CSU - Constellation Software

[gary17]

Thanks -- I did reach out to management and got similar response -- the question was to get me convinced that using adjusted net income make sense for the software business.  The next step of course is valuation... Is there a long enough horizon & targets & continued success of the team to justify the expensive multiple... That's where an investor needs to have a bit of leap of faith to believe that past performance is likely an indicator of the future... 

[Liberty]

Last I checked the FCF multiple was something like 24x. For a lot of the past couple of years it was around 20x. Doesn't seem high to me for this business.

 

A lot of VMS businesses trade for lower multiples than CSU because they don't have reinvestment opportunities. Once entrenched in their niches, they're cash cows growing at 1-2x GDP.

 

CSU does have reinvestment opportunities. It has developed a repeatable process of deploying capital at high ROICs. I think this partly justifies the higher multiple (along with management's discipline, the internal diversification vs being in just one vertical, etc).

 

Most of the value is created by maintenance revenue. It's high margin and recurring. That's why management focuses on it, sometimes even sacrificing other things that don't provide good returns or that can be used to get those recurring revenues (f.ex. they'll sometimes drop hardware sales or consulting segments when they acquire new things, or lower licenses--you can see the impact of this in the margins going up over time--this can make the aggregate organic growth seem worse, just like when they buy shrinking businesses for bargain prices). That's why I find it useful to look at both overall organic growth and maintenance revenue organic growth (they break it down). Over longer periods, the maintenance organic growth has been pretty good (esp. ex-FX, there's been headwinds in recent years) and as long as it's the case I'm not worried about the amortization.

[KJP]

Thanks -- I did reach out to management and got similar response -- the question was to get me convinced that using adjusted net income make sense for the software business.  The next step of course is valuation.

 

It's hard to separate them, because any net income figure (adjusted or not) is usually just an input into a valuation method.  For example, let's say the valuation method is (value of existing business) + (value of potential acquisitions). 

 

To value the existing business, you choose to capitalize an earnings number.  You think that the current business of a company like CSU that's making appropriate investments in sales and marketing and software development would be worth 25x earnings, in light of the likely organic growth that it can get from very low churn, annual price increases, and unit volume growth through new customers and additional "modules" sold to existing customers.  So, whether "adjusted net income" -- i.e., adding back all amortization -- is the right number to capitalize at 25x depends on whether the company is currently expensing sufficient amounts for sales and marketing and software development to create the type of low churn and revenue growth that would warrant the 25x multiple.   

 

On the other hand, let's assume that you intend to value the current business as a very low-growth business that warrants only a 15x multiple.  What earnings number should you capitalize under that method?  If you're using adjusted net income, then you're assuming that the amounts the company is currently expensing for sales and marketing and software development are enough to essentially to keep the company's existing business in something close to steady state. 

 

In short, I think whether "using adjusted net income make sense for the software business" depends on how your going to use it in your valuation.

[KJP]

Last I checked the FCF multiple was something like 24x. For a lot of the past couple of years it was around 20x. Doesn't seem high to me for this business.

 

A lot of VMS businesses trade for lower multiples than CSU because they don't have reinvestment opportunities. Once entrenched in their niches, they're cash cows growing at 1-2x GDP.

 

CSU does have reinvestment opportunities. It has developed a repeatable process of deploying capital at high ROICs. I think this partly justifies the higher multiple (along with management's discipline, the internal diversification vs being in just one vertical, etc).

 

Most of the value is created by maintenance revenue. It's high margin and recurring. That's why management focuses on it, sometimes even sacrificing other things that don't provide good returns or that can be used to get those recurring revenues (f.ex. they'll sometimes drop hardware sales or consulting segments when they acquire new things, or lower licenses--you can see the impact of this in the margins going up over time--this can make the aggregate organic growth seem worse, just like when they buy shrinking businesses for bargain prices). That's why I find it useful to look at both overall organic growth and maintenance revenue organic growth (they break it down). Over longer periods, the maintenance organic growth has been pretty good (esp. ex-FX, there's been headwinds in recent years) and as long as it's the case I'm not worried about the amortization.

 

Given the huge number of verticals the company is involved in, I doubt it would be practical for anyone, even a full-time analyst, to do a vertical-by-vertical assessment of likely organic growth, churn, etc. of each business line.  Instead, you have to revert to high-level, top-down assessments.  As a practical matter, those assessments likely boil down to a belief in the capital allocation skills and process of management.

[Liberty]

Given the huge number of verticals the company is involved in, I doubt it would be practical for anyone, even a full-time analyst, to do a vertical-by-vertical assessment of likely organic growth, churn, etc. of each business line.  Instead, you have to revert to high-level, top-down assessments.  As a practical matter, those assessments likely boil down to a belief in the capital allocation skills and process of management.

 

Exactly. I'm just saying it's worth tracking both the aggregate organic growth number and the maintenance organic growth number because it sharpens your understanding of how much value is being created. If organic growth was down but maintenance was flat, I'd be less worried than if it was the other way around.

 

But you can't track every business unit at CSU anymore than you can track how the stores in ever city are doing if you're an investor in Starbucks or Home Depot.

 

I track the acquisitions just to get an idea of the pace of deployment and out of curiosity, because it's interesting to see which verticals they're seeing more opportunities in.

[Liberty]

TSS made an acquisition:

 

https://globenewswire.com/news-release/2018/01/03/1281545/0/en/Constellation-Software-s-Total-Specific-Solutions-Acquires-FDC-A-S.html

[Liberty]

RBC:

 

Q4 brings Constellation’s capital deployed on acquisitions to $309MM FY17, +76% Y/Y from $175MM FY16. The increase reflects a higher frequency of acquisitions, as opposed to larger acquisitions. Constellation closed a record 55 acquisitions FY17 ...

 

CSU has a unique M&A model, pursuing an increase in the frequency as opposed to larger acquisitions. This strategy maximizes returns (small targets are available at lower multiples) and maintains the company’s VMS focus, where the market structure is more attractive.

 

...

 

Since FY05, Constellation has deployed $1.86B capital on 325 acquisitions. While the average  size is just $5.7MM per acquisition, the 21 acquisitions that exceed $20MM capital each represent 51% of total capital deployed.

 

 

 

Someday we’ll wake up to CSU having acquired a larger-than-usual corp (similar to TSS in 2013, maybe significantly bigger) and a bunch of analysts will have to scramble to redo their models… if CSU  does it without dropping their discipline & hurdle, a lot of value will be created.

[Liberty]

Acquisition in Croatia for Vela:

 

http://www.cbj.ca/constellation-softwares-vela-operating-group-completes-acquisition-of-croatian-software-and-services-provider-in2-group/

[Liberty]

Another one in dialysis software industry at QMS:

 

http://m.digitaljournal.com/pr/3616869

[Liberty]

https://globenewswire.com/news-release/2018/01/15/1289324/0/en/Volaris-Group-Expands-Position-in-Communications-Vertical-with-Acquisition-of-Sicap.html

 

Volaris today announced that it has completed its seventh acquisition in the Communications vertical with the acquisition of SICAP Schweiz AG (“Sicap”), a global mobile device management provider to Mobile Network Operators and Mobile Virtual Network Operators, Enablers and Aggregators. [...]

 

Sicap’s solutions are deployed in 76 countries with over 120 customer implementations across South East Asia, Eastern Europe and Middle East & Africa. Sicap’s tier-one mobile operating group customers include Vodafone, VEON, MTN, Zain, and Orange.

[Liberty]

Big deal for $250m:

 

https://globenewswire.com/news-release/2018/01/16/1289744/0/en/Constellation-Software-s-Harris-Operating-Group-Acquires-Acceo-Solutions.html

 

The purchase price is CDN $250 million, before possible post-closing adjustments.  Acceo’s estimated and unaudited trailing twelve month gross revenue for the period ended November 30, 2017 was CDN $116M.  Subsequent to completion of the transaction, Constellation expects to finance the Acceo acquisition on a stand-alone basis.  This is a continuation of Constellation’s use of leveraged capital structures to compete more effectively for larger vertical market software businesses.

 

To give you an idea, in all of 2016 they deployed $175m.

[chrispy]

You called it ~2 weeks ago!

[Jerry Capital]

Interesting that they are willing to pay higher interest rates to finance through the subsidiary rather than at the company level.

 

I mean unless they have a few more large acquisitions planned I am not sure why they would do this.

[FiveSigma]

I think that one good reason is compartmentalization, like bulkheads in a ship - if one sub gets in trouble financially, it will be limited to that sub.

[bonkers]

 

The purchase price is CDN $250 million, before possible post-closing adjustments.  Acceo’s estimated and unaudited trailing twelve month gross revenue for the period ended November 30, 2017 was CDN $116M.  Subsequent to completion of the transaction, Constellation expects to finance the Acceo acquisition on a stand-alone basis.  This is a continuation of Constellation’s use of leveraged capital structures to compete more effectively for larger vertical market software businesses.

 

To give you an idea, in all of 2016 they deployed $175m.

 

If I may, just a minor correction: In 2016 they deployed around 175 MUSD, this deal is announced in CAD, so only 250 x 0,80 = 200 MUSD. Post-closing adjustments might add something.

 

No matter, it's good anyway: It's only January and half the year's work is already done.  ;)

[Liberty]

Interesting that they are willing to pay higher interest rates to finance through the subsidiary rather than at the company level.

 

I mean unless they have a few more large acquisitions planned I am not sure why they would do this.

 

I think this is different than Malone's bulkhead concept. My understanding (based on I don't remember where this was mentioned, maybe a call, maybe a letter, maybe the AGM) is that they're keeping the option to use a bit of leverage to be competitive on the bigger deals.

 

The reason is that most buyers of larger VMS are private equity, and they'll put 5-8 turns of leverage on anything that moves, so they can pay much higher prices than if CSU tries to buy without debt. So to be able to meet their hurdle, they're probably putting a few turns of leverage on it--I don't doubt they're a lot more conservative than PE, so I wouldn't be surprised if it was just a few turns.

[Liberty]

A few more details here:

 

https://privatecapitaljournal.com/constellation-software-acquires-pe-backed-acceo-solutions-250m/

 

Constellation Software Inc. (TSX: CSU) has, through its wholly-owned subsidiary N. Harris Computer Corporation, acquired Acceo Solutions Inc. from Fonds de solidarité FTQ, Investissement Québec (IQ), Capital régional et coopératif Desjardins (CRCD) for $250 million.

 

Montreal based Acceo provides management, accounting and payment solutions, consulting and support for e-business to small and medium businesses, hardware and building centers, retail, public sector, daycare centers and tour operators.

 

In March 2012, Fonds de solidarité, IQ and CRCD, along with the management re-acquired ACCEO, then known as GFI Solutions, buying out the 62.4% stake held by France’s GFI Informatique SA for $75 million. Fonds de solidarité FTQ and GFI management members already held stakes of 31.1% and 6.7% respectively. Following the transaction, ACCEO was owned by Fonds de solidarité (38.4%), IQ (27.6%), CRCD (19.7%) and ACCEO management members (14.3%).

[Liberty]

Another one:

 

www.csisoftware.com/2018/01/constellation-softwares-vela-operating-group-enters-into-an-agreement-to-acquire-a-software-provider-in-engineering-and-construction-industry/

 

Vela Operating Group has entered into an agreement to acquire a software provider of document management solutions in the engineering and construction industry.  Completion of the acquisition remains subject to mutually agreed closing conditions.

[Liberty]

For owners of the debentures:

 

http://www.csisoftware.com/2018/01/constellation-software-inc-announces-annual-interest-rate-for-series-1-debentures-4/

[Liberty]

First deal in Norway:

 

Constellation Software’s Vela Software acquires the ProArc Technical Document Management unit from Tieto Oyj

 

https://globenewswire.com/news-release/2018/01/31/1329267/0/en/Constellation-Software-s-Vela-Software-acquires-the-ProArc-Technical-Document-Management-unit-from-Tieto-Oyj.html

[Liberty]

They're really on a roll at this point:

 

“Perseus has purchased Real Estate Digital LLC from Xome Holdings, excluding its reDataVault product which will be retained by Xome”

 

https://globenewswire.com/news-release/2018/02/01/1330292/0/en/Constellation-Software-s-Perseus-Operating-Group-Completes-Acquisition-of-Real-Estate-Digital.html

[Liberty]

For those who, like me, are curious about the AGM this year, it's going to be on April 26th at 10 a.m.

 

I was told: “It will start around 10am.  we’ll have our six Operating Group managers available.  Following general Q&A .. will organize six … break-out meetings, each hosted by one of the Operating Group managers.  The content & format will be left to the discretion of the managers”

 

I'll try to attend, but it might depend how things out of my control. If I can go, I'll do a little drinks get together the evening before like last year.

[KCLarkin]

If I can go, I'll do a little drinks get together the evening before like last year.

 

I hope you can make it Liberty! Last year was great fun. Having a group of people who all like the same stock is a very powerful filter for finding like-minded investors.

 

Unfortunately, the CSU AGM is at the same time as the FFH meeting. And the evening before will compete directly with the Premier Fairfax Financial Shareholder’s Dinner. Still, I'd like to do the CSU get-together even if Liberty can't make it.

 

I know this would be even trickier for you but if you can make it for the CSU AGM, you might consider coming two nights earlier. The Ben Graham Dinner on April 24th is a great event too.

[Astrea]

I plan to attend the CSU AGM again this year and will be flying in on 25 April from Boston where I am attending the Tyler Technologies annual conference. Would be good to see you all again.

[Liberty]

If I can go, I'll do a little drinks get together the evening before like last year.

 

I hope you can make it Liberty! Last year was great fun. Having a group of people who all like the same stock is a very powerful filter for finding like-minded investors.

 

Unfortunately, the CSU AGM is at the same time as the FFH meeting. And the evening before will compete directly with the Premier Fairfax Financial Shareholder’s Dinner. Still, I'd like to do the CSU get-together even if Liberty can't make it.

 

I know this would be even trickier for you but if you can make it for the CSU AGM, you might consider coming two nights earlier. The Ben Graham Dinner on April 24th is a great event too.

 

The reason why I'm not sure if I'm coming is because my wife is expecting our second boy in March. If I can get away at all, I'll stay just one night.

 

It's too bad about the two events being at the same time... If I arrive early enough in town, I might drop by NoRm's pre-dinner meeting at the Fairmount. Then later in the evening I'll probably go have a drink, probably again at the C'Est What, and anyone from here or FinTwit who wants to join is very welcome.

 

I plan to attend the CSU AGM again this year and will be flying in on 25 April from Boston where I am attending the Tyler Technologies annual conference. Would be good to see you all again.

 

It was a pleasure to see you last year, I hope to be able to make it this year again. I'll try not to drop my scotch all over myself this time. Cheers!