CSU - Constellation Software

[Liberty]

Great Canadian software company focusing on a variety of vertical software markets. Been one of my faves for a few years, though I've never really talked about it here. A few people felt it deserves a thread, so let's make one!

 

Mark Leonard, the CEO, is in my opinion one of the best managers and capital allocators out there. His letters to shareholders (used to be quarterly, now yearly) and calls are worth checking out.

 

A lot of people will no doubt consider it expensive as it tends to hover in the 20-25x FCF lately, but it all depends how much you think quality is worth and what future growth/capital deployment for it is going to look like...

[giofranchi]

Thank you, Liberty! :)

 

Cheers,

 

Gio

[Phaceliacapital]

I looked at it and saw Mark speak at the Ivey conference (which was quite the presentation...).

 

CSU is indeed active in vertical software, but the guy is basically running a listed private equity company right? From the material I read or heard, he almost never discloses business specifics, it's all IRR, payback periods etc.. Obviously he's very smart, but I found it difficult to determine his competitive advantage, especially at this valuation. For what it's worth, I think it's also in Giverny's portfolio..

[Liberty]

I looked at it and saw Mark speak at the Ivey conference (which was quite the presentation...).

 

CSU is indeed active in vertical software, but the guy is basically running a listed private equity company right? From the material I read or heard, he almost never discloses business specifics, it's all IRR, payback periods etc.. Obviously he's very smart, but I found it difficult to determine his competitive advantage, especially at this valuation. For what it's worth, I think it's also in Giverny's portfolio..

 

Yep, very little about operations is disclosed, which can be a turnoff for many.

 

But there are so many businesses (it's not a constellation for nothing...) in so many niches that I'm not sure how they could disclose things without it it being really clunky. There are also a lot of things that you want to keep quiet for competitive reasons.

 

I think the competitive advantage at the corporate level is capital allocation and M&A, and at the operational level, each tiny business tends to have very little competition because they operate in niches that are too small for the big software players to care about, and they are integrated into the mission-critical parts of various businesses with customized products (back-office stuff for a cab company, a hospital, a school district, whatever), stuff that doesn't change very often, very sticky once you're in, very recurring.

[abyli]

Listening to how Mark talks in conference call reminds me of Warren Buffett, very rational thinking. Both can convert complicated things into a few key factors, very few people can do that. Most conference calls make my brain dizzy, especially when analysts ask stupid questions and CEOs just replied back with fuzzy answers. :-)

[giofranchi]

Yep, very little about operations is disclosed, which can be a turnoff for many.

 

I have just read Leonard's last AL and I have found it very complete. With much emphasis on the performance of existing businesses, which of course is what you want to see in any company that relies heavily on M&A.

 

Gio

[Liberty]

Yep, very little about operations is disclosed, which can be a turnoff for many.

 

I have just read Leonard's last AL and I have found it very complete. With much emphasis on the performance of existing businesses, which of course is what you want to see in any company that relies heavily on M&A.

 

Gio

 

I think what Phaceliacapital meant is that you could read all the letters and listen to all the calls and still not be sure what Constellation actually does except run vertical market software (VMS) businesses. You'd get all the financial details about performance, but not much talk about products, managers at the operations level, customers, etc. You have to dig by yourself to figure out more about all that stuff.

[berkshire101]

Amazing company and management!  I wish I bought more a while back.  Oh wells.

[KCLarkin]

The moat of this business is very easy to understand:

- Enterprise software in general is inherently sticky (it is very difficult to replace a mission critical vendor)

- Niche businesses limit competition

- Scale advantages - bolt-on acquisitions deepen the moat

- High level of recurring revenue

- Diversified products and customer base

- Disciplined capital allocation

 

CSU is particularly attractive relative to other PE-type companies (3G, VRX) since it can fund acquisitions almost entirely from cash flow. The cash ROI is phenomenal. The company does not issue stock (for acquisitions or options). The company has a tiny amount of debt relative to FCF.

 

The CEO is exceptional. He does not take any salary, bonus, options, and pays his own travel expenses. He is one of very few CEO's who writes an annual report that is actually helpful to investors. The 10 year growth rate for EPS is 32%.

 

The drawbacks:

- Price is elevated. It was relatively cheap in fall 2014 but has had a big run-up

- Limits to growth? As the company grows, it will need to look at bigger acquisitions with lower ROI

- Cloud: The company will be purchasing more SaaS companies in the future. Cloud economics are much worse than traditional enterprise software.

- CEO with one foot out the door? CEO stopped taking a salary so he wouldn't feel guilty about spending more time with family. I suspect he enjoys the game so much that he will never retire.

 

Even though this is my favorite company, I foolishly decided to average into it and it is only 4% of my portfolio. Now the price is high enough to give me pause.

[KCLarkin]

I think what Phaceliacapital meant is that you could read all the letters and listen to all the calls and still not be sure what Constellation actually does except run vertical market software (VMS) businesses. You'd get all the financial details about performance, but not much talk about products, managers at the operations level, customers, etc. You have to dig by yourself to figure out more about all that stuff.

 

Personally, I think this is noise. You could spend a lot of time trying to understand the competitive dynamics of the golf course management software but I don't think it would improve your investment decision.

[Liberty]

I think what Phaceliacapital meant is that you could read all the letters and listen to all the calls and still not be sure what Constellation actually does except run vertical market software (VMS) businesses. You'd get all the financial details about performance, but not much talk about products, managers at the operations level, customers, etc. You have to dig by yourself to figure out more about all that stuff.

 

Personally, I think this is noise. You could spend a lot of time trying to understand the competitive dynamics of the golf course management software but I don't think it would improve your investment decision.

 

I agree on that level. No need to understand every single unit. But it's certainly good to understand enough of what VMS businesses do and what the dynamics are in the overall industry. There's a balance between trying to understand everything and understanding nothing...

[Liberty]

CSU is particularly attractive relative to other PE-type companies (3G, VRX) since it can fund acquisitions almost entirely from cash flow.

 

Historically that has been the case, but they've started raising more long-term debt (in a pretty innovative way), and have shown more comfort with debt (see TSS acquisition).

[KCLarkin]

Historically that has been the case, but they've started raising more long-term debt (in a pretty innovative way), and have shown more comfort with debt (see TSS acquisition).

 

Yes, as they start looking at larger (lower ROI) deals they plan to use leverage to compete with private equity firms.

[KCLarkin]

I agree on that level. No need to understand every single unit. But it's certainly good to understand enough of what VMS businesses do and what the dynamics are in the overall industry. There's a balance between trying to understand everything and understanding nothing...

 

Sure you just need to be careful:

http://greenbackd.com/2010/03/10/simoleon-sense-interviews-james-montier/

 

Intuition suggests that having more information should increase the accuracy of predictions about uncertain outcomes. In reality, more information decreases the accuracy of predictions while simultaneously increasing the confidence that the prediction is correct.

 

Certainly I would have been better off buying a full position in CSU rather than scaling in as I gathered more information.

 

[Liberty]

I agree on that level. No need to understand every single unit. But it's certainly good to understand enough of what VMS businesses do and what the dynamics are in the overall industry. There's a balance between trying to understand everything and understanding nothing...

 

Sure you just need to be careful:

http://greenbackd.com/2010/03/10/simoleon-sense-interviews-james-montier/

 

Intuition suggests that having more information should increase the accuracy of predictions about uncertain outcomes. In reality, more information decreases the accuracy of predictions while simultaneously increasing the confidence that the prediction is correct.

 

Certainly I would have been better off buying a full position in CSU rather than scaling in as I gathered more information.

 

That's a good point. Another good point is: be careful about hindsight bias. It's easy to say "I would have been better off buying a full position in CSU rather than scaling in as I gathered more information" after things turn out well, but in many other cases, I bet taking time to get comfortable and learn more has saved you from terrible mistakes.

[oddballstocks]

I spent 10-15 minutes trying to figure out a way to a) contact sales, and b) buy their software.  Their treasury management software had a site where I could get a sales brochure, but that was it.  All the manufacturing ERP stuff had nothing.  Weird that there's no online presence.

 

I get that enterprise sales is done differently and online presence isn't as necessary.  But I wonder if they're missing an opportunity for someone to find them, verses outbound sales only.  If I were a manufacturing company looking for an ERP system I'd never find them, there's no way to do it.  Rather I'd need to sit around and wait for someone from Constellation to call and tell me about their products.

 

Are these guys just selling consulting services?  They build custom ERP solutions for clients?

 

I'm inherently skeptical of companies that try to hide what they really do.  In most cases the IP is either protected via copyright, or the IP is the people and culture.  It's hard to protect people, but it's usually done via great benefits and a nice environment.  Software IP is much easier, it's patentable etc.

 

I don't see what these guys are doing that's so incredible.  I mean it's hard to know what they do at all.  So either they have some secret sauce that's making clients insanely profitable via their software, yet they don't want to broadcast it to the world.  Or they have a bang up sales team that is able to sell the heck out of a standard solution, and the secrecy makes clients feel like they purchased something magical. 

 

I'd like to learn more about them, not so I could dissect their competitive advantage, I just want to know what they're doing!

[gary17]

Great Canadian software company focusing on a variety of vertical software markets. Been one of my faves for a few years, though I've never really talked about it here. A few people felt it deserves a thread, so let's make one!

 

Mark Leonard, the CEO, is in my opinion one of the best managers and capital allocators out there. His letters to shareholders (used to be quarterly, now yearly) and calls are worth checking out.

 

A lot of people will no doubt consider it expensive as it tends to hover in the 20-25x FCF lately, but it all depends how much you think quality is worth and what future growth/capital deployment for it is going to look like...

 

I can't agree more

 

they grew sales without issuing any shares and no debt over the last few years -  the only other companies I know that's done this is Berkshire Hathaway , and RX (Biosyent) and Xpel (Dap-U)

 

Gary

 

[oddballstocks]

I made it to about page 7 in Google...I get what they do.

 

They simply purchase small software companies with high margins and let them just run.  There is no synergy between their portfolio.  This is essentially a fund buying into software companies.  Not that there's anything wrong with it.

 

Glassdoor reviews weren't all that great.  Tried to dig into a few of their products, not much out there at all. 

 

Questions are:

1. Can they keep finding niche software companies to buy?

2. Is part of their strategy minimizing costs on the back-end?  Wonder if they buy a company, consolidate the accounting, HR etc and boost profits that way.

3. Was growth fueled by small companies and now they face the Buffett problem?  They need larger and larger deals to move the needle.

4. Wonder if there's any plan to consolidate down their product teams across their portfolio.  Seems like a win.

5. Do they ever spin-off any of these companies?  I'd love to see financial performance before an acquisition and after.  What do they do to enhance the company?

6. What's the lifetime of a holding?  Software changes quickly and either you're investing a lot in growth or you fall by the wayside.  Wonder how long these companies contribute?

 

Fascinating find either way.

[magno111]

I spent 10-15 minutes trying to figure out a way to a) contact sales, and b) buy their software.  Their treasury management software had a site where I could get a sales brochure, but that was it.  All the manufacturing ERP stuff had nothing.  Weird that there's no online presence.

 

I get that enterprise sales is done differently and online presence isn't as necessary.  But I wonder if they're missing an opportunity for someone to find them, verses outbound sales only.  If I were a manufacturing company looking for an ERP system I'd never find them, there's no way to do it.  Rather I'd need to sit around and wait for someone from Constellation to call and tell me about their products.

 

Are these guys just selling consulting services?  They build custom ERP solutions for clients?

 

I'm inherently skeptical of companies that try to hide what they really do.  In most cases the IP is either protected via copyright, or the IP is the people and culture.  It's hard to protect people, but it's usually done via great benefits and a nice environment.  Software IP is much easier, it's patentable etc.

 

I don't see what these guys are doing that's so incredible.  I mean it's hard to know what they do at all.  So either they have some secret sauce that's making clients insanely profitable via their software, yet they don't want to broadcast it to the world.  Or they have a bang up sales team that is able to sell the heck out of a standard solution, and the secrecy makes clients feel like they purchased something magical. 

 

I'd like to learn more about them, not so I could dissect their competitive advantage, I just want to know what they're doing!

 

The CEO tries to operate like berkshire. If you visit Berkshire website you can't learn a lot about the dozens of companies they own, it is created just for shareholders. 

 

CSU is the same, it is holding company with 125+ plus business, if you look for individual companies you can learn a lot. For example they bought TSS last year  http://www.totalspecificsolutions.nl/

 

They bought this security software in Q1  http://www.interact911.com/

 

They bought this one few weeks ago  https://www.optum.com/providers/clinical-performance/critical-care.html ( formely called picis )

 

 

 

 

 

[berkshire101]

Did CSU really just acquired Optum?  My department is really dependent on Optum.  Optum basically manages our data and provides services for us to extract it.  Employees just go to Optum staff and say I want this done and Optum will kindly perform the request.  Really good customer service as no one really knows how to use the database with Optum's help.  So I can see the moat that Optum has. 

[no_free_lunch]

The CEO is great and I owned this one in 2014 but got out way too early it appears. 

 

Based on the last numbers I crunched aren't they around 32x owner earnings?  Not crazy expensive, but when I bought them, the multiple was about 17.

[Liberty]

I spent 10-15 minutes trying to figure out a way to a) contact sales, and b) buy their software.  Their treasury management software had a site where I could get a sales brochure, but that was it.  All the manufacturing ERP stuff had nothing.  Weird that there's no online presence.

 

I get that enterprise sales is done differently and online presence isn't as necessary.  But I wonder if they're missing an opportunity for someone to find them, verses outbound sales only.  If I were a manufacturing company looking for an ERP system I'd never find them, there's no way to do it.  Rather I'd need to sit around and wait for someone from Constellation to call and tell me about their products.

 

Are these guys just selling consulting services?  They build custom ERP solutions for clients?

 

I'm inherently skeptical of companies that try to hide what they really do.  In most cases the IP is either protected via copyright, or the IP is the people and culture.  It's hard to protect people, but it's usually done via great benefits and a nice environment.  Software IP is much easier, it's patentable etc.

 

I don't see what these guys are doing that's so incredible.  I mean it's hard to know what they do at all.  So either they have some secret sauce that's making clients insanely profitable via their software, yet they don't want to broadcast it to the world.  Or they have a bang up sales team that is able to sell the heck out of a standard solution, and the secrecy makes clients feel like they purchased something magical. 

 

I'd like to learn more about them, not so I could dissect their competitive advantage, I just want to know what they're doing!

 

The CEO tries to operate like berkshire. If you visit Berkshire website you can't learn a lot about the dozens of companies they own, it is created just for shareholders. 

 

CSU is the same, it is holding company with 125+ plus business, if you look for individual companies you can learn a lot. For example they bought TSS last year  http://www.totalspecificsolutions.nl/

 

They bought this security software in Q1  http://www.interact911.com/

 

They bought this one few weeks ago  https://www.optum.com/providers/clinical-performance/critical-care.html ( formely called picis )

 

Exactly. Nate, what you did was like going to Berkshire's website to look up Dairy Queens specials.

 

If you go here: http://www.csisoftware.com/our-companies/

 

You can see some of the operating groups, and by following with them you can learn more about the businesses within each group. But most are selling pretty niche stuff, and probably tend to go to their potential customers rather than hope for customers to come to them, so they might not have big marketing presences.

 

I suggest you read the letters from the CEO chronologically and listen to the calls. Good way to learn more about what they're doing and how he thinks.

[KCLarkin]

I made it to about page 7 in Google...I get what they do.

 

They simply purchase small software companies with high margins and let them just run.  There is no synergy between their portfolio.  This is essentially a fund buying into software companies.  Not that there's anything wrong with it.

 

Glassdoor reviews weren't all that great.  Tried to dig into a few of their products, not much out there at all. 

 

Questions are:

1. Can they keep finding niche software companies to buy?

2. Is part of their strategy minimizing costs on the back-end?  Wonder if they buy a company, consolidate the accounting, HR etc and boost profits that way.

3. Was growth fueled by small companies and now they face the Buffett problem?  They need larger and larger deals to move the needle.

4. Wonder if there's any plan to consolidate down their product teams across their portfolio.  Seems like a win.

5. Do they ever spin-off any of these companies?  I'd love to see financial performance before an acquisition and after.  What do they do to enhance the company?

6. What's the lifetime of a holding?  Software changes quickly and either you're investing a lot in growth or you fall by the wayside.  Wonder how long these companies contribute?

 

Fascinating find either way.

 

From the 2009 letter:

 

We have been a serial acquirer of inherently attractive small vertical market software

businesses in a large number of different verticals. We try to be competent long-term

oriented owners of these businesses. Our maintenance attrition and organic maintenance

growth numbers, coupled with our profitability suggest that we have been successful. In the

vast majority of cases, the longer we have owned a small software business, the larger and

better it has become. If we persist in this strategy (let’s call it the “many verticals” strategy),

we will continue to add new verticals and to make many more small acquisitions each year.

We’ve handled our geometric growth to date by largely abdicating management to the

general managers of each of our vertical businesses. We have a very thin overlay of

infrastructure at CSI. We count on the fact that with each new acquisition will come general

managers who are steeped in their verticals… veterans who have built industry leading

(albeit small) vertical market software businesses with great economics. Having owned more

than a hundred vertical market software businesses, we also have some best practices that we

can share. We coach the managers of our newly acquired businesses in how to grow their

businesses and make them even better. As long as we compensate these managers

appropriately, and are not tempted to meddle too much, then I think we can scale up

Constellation for many years to come.

[cubsfan]

Did CSU really just acquired Optum?  My department is really dependent on Optum.  Optum basically manages our data and provides services for us to extract it.  Employees just go to Optum staff and say I want this done and Optum will kindly perform the request.  Really good customer service as no one really knows how to use the database with Optum's help.  So I can see the moat that Optum has.

 

There is OptumHealth & OptumInsight from United Healthcare - their technology sub.

OptumHealth provides data analytics to help providers control costs.

 

Did they buy all of Optum from UNH? That would be a big acquisition!

 

[netnet]

 

From the 2009 letter:

As long as we compensate these managers

appropriately, and are not tempted to meddle too much, then I think we can scale up

Constellation for many years to come.

 

Okay that was 6 years ago, how many more years can they do this?

 

With Leonard reducing his involvement as well. (As I noted on the Great Managers thread, I sure wish I had known about this 10 years ago!!).  Leonard seems quite extraordinary.  Buffett like low compensation and attentive capital allocation with a good business model, in a field, software with often poor capital allocation.

 

Why is the model so good. Well virtually everyone in s/w thinks that growth is the key, in these verticals heavy R&D and large salesforce is wrong.

 

The problem with this company now is it is 11 billion and really expensive.  Can it grow or will he dividend out?  He seems rational enough to dividend out, but the price is so high.  I have a hard time seeing this as a 50 billion dollar company in say 10 years.