CSU - Constellation Software

[Liberty]

Bid for Bond International in the UK:

 

http://www.lse.co.uk/regulatory-news-article.asp?ArticleCode=hgg3zr0i&ArticleHeadline=Posting_of_Offer_Document

 

And here's a revised bid:

 

http://www.marketwired.com/press-release/constellation-software-inc-constellation-company-revised-cash-offer-bond-international-tsx-csu-2160974.htm

 

Constellation has made a revised cash offer (the "Revised Offer") today, through a wholly owned subsidiary, for all the issued share capital of Bond that the CSI Group does not currently own, at a price of £1.15.5 per ordinary share. The Revised Offer values the existing ordinary share capital of Bond at approximately £48.7 million.

[Liberty]

Q3: http://www.csisoftware.com/wp-content/uploads/2016/10/PR_Q3_2016.pdf

 

Q3 2016 Headlines:

 Revenue grew 19% (4% organic growth, 5% after adjusting for changes in foreign exchange rates) to $546 million compared to $460 million in Q3 2015.

 Adjusted EBITA increased $20 million or 17% to $140 million as compared to $120 million in Q3 2015.

 Adjusted Net Income increased 22% to $121 million ($5.70 on a diluted per share basis) from $99 million

($4.67 on a diluted per share basis) in Q3 2015.

 Net income increased 48% to $68 million ($3.18 on a diluted per share basis) from $46 million ($2.16 on

a diluted per share basis) in Q3 2015.

 Fifteen acquisitions were completed for aggregate cash consideration of $42 million (which includes

acquired cash). Deferred payments associated with these acquisitions have an estimated value of $8

million.

 Cash flows from operations were $138 million, an increase of 31%, or $33 million, compared to $105

million for the comparable period in 2015.

 

Nice to see maintenance and recurring revenues grow faster than overall in both public and private. This means they're growing faster on the more sticky and high-margin side, which creates more value.

[gary17]

agreed - very nice quarter

[Alex.N.B]

Short write-up on CSU by Grant's .. looks like it came out today

Grants_Vol._34_No._23_Dec_9_2016.pdf

[thefatbaboon]

Short write-up on CSU by Grant's .. looks like it came out today

 

Some of this seems misleading. 

 

For example, where the author is writing of the declining quality of acquisitions he find a Leonard quote that is made about new entrants into the 30,000 company funnel and makes it seem Leonard is talking about new acquisitions. Perhaps Leonard does think that the new acquisitions are worse - but it isn't what he is saying in this quote.

 

Then there is talk about the booking of an acquisitions initial price increase into organic growth.  In the annual report CSI then break this organic growth into a) new maintenance, b) price increases, c) lost customers d) lost modules. So where does the analyst and Grants think it should go? I haven't a problem with this.

 

The math they do on the inconsistency between the reported organic growth rate in the 3Q and the $ added to prior year from acquisitions seems right. Although they have picked examples that have the manual adjustment giving lower organic rates.  If you do the same for some of the 9m numbers they have reported a lower % from 9m Private Sector as compare to the % implied by making the $ adjust to prior year rev oneself.  Constellation should explain what it is that causes the inconsistencies. 

[Alex.N.B]

Related to the Grant write-up, just some thoughts:

 

I think some of their points are valid but I think you could argue the same thing about disclosure at Berkshire sometimes.. don't think that is necessarily a good point. The fact that Mark Leonard writes a very detailed investor letter every year is greater disclosure than most companies I would argue. I think the Grant write-up is a little biased - I am not sure that CSU "maintains that it jacks up the prices on the acquired software" .. they probably do it over time because the business model allows them to do so + any other software company with a recurring revenue business model would do the same.

 

They do have a lot of businesses and it's hard to know about all of them. I think looking at maintenance revenue growth over time is a good indication of how well the overall business is doing, if that is increasing and value is being created in the business I also think Adj. EPS is the right metric - so ~20x earnings for a business that can probably double in the next 4 to 5 years. They've been scaling up their acquisitions over time and they have some long-term shareholders who will probably help the company take on some long term debt as well to make larger acquisitions. This is a company with a track record, built from the ground up by Mark Leonard and executives are shareholders of the company along with him. I generally don't like platform companies but I think CSU has clearly developed a successful process for making acquisitions.

 

I do think there are some risks, obviously the market might have gotten a little ahead of itself given the strong recent performance so maybe something happens and there is a good opportunity to buy.. but I don't think it's a good short.

[thepupil]

I think some of their points are valid but I think you could argue the same thing about disclosure at Berkshire sometimes..

 

Berkshire Balance Sheet = $604B of assets,

$80B of cash

$24B of mostly soveriegn fixed income,

$100B of equities

$15B in other which includes warrants/prefs/ stuff linked to public companies

$169B in Utilities and Railroads which are seperate filing companies with 10-k's and 10-q's

 

$400B / $600b of the asset side is pretty transparent, of the remaining $200, $53B is goodwill (nothing to verify) and there PCP is in there (which was recently a public company)

 

Of the $331B of liabilities

$73B related to railroads and utilites which are separate public companies

$73B is deferred income tax related to unrealized gains and accelerated depreciation / capex > depreciation

$105B is the insurance business <---where there would be shenanigans as this is obviously the most subjective.

 

I would say that the bulk of Berkshire is very transparent and not at all comparable to how this company is portrayed. I'm not saying that something bad can't happen at Berkshire because it can, but in terms of the material drivers of value, there is a pretty good amount of info out there and public assets.

 

I have no opinion of constellation and have never really looked at it, but just saying that I think the Berkshire comparison is off from a purely "how much of the balance sheet / revenue / net income is somewhat verifiable" perspective.

 

 

 

[Guest Schwab711]

I know very little about CSU but going off Grant's: if 2/3 of revenue is from US/CAD government (public) entities then are tax payers paying the price hikes/providing the outstanding returns?

[DooDiligence]

Speaking anecdotally regarding forced software upgrades.

 

I recently upgraded to Mac OS Sierra only to discover that QuickBooks didn't support it.

 

Here I was, locked out of nearly 20 years of data @&$?!

 

They did this to us before except it wasn't a total lockout; you had to upgrade in order to import data to TurboTax (I promptly stopped using TurboTax in favor of HR Blocks Tax Cut.)

 

It wouldn't be so bad if the upgrade actually provided value but it doesn't.

 

As the Grants article claimed similar issues, I tend to believe them (although by their own admission, a lot of their short calls get c0k blocked...)

[vinod1]

I see two problems with the way the company is reporting adjusted earnings

 

a) Assuming 100% of amortization expenses are non-economic.

 

To take an example, if the company has say 250 different vertical market software products, it is tough to accept that nearly all of them would remain viable, even with R&D, 25 years from now. I would assume some of them would be supplanted by other firms and new technologies may obviate the need for the software.

 

The company logic seems to be that, fine even if 50 of these products are supplanted, if the remaining 200 products have revenue growth that can exceed the combined revenue of the 250 products, then in aggregate there is no need for amortization.

 

This is a very reasonable view and I cannot disagree all that much, but for conservatism sake I would incorporate a small portion of the amortization expense as economic.

 

2. No tax adjustment for amortization expenses.

 

I find it surprising that the adjusted net income figure does not deduct for taxes for the amortization expenses. I have always adjusted for non-economic amortization charges by deducting for taxes and adding it back to get normalized earnings.

 

Constellation is adding back the full amortization expense to get adjusted net income. The logic seems to be that the company gets tax deduction anyway and cash flow would equal amortization expense so "cash earnings" would equal net income + amortization expenses. There are other minor adjustments but let us leave them out for now.

 

It seems rather aggressive to me to assume a temporary tax break to be a perpetual tax break. The company is amortizing its intangibles for about 9 years in aggregate. So instead of valuing the 9 year tax break the company assumes that the tax break would be forever.

 

I might be missing or misunderstanding something and would love to hear others thoughts on this.

 

My current view is to treat all amortization expense as non-economic but adjust for taxes on amortization expense. This way I am not even giving the company the benefit of 9 years of tax breaks but that should roughly make up for treating the entire amortization expense as non-economic.

 

Vinod

[Liberty]

Japanese JV announced:

 

http://www.csisoftware.com/2016/12/constellation-software-announces-agreement-with-hikari-tsushin/

 

announced today that it has entered into an agreement with Hikari Tsushin, Inc. for the incorporation, management and operation of a joint venture company.  The joint venture company, to be named Constellation Software Japan, will seek to invest in, acquire and manage vertical market software companies with a primary place of business in Japan.

[snowball82]

Japanese JV announced:

 

http://www.csisoftware.com/2016/12/constellation-software-announces-agreement-with-hikari-tsushin/

 

announced today that it has entered into an agreement with Hikari Tsushin, Inc. for the incorporation, management and operation of a joint venture company.  The joint venture company, to be named Constellation Software Japan, will seek to invest in, acquire and manage vertical market software companies with a primary place of business in Japan.

 

Thanks for the post Liberty, it will be interesting to see if they will have opportunities to invest significant capital there. HIKARI TSUSHIN seems to be positionned in many segments :

 

https://eng.hikari.co.jp/wp-content/uploads/Side-presentation160815-3.pdf

 

[Shooter MacGavin]

I see two problems with the way the company is reporting adjusted earnings

 

a) Assuming 100% of amortization expenses are non-economic.

 

To take an example, if the company has say 250 different vertical market software products, it is tough to accept that nearly all of them would remain viable, even with R&D, 25 years from now. I would assume some of them would be supplanted by other firms and new technologies may obviate the need for the software.

 

The company logic seems to be that, fine even if 50 of these products are supplanted, if the remaining 200 products have revenue growth that can exceed the combined revenue of the 250 products, then in aggregate there is no need for amortization.

 

This is a very reasonable view and I cannot disagree all that much, but for conservatism sake I would incorporate a small portion of the amortization expense as economic.

 

2. No tax adjustment for amortization expenses.

 

I find it surprising that the adjusted net income figure does not deduct for taxes for the amortization expenses. I have always adjusted for non-economic amortization charges by deducting for taxes and adding it back to get normalized earnings.

 

Constellation is adding back the full amortization expense to get adjusted net income. The logic seems to be that the company gets tax deduction anyway and cash flow would equal amortization expense so "cash earnings" would equal net income + amortization expenses. There are other minor adjustments but let us leave them out for now.

 

It seems rather aggressive to me to assume a temporary tax break to be a perpetual tax break. The company is amortizing its intangibles for about 9 years in aggregate. So instead of valuing the 9 year tax break the company assumes that the tax break would be forever.

 

I might be missing or misunderstanding something and would love to hear others thoughts on this.

 

My current view is to treat all amortization expense as non-economic but adjust for taxes on amortization expense. This way I am not even giving the company the benefit of 9 years of tax breaks but that should roughly make up for treating the entire amortization expense as non-economic.

 

Vinod

 

Vinod,

 

On your first point, I'm not terribly worried about this.  I think it's valid, though its probably not too meaningful to amortize a small portion of their software.  Mark himself tells shareholders to not give them an add back on amortization if you start to see the  maintenance revenue metrics go south. However, the majority of the amortization is from acquired intangibles, not internally developed software.  Internally developed R&D is mostly expensed in the current period unlike at most other software companies.  Since these guys are very acquisitive, I think it's unclear if what is reflected on the balance sheet for intangibles is remotely close to economic reality. Consequently, I'm not sure that stated amortization can accurately reflect economic reality (even if there is some economic amortization).  Mark says to judge this, look and see if maintenance revenue is going down.  Of course, it's still not a perfect solution because they have been buying declining businesses for very low prices.  At the end of the day its about IRR.

 

On the second, I think this a valid question.  I wonder, though I don't know, if you are allowed to take a tax deduction on the amortization of acquired intangibles.  I believe you are for US tax purposes. However, I think this would be a good question for them.  In other words, maybe they're not deducting the majority of it for tax purposes to begin with.  I don't know. 

[Liberty]

CSU acquisition in the communication towers management business:

 

http://www.marketwired.com/press-release/volaris-group-expands-position-communications-vertical-with-acquisition-tarantula-global-2186008.htm

 

Tarantula's Tower Management Solutions are sold to mobile "towercos and telcos" that operate their own tower networks. Towers are vertical structures built on a parcel of land designed to accommodate multiple tenants using different technologies including telephony, mobile data, broadcast, television and radio to a geographical area surrounding the tower. Tarantula's solution enables tower portfolio operators to rollout new towers, mange colocation contracts, manage location details, manage site access and leases, acquire new towers, manage site inventory, bill for colocation tenants, manage field workforce, and manage operations and maintenance activities. In essence, and end-to-end ERP system for tower portfolio operators.

 

http://www.tarantula.net

[maybe4less]

CSU acquisition in the communication towers management business:

 

http://www.marketwired.com/press-release/volaris-group-expands-position-communications-vertical-with-acquisition-tarantula-global-2186008.htm

 

Tarantula's Tower Management Solutions are sold to mobile "towercos and telcos" that operate their own tower networks. Towers are vertical structures built on a parcel of land designed to accommodate multiple tenants using different technologies including telephony, mobile data, broadcast, television and radio to a geographical area surrounding the tower. Tarantula's solution enables tower portfolio operators to rollout new towers, mange colocation contracts, manage location details, manage site access and leases, acquire new towers, manage site inventory, bill for colocation tenants, manage field workforce, and manage operations and maintenance activities. In essence, and end-to-end ERP system for tower portfolio operators.

 

http://www.tarantula.net

 

I like the fact this company is headquartered in Singapore. Hopefully more quality Asian acquisitions for them in the near future.

[Liberty]

Bit of a slower quarter for CSU:

 

http://www.csisoftware.com/wp-content/uploads/2017/02/SR_Q4_2016.pdf

 

But still a bit over 23% FCF growth for the year.

 

The FX for the debentures is still making things a bit fuzzier ($25m swing from revaluation of the Company's unsecured subordinated floating rate debentures (CAD) between 2015 and 2016.)

 

Also, new acquisition announced by Volaris this morning. Press release threshold is $10m:

 

http://www.csisoftware.com/2017/02/volaris-group-a-constellation-software-company-enters-into-agreement-to-acquire-provider-of-digital-financial-services-to-mobile-operators/

[Liberty]

I'm seriously considering going to the CSU AGM this year (April 28, to be officially confirmed later in march, but that's what I was told by the CFO). Anyone else here going?

[Astrea]

I am considering going - has anyone been before and know the format? Is it a full day event type of thing? Thanks

[Liberty]

I am considering going - has anyone been before and know the format? Is it a full day event type of thing? Thanks

 

From what I've been told, it's about 2 hours, from maybe 10:30 AM.

[snowball82]

I'm also interested to go. I liked the experience last year ... that said if you go for new content you could be a bit disapointed. Funny thing, the CEO said last year not to buy the stock at current price but do a big buy if there is a significant dip :) Fortunately we didn't listened him and we added to our position last year ...

[smartone]

any update on date/time?  Thanks. Can't seem to find anything about it on the website.

[Liberty]

any update on date/time?  Thanks. Can't seem to find anything about it on the website.

 

It's in the proxy, first paragraph:

 

Notice is hereby given that the annual meeting (the “Meeting”) of the holders of common shares (“Common Shares”) of Constellation Software Inc. (“CSI” or the “Corporation”) will be held at the offices of McCarthy Tétrault LLP, Suite 5300, TD Bank Tower, 66 Wellington Street West, Toronto, Ontario on April 28, 2017 at 10:30 a.m. (Eastern Standard Time)

[Astrea]

I've booked my ticket to Toronto so I'll be there.

[Liberty]

I've booked my ticket to Toronto so I'll be there.

 

Cool. I'll be having some drinks with a few people from this forum and Twitter on the day before (Thursday, april 27) at the 'C'est What' pub downtown, not far from where the AGM is taking place. Feel free to join us. Not sure yet exactly at what time, but probably not too late in the evening.

 

I'll try to post on my Twitter and maybe here when I know more. I need to go eat first and drop my stuff at my AirBNB when I get off the train.

[Astrea]

Great, thanks. I'll keep an eye out for the time.