 26.81 18.39 15.00 1.79Interwoven Inc 24.53 - 281.25 24.53 - 45.12 34.30 33.07 N/A 27.50 1.20Vignette Corporation 14.06 - 30.94 23.33 - 30.60 26.44 25.00 N/A 25.00 1.00Peer group average 25.16 26.12 14.76 21.80 1.25Source: Bloomberg, IIIR estimates

Comparative valuation : PEG approachCompany 3 yr trading

range

TTM trading

range

TTM P/E

average

Current

P/E

Forward

FY 2009 P/E

LTGR

(%)

DCF valuation

Using the DCF valuation method, we arrive at a 6-24 month target price of US$23.58 per share for the Open Text NASDAQ common stock, which represents a potential upside of 6.3% from current levels. We have based our valuation on the following assumptions:

Weighted Average Cost of Capital (WACC) of 9.14%: We have assumed a risk-free rate of 4.89%, in line with the three month average of the yield on the 10-year US Treasury bond. We have arrived at the WACC by multiplying the cost of equity (which stands at 10.53%) and the tax-adjusted cost of debt (which stands at 5.20%) by their respective estimated weights of 73.89% and 26.11%.

Terminal growth rate: We have developed Free Cash Flow (FCF) estimates for FY 2007 to FY 2016. Thereafter, we have assumed a perpetual growth rate of 3.0% (implied terminal year exit sales and EBITDA multiples of 2.29x and 9.90x respectively).

Based on our DCF model, the NASDAQ common stock is valued at US$23.58 per share


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DCF Valuation : Key MetricsAll figures in US$ '000 FY 2006 A FY 2007 E FY 2008 E FY 2009 E FY 2010 E FY 2011 E FY 2012 E FY 2013 E FY 2014 E FY 2015 E FY 2016 E

Revenues 409,562 583,582 699,910 695,239 730,001 766,501 800,993 835,035 870,524 905,345 941,559

Operating profit* 39,133 51,042 60,157 75,227 94,529 104,944 160,920 168,260 175,846 184,238 192,549

Operating profit margin* (%) 9.55% 8.75% 9.09% 10.82% 12.95% 13.69% 20.09% 20.15% 20.20% 20.35% 20.45%

Net income* 26,372 21,718 18,693 28,097 40,141 46,640 81,569 86,149 109,728 114,964 120,150

Net margin* (%) 6.44% 3.73% 2.82% 4.04% 5.50% 6.08% 10.18% 10.32% 12.60% 12.70% 12.76%

Cash and cash equivalents 107,354 70,011 130,945 220,773 306,995 396,980 461,540 545,113 643,349 751,154 862,838

Total assets 671,093 1,137,554 1,151,587 1,205,827 1,279,050 1,347,425 1,504,514 1,605,280 1,771,641 1,902,690 2,039,788

Debt 13,368 400,639 400,748 391,934 383,118 374,495 366,067 357,828 349,774 341,902 334,207

Shareholders' equity 442,842 447,100 436,294 475,106 533,391 603,331 713,176 838,487 999,178 1,176,752 1,370,599

Total liabilities and equity 671,093 1,137,554 1,151,587 1,205,827 1,279,050 1,347,425 1,504,514 1,605,280 1,771,641 1,902,690 2,039,788

Free Cash Flow (FCF) Analysis

NOPLAT 7,458 31,022 39,102 48,898 61,444 68,214 104,598 109,369 114,300 119,755 125,157

Depreciation and amortisation 39,202 76,693 89,223 83,496 71,911 70,355 22,027 22,963 23,939 24,897 25,893

Change in working capital 14,110 15,753 11,487 3,721 3,923 4,478 4,335 3,323 3,504 3,034 3,344

Capex (19,278) (303,937) (18,209) (19,119) (24,090) (25,295) (22,027) (22,963) (28,727) (29,876) (31,071)

Free Cash Flow (FCF) 41,492 (180,470) 121,603 116,996 113,188 117,752 108,933 112,692 113,016 117,809 123,322

PV of FCF (180,383) 111,342 98,155 87,010 82,940 70,287 66,625 61,223 58,476 56,074

Terminal Cash Flow 941,068

Perpetual growth rate 3.00%

WACC 9.14%

* IIIR adjusted to exclude non-recurring itemsSource: Company data, IIIR estimates

WACCRisk free rate 4.89%Equity risk premium 5.08%Beta 1.11

Cost of equity 10.53%Marginal cost of debt 8.00%Marginal tax rate 35.00%Tax adjusted cost of debt 5.20%Debt/ capital ratio 26.11%WACC 9.14%


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DCF sensitivity analysis

1.50% 2.00% 2.50% 3.00% 3.50% 4.00%7.64% 26.58 28.51 30.82 33.63 37.11 41.568.14% 23.96 25.54 27.40 29.63 32.33 35.69

WACC 8.64% 21.70 23.02 24.54 26.33 28.48 31.089.14% 19.75 20.84 22.11 23.58 25.31 27.379.64% 18.03 18.96 20.02 21.23 22.65 24.32

10.14% 16.51 17.30 18.20 19.22 20.39 21.76

Source: IIIR estimates

Terminal growth rate

Weighted average valuation

We assigned a 60% weight to the target price derived from our DCF valuation and 20% weights each to the target prices derived from relative valuations based on P/S and PEG multiple methods. The weighted average valuation reflects our estimate of intrinsic value and market expectations and sentiments. Applying these weights on our target prices we arrived at a weighted average target price of US$24.69 for the Open Text NASDAQ common stock, representing an 11.4% upside from current levels. Therefore, we initiate the Open Text’s NASDAQ common stock with a BUY on fundamental grounds. The technical condition of the NASDAQ common stock suggests a HOLD (see page 19). The Canadian stock is rated a HOLD due to anticipated negative currency impact (see page 1).

NASDAQ common stock (OTEX): Target price (US$), 6-24 months

Methodology

Weight assigned

Target priceWeighted average

price

Target price using DCF approach 60.0% 23.58 14.15

Target price using PEG approach 20.0% 27.01 5.40

Target price using P/S approach 20.0% 25.73 5.14

Weighted average NASDAQ common stock target price 24.69

Current NASDAQ common stock price 22.17 Upside/(Downside) from current levels 11.39%

Source: IIIR estimates

Key risks to fundamental rating

Continued relationship with strategic partners is essential to sustain growth

Open Text relies on its close ties with partner organizations and their cooperation for its sales and development as well as optimization of opportunities which may arise in the competitive environment in which it operates. In the event that any strategic partner decides to scale back or discontinue its relationship with Open Text, the company’s business would be adversely affected.

Continued ability to develop technologically advanced products

The market for ECM products is intensely competitive and is subject to rapid technological change and modification. The company must be sensitive to market demands as well as competitive threats in order to design and distribute both new and innovative software products and enhancements to existing products on a timely basis. Open Text currently relies on its proprietary R&D resources and has been able to maintain responsiveness to customer requests. Since the primary market for ECM products is rapidly evolving, the level of acceptance of current and future releases is not certain. In

The weighted average target price for the NASDAQ common stock is US$24.69 per share

Failure to continue relationship with strategic partners may adversely impact performance

Market acceptance of Open Text’s products is essential for continued healthy growth in revenues


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addition, revenues from licenses drive revenues from customer support and services. If Open Text’s products are not well received by the market, it could negatively impact the top-line and our rating for the stock.

Further consolidation will be a threat to Open Text

The recent acquisition of Documentum by EMC and that of FileNet by IBM signifies that larger players are keen to capitalize on opportunities offered by the ECM market. These acquisitions have replaced the main comparable competitors of Open Text with larger companies. These companies have considerable resources at their disposal to compete with the products and services offered by Open Text, at a lower cost. For example, Microsoft recently launched SharePoint, a software product that competes with some of those offered by Open Text at a lower cost to the customer. Microsoft offers this ECM product as an add-on to its hugely popular OS product, thus capitalizing on the large market share it already enjoys. Going forward, further consolidation is expected in this space which could be a threat to Open Text.

Financial statements

All figures in US$ '000 unless specified FY 2006 A 1Q 07 A 2Q 07 A 3Q 07 A 4Q 07 E FY 2007 E FY 2008 E FY 2009E

Total revenues 409,562 101,155 163,261 156,052 163,114 583,582 662,132 695,239

y-o-y growth 9.20% 47.39% 54.62% 55.00% 42.49% 13.46% 5.00%

Operating expenses 255,423 55,909 98,012 88,092 92,627 334,640 411,149 418,949

Operating income 12,951 11,007 9,764 13,539 11,479 45,789 60,157 75,227

Operating margin 3.16% 10.88% 5.98% 8.68% 7.04% 7.85% 9.09% 10.82%

Operating income* 39,133 10,539 14,607 14,417 11,479 45,789 60,157 75,227

Operating margin* 9.55% 10.42% 8.95% 9.24% 7.04% 7.85% 9.09% 10.82%

Non-GAAP** operating income 67,640 19,407 34,034 33,409 30,933 117,783 137,792 146,556

Non-GAAP operating margin 16.52% 19.19% 20.85% 21.41% 18.96% 20.18% 20.81% 21.08%

Income before tax 9,650 11,772 2,581 5,891 3,929 24,173 29,957 45,027

Minority interest 579 137 131 124 102 494 779 1,171

Net income 4,978 7,301 2,277 3,853 2,452 15,883 18,693 28,097

Net margin 1.22% 7.22% 1.39% 2.47% 1.50% 2.72% 2.82% 4.04%

Net income* 26,372 7,206 7,449 4,633 2,430 21,718 18,693 28,097

Net margin* 6.44% 7.12% 4.56% 2.97% 1.49% 3.72% 2.82% 4.04%

Non-GAAP net income 43,966 12,615 22,122 26,909 20,106 76,559 89,565 95,262

Non-GAAP net margin 10.73% 12.47% 13.55% 17.24% 12.33% 13.12% 13.53% 13.70%

Diluted EPS (US$) 0.10 0.15 0.04 0.08 0.05 0.31 0.38 0.58

Diluted EPS* (US$) 0.53 0.14 0.15 0.09 0.05 0.43 0.38 0.58

Non-GAAP EPS (US$) 0.88 0.25 0.44 0.53 0.40 1.52 1.84 1.96

Outstanding shares ('000) 49,950 50,219 50,739 51,134 50,510 50,510 48,640 48,640*Excluding non-recurring items **We have calculated non-GAAP figures for 1Q 07 and 2Q 07 as the company did not publish non-GAAP figures for these two quarters

Source: Company data, IIIR estimates

Forecast income statement, FY 2006- FY 2008

Further consolidation in the ECM space by large players could be a threat to Open Text’s market share


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Forecast Balance Sheet, FY 2006 A - FY 2009 EAll figures in US$ '000 unless specified FY 2006 A FY 2007 E FY 2008 E FY 2009 E

Assets

Cash and cash equivalents 107,354 70,011 130,945 220,773

Accounts receivable (trade) 75,016 111,920 126,984 133,333

Capital Assets 41,262 41,262 41,262 41,262

Goodwill 235,523 526,636 526,636 526,636

Acquired intangibles 102,326 329,570 258,556 194,179

Other current and non-current assets 109,612 58,155 67,204 89,644

Total Assets 671,093 1,137,554 1,151,587 1,205,827

Liabilities

Accounts payable 62,535 85,599 97,766 103,010

Long term debt 13,368 400,639 400,748 391,934

Share capital 442,842 447,121 431,005 459,102

Minority interest 5,804 6,299 6,299 6,299

Other current and non-current liabilities 146,544 197,896 215,769 245,482

Total liabilities and shareholders' equity 671,093 1,137,554 1,151,587 1,205,827Source: Company data, IIIR estimates

Forecast cash flow statement, FY 2006 A - FY 2009 EAll figures in US$ '000 unless specified FY 2006 A FY 2007 E FY 2008 E FY 2009 E

Net income 4,978 15,883 18,693 28,097

Net cash flow from operating activities 60,798 152,994 113,164 115,477

Net cash flow from investing activities (54,727) (573,530) (18,209) (19,119)

Net cash flow from financing activities 18,202 383,192 (34,022) (6,530)

Change in cash and cash equivalents 27,456 (37,343) 60,934 89,828

Cash and cash equivalents at the beginning of year 79,898 107,354 70,011 130,945

Cash and cash equivalents at the end of year 107,354 70,011 130,945 220,773

Source: Company data, IIIR estimates


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Industry context for our recommendation – Software products and servicesCompany Ticker Key issues Fundamental rating

Amdocs Ltd DOX

Amdocs’ 2Q 07 revenues were in line with our expectations but earnings were better than ourexpectations, on the back of lower R&D spend. The company has made major deals, including one withAT&T, which are expected to boost its revenue stream going forward. Profitability from further expansion ofmargins is expected, aided by cost control measures.

BUY

Business Objects S.A. BOBJ

Business Objects records strong results in 1Q 07, driven by revenue growth across all segments. Operatingand net margins witnessed a rise, enabled by stringent cost controls. Going forward, the company hasguided for strong revenue growth inFY 2007 on account of which we anticipate robust growth to continue.Acquisition of Cartesis will also boost both the top- and bottom-line for the company going forward.

BUY

Check Point Software Technologies Ltd.

CHKP

Although 1Q 07 was a decent quarter for Check Point, it was not a very encouraging one, as there was noreal turnaround. The top-line results were broadly in line with our expectations, with marginally lower thanexpected contributions from the Protect Data acquisition. However, profitability failed to impress withnoticeable margin dilution resulting from the acquisition. Management’s muted guidance for FY 2007affirms our cautious outlook for the stock.

HOLD

Cognos Inc. COGN

Cognos reported strong results in 1Q 08, driven by market acceptance of its upgraded product suite.Management guidance continues to be optimistic for the next quarter as well as the full year. Our outlookfor the stock remains positive considering the planned upgrades to existing product suites and thecompany’s strong order pipeline.

BUY

Corel Corporation CREL

Corel posted impressive top-line growth in 2Q 07 aided by strong demand for its existing products as wellas healthy contribution from the Intervideo acquisition. The company’s profitability also witnessedencouraging revival aided by cost synergies from Intervideo. We believe that Intervideo will provide ahealthy top-line contribution going forward and will improve the company's margins.

BUY

Dassault Systems DAST.PA

Although the company reported encouraging 1Q 07 top-line growth, broadly in-line with our expectations,we expect the company to witness some slowdown in its volume growth going forward. Management hasalso lowered its FY 2007 top-line guidance, Furthermore, 1Q 07 operating and net margins were below ourestimates. We believe that Dassault will continue to face margin pressure going forward, on the back ofrising operating costs. Therefore we anticipate some slowdown in Dassault’s profitability.

HOLD

Infosys Technologies Ltd.

INFY.BO

4Q 07 results were slightly lower than our expectations mainly due to the appreciation of the Indian rupeeagainst the US dollar during the quarter. Volumes and pricing growth were modest during the quarter.Going forward, we expect a stable pricing and margin environment, growing client base, and additionalstaffing, and increasing global demand for offshoring, indicating attractive future prospects.

BUY


OTEX.O

Open Text is the world's largest independent provider of Enterprise Content Management services.Based on the growing demand for ECM products, primarily because of heightened concerns overcompliance requirements among corporations, which can be managed efficiently using ECM suites, weexpect Open Text to maintain its dominant position in the ECM market. Based on these factors ouroutlook for the stock is positive.

BUY

Patni Computer Systems Limited

PTIThe solid organic growth, robust Indian IT Software& Service industry, expanding client base, and ABN dealare expected to boost revenues, indicating attractive future prospects.

BUY

SAP AG SAPG.DEDecent top-line growth and strong earnings growth on the back of strong Software revenues and Supportrevenues in 1Q 07. Signs of recovery visible after a weak last quarter in the Americas in FY 2006. Strongorder entry and a marked improvement in new contracts suggest a decent build-up for SAP in FY 2007.

BUY

Satyam Computer Services Ltd.

SATY.BO

4Q 07 results were in line with our expectations and surpassed market expectations and companyguidance aided by robust volume growth, higher billing rates and favorable revenue mix effects. Improvingprofitability from subsidiaries, increasing client base and employee count, lower attrition and increasingglobal demand for IT offshoring combine to maintain the positive outlook for Satyam.

BUY

Wipro Ltd. WPRO.IN

Healthy 4Q 07 results were in line with our expectations and broadly surpassed market expectations.Performance was supported by healthy volume growth, higher price realizations, benefits from BPOtransition and improved contribution from the acquired portfolio. Robust client wins and manpower buildupindicate visibility for strong growth going forward.

BUY

Source: IIIR


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Technical Overview: OTEX.O

Data Source: Bloomberg LP. For training resources see “Analytic Techniques” at http://www.iirgroup.com/pal/index.html

Outlook:

The technical condition of the NASDAQ common stock is rated a HOLD, with a target price of US$21.69. Note, however, the NASDAQ common stock is rated a BUY on fundamental grounds. The Canadian stock is rated a HOLD due to anticipated negative currency impact.

Resistance

Resistance: US$22.94, US$23.80

Support: US$21.69

Strategy

A sustained break below support at US$21.69 is required ahead of a down move to US$21.13 from here. However, note that a sustained break above resistance at US$22.94 opens up further upside to US$23.80 and potentially to US$24.37.


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Footnotes 1 We have adjusted the reported operating profit, net income and diluted EPS for non-recurring income/expenses by subtracting/adding the non-recurring items from/to reported operating profit, net income and diluted EPS in order to arrive at our adjusted operating profit, net income and diluted EPS. Note, however, that in doing so we have not recalculated the tax liability for the period to reflect the above change and have used the provision for tax as reported in the income statement for the period. 2 Non-GAAP accounting principles do not consider non-cash charges such as stock-based compensation expenses, acquisition-related in-process R&D expenses and acquisition-related amortization expenses as operating expenses, which are considered as operating expenses under US GAAP accounting principles. Unless otherwise stated the results in this report are reported under US-GAAP.

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Guide to IIIR’s research approach

Valuation methodologies

We apply the following methodologies to triangulate the ‘fair value’ for the stock assessed fundamentally:

DCF valuation:- The DCF method values the stream of future cash flows discounted to the present day, most often using the company’s WACC. This method is used to estimate the attractiveness of an investment opportunity and as such provides a good measure of the company’s value in absolute terms. There are several approaches to discounted cash flow analysis, including Free Cash Flow to Firm and Free Cash Flow to Equity. The selection of a particular approach depends on the particular company being researched and valued.

Comparative valuation:- In Comparative valuation or Relative valuation, various comparative multiples including Price/Earnings, Price/Sales, Enterprise Value/Sales, EV/EBITDA ratios are used to assess the relative worth and performance of companies which operate in the same industry/industries and are thereby in the same peer group. In general at least two multiples will inform the valuation of every stock.

Other methodologies:- Other methodologies such as Dupont Analysis, EVA, Dividend Discount Method and P/NAV are applied where appropriate.

The target price derived from each methodology is then weighted, based on industry characteristics, to provide a weighted average target or ‘fair value’ for the stock.

Stock ratings

Buy recommendations are expected to improve, based on consideration of the fundamental view and the currency impact (where applicable) by at least 10%.

Hold recommendations assume that value is fully reflected in the current share price or that the overall view on the stock is fully compensated by the currency impact (where applicable).

Sell recommendations are expected to deteriorate, based on consideration of the fundamental view and the currency impact (where applicable) by at least 10%.

Currency impact and premium/discount

Our fundamental analysis is always conducted on the security which is traded in the company’s reporting currency. For global equities coverage, we also factor in any currency impact on the target price of the derivative security. In most cases, the derivative security will be the ADR, but in cases where the company reports in US dollars, we assume the company’s major trading currency is the US dollar and therefore, since the impact of US dollar fluctuations will be minimized, the currency impact is applied to the non-US issue. We assume that fluctuations in the exchange rate linking the two securities will always impact the derivative security which may result in higher or lower returns compared to the base security and therefore may result in a different rating compared to the fundamentally assessed security. IIIR forecasts forward exchange rates for all major currency pairs utilizing its proprietary methodology. The forward exchange rates are overlaid on the target price for the fundamental stock over the defined investment horizon to derive the target price for the derivative security, helping investors to identify additional opportunities and risks associated with investing in a stock in US dollars or local currency.

Note that under some circumstances the currency impact alone can be responsible for driving a buy or sell rating on an otherwise fundamentally neutral conclusion.

In certain cases, the two issues under coverage may trade at a premium or discount which is not explained by the exchange rate impact. Typically this will be a premium or discount of the derivative stock relative to the base security. Our approach factors in the 12-month average premium or discount to our forecast target price. However, to forecast the price based only on currency impact for investors, we factor in the current premium/discount in order to clearly isolate the upside/downside purely attributable to currency impact.

Technical condition

IIIR also provides a view on the technical condition for all fundamentally assessed securities in our reports (where data is available) utilizing our proprietary Pronet product. This component of the report aims to provide investors with an alternative assessment of the technical condition of the security and is not considered when deriving the target price and rating for the common stock and ADR.

Disclaimer

Independent International Investment Research PLC supplies this research via Pronet Analytics.com Ltd. ('Pronet'). Pronet is Regulated and Authorized by the Financial Services Authority (FSA) and registered with the Securities Exchange Commission (SEC). You are reminded that investment advice provided by Pronet is for your general information and use and is not intended to address your particular requirements. Any advice or recommendations contained in this report may not be suitable for you and are not intended to be relied upon by you in the making (or refraining from making) any specific investment or other decision. Such decisions should only be made on the basis of independent advice from an appropriately qualified adviser. Pronet Analytics.com Ltd. and Independent Financial Markets Research Ltd. are subsidiaries of Independent International Investment Research PLC (the 'Group'). Research analysts working for the Group are subject to stringent confidentiality and security policies and are located in secure-access premises which may be in the proximity of professionals conducting similar work for other firms. The Group is not nor has been nor will be engaged in investment banking and does not make markets in any of the securities covered in this report or have any investment banking relationship with the firm whose security is covered in this report. No employee or contractor of the Group is permitted to personally buy or sell stock in the company covered in this report, and neither the analysts responsible for this report nor any related household members are officers, directors, or advisory board members of any covered company. No one at a covered company is on the Board of Directors of the Group or any of its affiliates. This report is not a solicitation to buy or sell any security and past performance is no guarantee of future results.

Copyright © 2007 Independent International Investment Research PLC. All rights reserved.

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