Open Text Corporation (NASDAQ:OTEX) Citi’s 2024 Global TMT Conference Call September 5, 2024 4:40 PM ET
Company Participants
Madhu Ranganathan – President, CFO & Corporate Development
Conference Call Participants
Steven Enders – Citi
Steven Enders
Well, thanks, everybody, for being here. I think we’re at the last session of the day for day 2 of the Citi Technology Conference. I’m Steve Enders part of the software research team here. With us today for, I guess, the last session today is Madhu from OpenText. Madhu, thank you so much for being here.
Madhu Ranganathan
Thank you, Steve, for having OpenText.
Question-and-Answer Session
Q – Steven Enders
Yes. So maybe to start off, I think OpenText has gone through a pretty — a lot of changes in the past few years. Clarification, acquiring Micro Focus, divesting parts of Micro Focus and a recent restructuring. So maybe can you kind of walk us through that journey and maybe how is OpenText as a business different today than it was a few years ago?
Madhu Ranganathan
Yes, absolutely. As you rightly pointed out, we’ve gone through many changes. We’ve gone through dramatic changes. I’ll start here. We are a relatively software company at 33 years old. And our growth historically has been driven by value-driven acquisitions and by organic growth. I do want to put an emphasis on cloud, especially to your question about what is different today than the journey of OpenText. Several acquisitions have contributed to the foundation of OpenText in content, in business network, in cybersecurity. The most transformative acquisition is what we closed in January 2023, that’s Micro Focus.
And now thinking of Micro Focus X, the mainframe business AMC, which we divested, is really where we are as an information management company. And what I would say is when we think about data in enterprises, data that’s stored, data that’s moved, data that’s secured, all of that is managed by OpenText, and that’s the right way to think about it. So we are focused on our top priorities where we sit today. which is really deepening and expanding our competitive advantage, growth in the cloud, cloud acceleration. .
We have done very well. We had a very good fiscal ’24 in terms of our full year of integration of Micro Focus. So we are well on our path of margin expansion. And lastly we can talk more about it, is we are back into very strong capital allocation driven by dividends and share buybacks. So where we are today, that’s different, given all the rapid journeys, I would put a stronger emphasis on cloud, Expect to hear more from us from a cloud perspective. And also, as I said, we have always been unique in terms of operational efficiency and profits, and we’re going to continue to be on the path.
Steven Enders
Okay. Now that’s — it’s a great place to start. I think maybe think about OpenText, the roots are in kind of ECM, content management. You’ve talked a lot more about information management. Can you maybe just talk about that transition and kind of everything that you would kind of include in that information management umbrella?
Madhu Ranganathan
Yes. So in our most recent earnings presentation, it’s specifically Slide 7 of our investor deck, you will see how we’ve broken down our revenues, which is really our product groups and our markets. So it’s content, is about 40%, and cybersecurity is 20%, business network is 10%, IT operations management is 10%, application automation is 15% and analytics is 5%.
Now think about these in the context of what I said earlier on the cloud, which is it’s led by content, business network and ITOM, but really think about all of them are business cloud. Some are more advanced from a cloud perspective than the others. But those are really the opportunities for us. Again, we can talk more about fiscal ’27 when we speak about 7% to 9% growth. Content has seen a lot of R&D investments for cloud and is on its path to be very strong in the cloud. Cybersecurity has a lot of cloud in it. ITOM is early in the cloud. Application automation is early in the cloud, right? And business network has always been in the cloud.
So depending on where the different product groups are — but that’s how we’re defining information management, right? It’s content, it’s business network, cybersecurity, ITOM, IT operations management, application automation and, of course, all wrapped around from analytics. And actually, you have a question on AI, we can talk about it, but AI is a real calling for us to continue the growth in the cloud and in many different directions.
Steven Enders
Okay. Yes. I definitely want to touch on AI in a bit. I think maybe before we get there, a lot of areas in the portfolio, can you maybe help us think through kind of what are the — where you would consider the growth of your areas, where you see kind of the opportunity and which maybe are a little bit kind of more mature and you’re kind of managing through some of those?
Madhu Ranganathan
Yes. So with cloud being a leading growth driver, think about content as very well poised and continuing to report and we’re thinking about disclosures down the road, very strong growth rates in the cloud, right? Business network, again, it’s very sector focused. We serve industrial, we serve automotive.
We serve the pharma. And given the strength of the sector, you will see the strength in business network as well. We are driving security and AI across our business clouds, and that’s going to remain a growth driver. I mean most important is what I would say, new use cases are emerging, and those use cases are going to require any form of cloud that we offer. We offer private cloud, we offer public cloud and we offer SaaS. We actually finished our fiscal ’24 with a strong organic growth rate in the cloud, but more importantly, in Q4, we saw slightly over 3%. And all of these growth drivers are going to contribute to the 2% to 5% in ’25 and 7% to 9%. Our leading indicator remains the cloud bookings growth, right?
When you look at our 25% growth rate, we’re looking at over $900 million of enterprise cloud bookings in fiscal ’25. And that’s at the heels of about $700 million previous year, $530 million in the previous year. Again, all of this is — today, cloud is about 35% of our revenues. And when you look at our fiscal ’27, it’s going to be well north of that, right? So those are kind of the key areas from a growth driver perspective.
Steven Enders
Okay. That makes sense. I do want to ask about the — some of the optimization initiatives, and I think you had about 2% RIF in July. I guess what led that change? How do you think about the focus areas of reinvestment from here? And I guess, kind of any implications this has on the margin trajectory?
Madhu Ranganathan
Yes, absolutely. Look, many companies have different reasons for their restructuring and optimization Ours is a very relentless focus on how efficient can we be at the scale. So the 36% to 38% in ’27 upon a $5.7 billion to $5.9 billion revenue range, that is our measure of efficiency at that size and scale. Now coming about 18 months off of the Micro Focus acquisition, we saw opportunities to be in that efficiency path. The restructuring was focused primarily on the U.S. workforce and moving our talent to what we call the centers of excellence. Our centers of excellence are centers where there’s market for the talent. We can hire at the rate that we want to.
And of course, there could be a cost differential, right? So our centers of excellence are India, are Romania and Canada, and that’s really the shift we made. Now we maintain the U.S. workforce in areas like professional services, sales, so the reinvestment we made, think of them as back carriers. As quota carriers. It’s the best reinvestment you can make, right? And you have to make it much in advance. So these are sales reps, these are renewal reps and these are professional services reps.
Now from a margin expansion perspective, we focused on the reinvestment starting from the beginning of the fiscal year. So think of it as us carrying costs for the entire year. So that’s also why we expanded the margin 100 basis points and not more than that. But the benefit of that is going to come through to our fiscal ’27 path of the 36% to 38%.
Steven Enders
Okay. All right. That’s a great context there. There’s been some leadership changes, brought in some new go-to-market leaders. I think you yourself took on a bit of a promotion here. So congratulations.
Madhu Ranganathan
Thank you.
Steven Enders
But I guess what has changed from an execution standpoint? And are there other shifts underway with the new leadership coming in? And how do you kind of think about some of the, I guess, near-term execution?
Madhu Ranganathan
Yes. So again, different companies have different org structures, but I’d like to speak to the 3 president structure as one that was needed for the size and scale of OpenText. Now let’s talk about sales. Prior to this, Todd Cione is the President of Worldwide Sales, we had about 5 theaters reporting into a CEO directly, right? So this is the right time at the heels of Micro Focus coming out of an 18-month great integration framework to appoint Todd as the Worldwide Head of Sales. Paul Duggan, he runs all of renewals, and he also runs the cloud services business. So think of him as cloud once the cloud booking is done, he’s responsible for the delivery of the revenue and of course, a very marquee installed base.
Now these 2 growth revenue organizations, the leadership there is really intended to bring unification to the renewal side, unification to cloud deployment and unification to the selling organization, right? And we have various product groups, as we just talked about earlier and this is really going to be very instrumental. And the unification is important is how you think about value proposition for a large customer, right? And having that across the pillars is very important. And both of them bring tremendous years of enterprise selling experience, and we couldn’t be — and we could be more excited.
And as for myself, the add has been twofold. One is just leading operations throughout the company more officially, so to speak. And I always was seeing that as part of the role now just taking an operational lens throughout the company, and that’s going to be very integral to our march towards upper quartile EBITDA margin and, of course, taking on corporate development as well. So that includes the AMC divestiture, includes TSA with AMC. And we’re excited to be more into the tuck-in M&A process from a corp dev perspective.
Steven Enders
Okay. I guess maybe this is a good time to maybe talk a little bit about the cloud opportunity and kind of the AI side and how you’re thinking about that opportunity there. Maybe we can just start on kind of the cloud side. I think cloud bookings has seen some pretty impressive quarters here the past couple. But I don’t think we’ve necessarily seen that translate yet to the revenue side. Can you maybe help us kind of bridge the gap between the, I think, 33% bookings growth you saw in ’24 versus the kind of 2% to 5% ’25 cloud revenue growth guide?
Madhu Ranganathan
Yes, yes, absolutely. It’s a question we get asked often, and it’s one that’s very important. What the booking does is give us forward visibility. We shared a quarter ago in our earnings call that our cloud contracts are getting into a median or an average of 4-year tenure versus 3 tenure.
And that means a lot, right? So our ramp time for the OpenText Enterprise cloud, particularly in the private cloud side, just the ramp time could be as long as 6 to 9 months. And then, of course, there are leading applications that enterprises think about when they purchase — and OpenText solution is not just purchased on its own. It’s purchased on the heels of a CRM. It’s purchased on the heels of an ERP. So I say that those horses leave the barn before we do, right? So the ramp time could be as long as 6 to 9 months. And then, of course, we start the deployment and the curve goes a bit sort of slower and then very fast into the third year or the fourth year. So think of these bookings as giving us visibility and strength into the 2% to 5% of fiscal ’25. And to the 7% to 9% of fiscal ’27, right? So we look forward to like sometime in fiscal ’25, to coming with better correlation, algorithm, so to speak, on how do you take the bookings to revenue.
That has been an important aspect that we obviously track very detail internally, but we’d like to give investors a consumable model to that. But we couldn’t be more excited about the visibility and the strength of bookings. The last thing I’ll say is our cloud bookings, they’re all noncancelable. So over the term of the 3 years or the 4 years and in some cases, even longer, right, we end up receiving the full benefit of those bookings. It’s just a matter of time.
Steven Enders
Okay. That makes sense. I mean it does feel like you are seeing pretty good just general strength on the cloud side based on the execution in ’24, but also I think for ’25, you raised the guide on cloud bookings now to 25%. So I guess, what are you seeing from a new demand perspective or migration activity that’s given you confidence in this elevated level? .
Madhu Ranganathan
Yes. And you asked the question in your earlier comments, so let me just expand on it. And we’ve said this in the last few quarters. the AI wave was really helping OpenText to expand its cloud bookings. The volume of unstructured data that sits in enterprises still remains very, very high. And customers are very keen to what we call organize for AI or prepare for AI. That is really the strength that you’re seeing in our cloud bookings. We’re having hundreds of conversations in AI. AI is part of every cloud conversation. As I spoke about it earlier, there are new use cases, they’re thinking about new workloads.
But for our business model, it’s really bifurcated into two phases: one, preparing for AI, the strength of the cloud bookings and the actual AI revenues itself, which we’re not calling out yet, right? We are product ready on the Aviator, which is our AI products. And Aviator product is really launched in every one of our product groups in content, in cybersecurity and ITOM, et cetera.
So I would say the big demand drivers remain the customers wanting to be ready with respect to AI. And the second piece I will outline that’s probably unique to OpenText is, our customers are talking about very large complex problems, right? They’re not talking about kind of the smaller use cases. So that, again, is an important tailwind for us. And I would say a minor point, please think of the cloud growth rate as an annual growth rate, right? We do have certain quarters where we do really well. So the 33% at the heels of that, I would put out 25% vis-a-vis a 15% starting point we had about 2 quarters ago that we were able to take it up to 25%. So I think in summary, I would say, preparing for AI, really large complex problems that the customers are trying to solve and organizing for AI that’s creating these demand drivers.
Steven Enders
Okay. Maybe we can talk a little bit now that we’re on the topic of AI. How should we — you’ve already talked around like people are getting ready for AI, and that’s beginning to impact things. But I guess, how should we be thinking about kind of the next level of AI monetization, where people are leveraging OpenText AI and Aviators and all those kind of other products that you’ve been coming out with.
Madhu Ranganathan
Yes. So we began to be product ready last October. And the aviator products themselves have come through a few evolution points. As I said, we’re having hundreds of conversations. They are also translating into customers kicking off pilots and we noted Bosch as an important customer. We noted a large retailer that’s thinking about a $50 billion of contract value in terms of AI.
So the key thing here has been introduce what we call our Aviator Thrust offerings and grow our Aviator Thrust offerings. We have the sales team ready. We have the professional services team ready. So look to us to speak more about these pilots, to the use cases from an AI Aviator perspective, that will eventually turn into, I mean like turn into monetization. But more importantly, I think as you outlined earlier, we see the tailwind of this helping us in our cloud bookings. And that’s really why we can see the 25% growth which again, if you do the math, it’s well over $900 million of cloud bookings in the year, and we’re actually quite excited about it.
Steven Enders
Yes. No, it’s pretty impressive growth. I think you did — you’ve talked about some of these early wins, but maybe we could talk a little bit more around the actual use cases that people are coming to OpenText to help solve for leveraging those AI. Like what do those look like? Or how do you feel like you’re actually helping the customers leveraging your AI solutions?
Madhu Ranganathan
Yes. So a few comments there. The right to AI, we really think about it as the readiness for AI, as I talked about. We are just more than ready. For our customers, there’s no vendor better than OpenText to deploy AI just given they have trusted us with their content and data, in many cases, multiple years or multiple decades.
Customers are looking at optimizing like literally their $1 billion supply chain, right? And when you look at this volume of contracts where AI can be applied, you’re talking about $50 billion worth of contracts where, again, the customers are deploying — are thinking about pilots at the moment, but it’s going to be what we call the steady, steady and somewhere an inflection point, right? And in the business network, for example, automotive, et cetera. They are looking at every single trade that can be optimized through that — through the application of AI and Aviator.
So whether it’s a content customer or a BN customer, that’s really where we personally are excited in the importance of how OpenText rolled out Aviator by the product group. We made it easier for the customer to not think too much about where the product would fit, but to think more about what problems and use cases that they’re trying to solve, right? And stay tuned and more to come on that.
Steven Enders
I’m sure we’ll hear more at the — your conference in next month or…
Madhu Ranganathan
It’s in November. I mean I was going to say, the product teams or sales teams are absolutely going to showcase all the product innovation and AI is going to be a key theme. It’s in November 18 and 19, and you’ll hear more from our IR teams.
Steven Enders
Okay. Perfect. No, I’m sure we’re all excited and ready to see what comes out of that. Maybe shifting gears slightly, understanding the AI solutions. It sounds like it’s having good performance on it. But maybe what does the macro backdrop look like today? Are customers at a point where the budgets are unlocking, they’re beginning to put dollars to work for AI? Or what is kind of the general OpenText customers budget look like today?
Madhu Ranganathan
Yes. So I think one unique aspect about us is we don’t speak about macro too often. And here are a few reasons for that. The macro is uneven for all customers. But for us, what we found is that a very positive macro background or a very challenging macro background, our customers are always sort of in the business of revenue augmentation or cost optimization. So our solutions become mission-critical from an enterprise perspective. And what I would also say is that the demand drivers we’ve talked about have remained very consistent for our customers. And whether it’s private cloud, it’s public cloud or SaaS, where they really look for is the value proposition in their environment, and that’s really where our solutions are focused on.
Our sales dialogues are kind of geared towards that. I would say, from a financial model perspective, we have assumed no improvement in interest rate environment and no improvement in the FX environment, which again, if there are green shoots on either side, we are certainly going to be able to do better. And the last one of the most important point, the breadth of our business model, the various product groups, we always find gives it an inherent resilience to macro, right?
The business network could have macro impact from automotive or energy, oil and gas, but then content could be doing really well, right? So our growth rates are really predicated on sort of — I mean, a combined influence of the macro. So we come out more resilient to the macro environment just given the nature of our solution as well as I would say, somewhat of a built-in resilience within the product groups as they’re sort of the reaction to the macro.
Steven Enders
Okay. I guess maybe digging in a little bit more for the different segments. Maybe where are you seeing a little bit of strength right now, maybe things are a little bit softer. Any way to kind of help frame what that’s looking like?
Madhu Ranganathan
Yes. So from a product group perspective, content to school again, our content is running very strong, right? And we see that runway quite far. And cybersecurity is a very important pillar for us and both on the enterprise side we called an SMB headwind. We’re not quite calling it anymore. But as it turns into a tailwind, I think that certainly could be very supportive for us. But think about ITOM, and our solutions here certainly ServiceNow is the big gorilla out there, but we are in very exciting early stages of our service management solutions. So I think, Steve, many of our products are especially ones from Micro Focus, where we are relentlessly focused on getting those declines to flat to flat growth, right? So the product innovation, the go-to-market efforts inherent in all of that is going to be our own growth drivers, so to speak.
Steven Enders
Okay. Makes sense. On the Q4 performance, I think things maybe were a little bit choppier this quarter. Can you maybe kind of walk through what happened, I guess, what that looks like going forward? And I guess, kind of like what’s fixable from that perspective? And how do you feel like the business is positioned to move forward here?
Madhu Ranganathan
Yes, absolutely. I’ll take it from the last point of your question, the business is positioned very strong. Look, Q4 marks the last quarter of our fiscal ’24, and we truly had an outstanding ’24. Specific to Q4, the miss was on license, and the miss was on Micro Focus license. And what we found in the quarter was it was the same sales reps, account execs of Micro Focus who were speaking with the AMC customers about the divestiture that happened and how they’re standing within OpenText still remain very strong. So if you really think about it, sales teams are all about selling time, lost a bit of selling time. We haven’t lost the deals. We haven’t lost the business and customers are well grounded, but that did contribute to a miss in license and Micro Focus license in Q4.
Now Q4 turned the corner very nicely on our cloud organic growth. We were slightly over 3% in Q4. It was kind of the highest in the year. And we are assuming the trajectory into fiscal ’25 at 2% to 5%. Again, we should measure the business and annual bookings growth rate. So the 33% is very strong, and I would point to the 25% in ’25. So Steve, 25% is going to be marked by another second year built upon the strong scaled company with Micro Focus, the debt burden eased a bit with the delever of the $2 billion, right? And we can talk more about cash flows, but it’s going to start the trajectory of growing cash flows. We are expanding EBITDA margins. So we look at fiscal ’25 as it’s a very strong foundation going into ’26 and ’27.
Steven Enders
Okay. I do want to ask about the kind of ramp here in the new medium-term guide that you laid out. I think before we get there, I guess you talked a bit about the selling time lost in Q4. I guess, as we think about the changes that got put in place here so far in 1Q and the RIF and some of the changes in go-to-market leadership. I guess do you feel like there’s any kind of — any incremental risk that kind of comes from those changes? Or how should we think about what that means for the business in 1Q?
Madhu Ranganathan
No, thank you for the question. And look no incremental risks and we believe only incremental benefits. Todd Cione has already hired quite a group of very strong sales leaders into various parts of the business. And we are very pleased with the hiring and as all of them ramp up is to bring the organic growth, selling DNA more and more into the business, right?
We have to become more efficient given the scale and the restructuring we did, which is the first step towards that. We are investing a lot into our centers of excellence to actually get them even more productive and value-adding at a global scale and whether that’s Canada or India or Romania and that’s part of our plan. So I would say think transformative Micro Focus, divest of AMC, bringing OpenText along. We’ve kind of really stabilized and strengthened the company to what we need to deliver in ’25 and beyond.
Steven Enders
Okay. All right. Makes — that makes sense.
Madhu Ranganathan
And maybe if you don’t mind, I’ll just add. We talked about Paul Duggan, and particularly on the renewal side. Paul is launching, as he shared in the earnings call, I mean a digital renewal center, right? And renewal is $2.4 billion plus of business. And that’s a very important step in turning the renewals from a renewal to expansion, and we can talk more about that if you’d like. But again, the changes we made, look, changes are hard, but we’re very thoughtful about the changes we made, and these are absolutely going to strengthen us to grow, strengthen us to expand margins. and expanding margins is really going to put a better lens towards capitalization as well.
Steven Enders
Okay. No, that’s great. Yes, maybe we do ask about the expansion and renewal potential of the business. And I think that historically, there’s been focus on Micro Focus and trying to get that to kind of corporate average there. So how should we be thinking about what the implications are with the sales changes on retention rates and renewals moving forward? And how are you all thinking about the changes actually being put in place to drive that motion?
Madhu Ranganathan
Absolutely. Think of us a few steps behind what the industry has always spoken about like net renewal rates and expansion rates, right? So we are looking forward to bridging that gap. Look, the Micro Focus renewal journey was a great milestone in ’24, but not quite done yet. We do want to get Micro Focus into the low 90s, right?
So the net renewal rate has been in the works for a while, and it’s obviously led by Paul Duggan. And we finished our renewal rates at 95% off-cloud, 92% cloud. If we had applied the expansion rate, they would actually be in the mid-90s, right, from a cloud perspective as well. Now all companies generally capture consumption and expansion. We captured consumption, we haven’t captured expansion and which is what we look forward to bringing together to share.
And that’s where the real growth is the renewal reps in our business are not just responsible for renewing at a principal value they’re responsible for adding workloads, right, adding premium rates. And we actually call it the customer success organization, and Paul has actually implemented new customer success tiers, which you will see in the expansion. And we believe ’25 is the right time to do that. We’re slightly behind, but we’re looking forward to catching up.
Steven Enders
Okay. No, that makes complete sense. Maybe we can switch gears a little bit and talk a little bit about the margin profile here. I know there’s been a lot of changes in the business. So maybe we can just talk — just start on the short-term cash flow nuances or the interest expenses and kind of what the path to improving EBITDA and EBITDA conversion looks like from here?
Madhu Ranganathan
Yes, absolutely. So for fiscal ’25, we’re looking at 33% to 34%, right? EBITDA margin, adjusted EBITDA margin. Now when you actually look at fiscal ’24, it was $2 billion of adjusted EBITDA dollars, that’s 34%, right? Now the margin expansion from 33% to 34%, 36% in ’26, and 36% to 38% is going to be contributed in a few different angles. From an OpEx perspective, we rightsized in early July through the plan you just mentioned.
I talked about cloud gross margin. It’s a very important lever to the EBITDA margin. A trough on cloud gross margin was 59%. We picked up in Q4. We are modeling low 60s in fiscal ’25 and with some of the efficiencies and growth in revenue and scale and a better product mix of SaaS, which is also part of the engineering innovation. We do expect cloud gross margin to contribute. From an OpEx standpoint, we talked on the call about being more efficient in sales, having a AI Aviator to help out in our sales process and have engineering, have specific projects on automating QA all of that.
So increasing those efficiencies actually going to get us to the 36% to 38% gross margin, of course, helped by the top line as well. Now that’s going to translate to $1.2 billion to $1.3 billion in free cash flows, right? Our distribution of free cash flow our capital allocation is 50% dividend and buybacks. And at the moment, we believe our stock is the best buy. So we are actively in the share repurchase program we announced. And getting to $1.2 billion to $1.3 billion, expect the capital allocation on the remainder of the 50% will continue to decide between, as you rightly said, dividend, debt reduction share repurchases and selective M&A.
Steven Enders
Okay I do want to come back to that topic. But before talking about that, you have those fiscal ’27 targets out there. And I think one of the questions we’ve still been getting, especially on the cash flow side is kind of help us bridge the gap between where things sit on the free cash flow today versus that ’27 target. So can you maybe just kind of walk through the onetime things that are kind of in there and kind of bridge the gap between those 2 numbers?
Madhu Ranganathan
So the $575 million to $625 million we have for fiscal ’25. It’s a bit burdened by the tax gain in the AMC transaction and that’s about $250 million. And again, we have to think about it as coming off of the proceeds, but it’s going to hit the free cash flow this year. So if you were to take the midpoint and you sort of get up to more the $850 million range, that’s really the path from the $850 million over to the $1.2 billion to $1.3 billion, right?
And as EBITDA improves, our cash flow conversion from the EBITDA is also going to rise from somewhere in the 40s today into the upper 50s, and that’s what’s going to contribute to the free cash flow. Two important aspects here, including Micro Focus. Our working capital remains strong. right? Going from profitability to our operating cash flows, our working capital remains strong. We brought Micro Focus on to our working capital parity as you see from the DSOs and other metrics that we share. And notwithstanding the cloud growth, our CapEx also remains efficient, right?
We’ve remained at around 2% — 2% to 3% of revenues on CapEx and we’re going to stay at that. And maybe a word on that is making our cloud operation more efficient is going to mean in the private cloud, our own data center footprint being more efficient and also leveraging the hyperscalers, right? So that’s how we think about that, Steve. I think more in the $800 million range in terms of free cash flow as a starting point, if you want to talk about ’25, ’27. And then ramping up the EBITDA and then ramping up the conversion rates, but founded on strong working capital and CapEx efficiency.
Steven Enders
Okay. All right. All that makes sense. I do want to talk a little bit about the shift in the strategy a little bit in terms of how you’re thinking about M&A. I think historically, think about OpenText. It’s been a pretty big acquirer, and there was some digestion that happened here. And now it seems like instead of going full on the M&A bucket, it’s more on kind of tuck-ins and some smaller things. So can you talk a little bit about how you’re thinking about what that actually means from an M&A perspective to be part of the capital allocation plan. And what are kind of the criteria that you would be looking for in a potential target now?
Madhu Ranganathan
Yes. Yes, absolutely. Look, we are in a bit of a unique position that is not a very highly desired position, which is for all the things we’ve done and where we stand and what we have in terms of future product and growth and market opportunities, we do remain tremendously undervalued. So we prioritize share repurchases as top of the house from a capital allocation perspective. I think your term is right. I think it is about digestion.
And for us, the digestion means getting the Micro Focus products back to more organic growth. Upping the renewal rates and clarification, we never did the Micro Focus transaction for their license business. We did it for the opportunities to cloudify and that was a 10-year journey for OpenText is probably a shorter journey as we look ahead. So that clarification of Micro Focus products is also part of the digestion process opportunity ahead, right? So all of those in front of us, we remain — we believe our stock is — I mean, our stock is the best buy. Look, we have a lot of muscle memory on M&A.
That’s an understatement, right? So we will be in the M&A market, but down the road as we get into a better currency from a stock perspective, improve the cash flows. And once again, we remain cognizant of the debt, so we’ll keep evaluating the 4, which is, of course, dividend, repurchases, debt reduction and M&A. But when all of that currency improves and the right transaction comes in at the right value and the right value to us and the right value from a market perspective, we would not be hesitant to engage in it.
Steven Enders
Okay. I know we’ve kind of already touched on capital allocation a little bit. And like there is the view that the stock is cheap, so let’s go buy it. But how are you thinking about — well, you do have the plan already in place on that part. But how does that plan maybe come together? And how should we think about maybe what the right mix looks like moving forward between buybacks, dividends, M&A and also continuing to kind of delever the business?
Madhu Ranganathan
Yes. So as I said earlier, we haven’t really modeled any improvement in interest rates, right? So the — or sort of the average portfolio is still about 6%, and they still appetite to optimize that. So look, we have been a consistent dividend payer and look for that to continue, right? But between the other 3, we would definitely keep doing the math and the modeling around can we delever even more. We’re delighted we delever 30%. Can we delever even more. Is the 2.9-ish the right net leverage ratio, could be lower than that. right, of course.
And I think share repurchases as long as the stock is around these levels, we’ll continue to prioritize share repurchases. The type of M&A we look at was also your question, our lens is definitely cloud-related M&A, right? And we can talk a lot about this, but we’re not going to compromise on our cash flow targets, profitability targets, but grow your assets if they come at a reasonable price, and add to the organic growth of OpenText. And where we can bring our excellence in operations to those grow your assets and keep our customer target, we’ll certainly entertain that. So I would say the measurement really is the value of the stock, is the cost of the debt, right? And how fast or how much can an asset add to our growth and add to our cash flows.
Steven Enders
That makes sense. You mentioned the leverage ratio. But I guess why is this kind of the right area, 3x, 2.9x. Why is that kind of the right area for OpenText to be at?
Madhu Ranganathan
So at a lower scale company being below 3 was sort of the right — was sort of the right area zone for us. And at this point, I would say we are delighted with the 30% deleverage we did, but should the right opportunity present itself to delever even more, we will. And as you can appreciate, it’s definitely a drain on the cash flows, right? And the more we can optimize the free cash flow, the opportunities open up as we just talked about in terms of M&A as well. So that’s sort of how we think about the use of the cash flows.
Steven Enders
Okay. Right. Makes sense. I think we’re running up on time here. We’ve got about a minute left. But I do want to ask about OpenText World in November, so I appreciate the clarity on that one. I guess, what should investors be paying attention to at the upcoming conference?
Madhu Ranganathan
Yes. So we welcome wide distribution of the content information, and we are looking for very strong attendance. We did something similar last year and Harry and the team did that. It was very well received. So here’s what I’d leave you with, right? You hear a lot about the financial profile of OpenText and financial targets in our earnings call and plenty of conversations ensue on that.
So at OpenText World, we’re looking forward to presenting to you from the sales organization, from the product organization, and there will be plenty of real live product demos. So the 3 areas we’d like you to walk away with is much higher confidence around our product and innovation strategy, much higher confidence and several proof points of our growth strategy. And we’re also going to add Shannon Bell, who leads our cloud operation to speak to you about cloud operations and infrastructure, which is important for the growth strategy. It is also important for the financial profile and cloud being kind of the lead growth driver in the future. So those would be the 3 big takeaways with plenty of other bells and whistles around it.
Steven Enders
Okay. All right. Well, that’s great to hear. I guess we’ll look forward to that event. Madhu, I want to thank you so much for being here and the rest of the OpenText team, and I want to thank everybody in the room as well.
Madhu Ranganathan
Yes, thank you, and thank you to Citi.
Steven Enders
All right. Thanks, Madhu.
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