CSU - Constellation Software

[Liberty]

Q4: https://globenewswire.com/news-release/2018/02/14/1348408/0/en/Constellation-Software-Inc-Announces-Results-for-the-Fourth-Quarter-and-Year-Ended-December-31-2017-and-Declares-Quarterly-Dividend.html

 

Subsequent to December 31, 2017, the Company completed a number of acquisitions for aggregate cash consideration of $278 million (which includes acquired cash).  Deferred payments associated with these acquisitions have an estimated value of $42 million resulting in total consideration of $320 million.

 

http://www.csisoftware.com/wp-content/uploads/2018/02/Q4-2017-Shareholder-Report.pdf

[gary17]

i think this is very solid result ---

 

[FiveSigma]

More capital deployed in half of first quarter than all of 2017!

 

If this is the new new steady state (even ex-Acceo) - the stock is a bargain.

[Liberty]

More capital deployed in half of first quarter than all of 2017!

 

The first quarter isn't even over  ;)

 

[thowed]

See the end comment.

 

https://dontfuckwithdonville.blogspot.co.uk/2018/02/visa-and-mastercard.html#comment-form

 

Every year I regret not buying it, and also think it's too late now.  Additional inertia because it's fiddly for me converting the currency.

 

Appreciate your updates though, Liberty, very helpful in getting a better picture.

[Liberty]

Speaking of conference calls, at the end Leonard said that he was thinking about stopping the conference calls and requested feedback from long-term shareholders (via emailing them or calling them) about this. I personally wrote that I think the calls are useful because they help us get to better known management and how they think about certain things, and even if the analyst questions aren't always the best, often there's some aside that Mark or Bernie will make that will be super useful in understand some part of the business or the VMS industry, and that some things that might seem obvious to them might not be as obvious to us, so it's still a good chance to learn. There's also be interesting things that have been said on the calls that haven't been written anywhere else (such as about how they go about decentralizing and pushing down M&A responsibilities), and usually when I have a question when reading the filings, there's a good chance it will be answered on the call.

[no_free_lunch]

I don't have a position right now (have in the past) but I agree that you want the conference calls.  He doesn't really care because the only impact might be a lower share price and he pays for all his acquisitions with cash.  Still I find the Q&A valuable.

 

Then again to flip it.  I don't have a position, the management / business model seems amazing and stopping conference calls could lower the share price.  Yes, no more conference calls!

[Shooter MacGavin]

Speaking of conference calls, at the end Leonard said that he was thinking about stopping the conference calls and requested feedback from long-term shareholders (via emailing them or calling them) about this. I personally wrote that I think the calls are useful because they help us get to better known management and how they think about certain things, and even if the analyst questions aren't always the best, often there's some aside that Mark or Bernie will make that will be super useful in understand some part of the business or the VMS industry, and that some things that might seem obvious to them might not be as obvious to us, so it's still a good chance to learn. There's also be interesting things that have been said on the calls that haven't been written anywhere else (such as about how they go about decentralizing and pushing down M&A responsibilities), and usually when I have a question when reading the filings, there's a good chance it will be answered on the call.

 

i agree 100% and I did the same.  Maybe they don't need to do it every quarter but they are very useful.

[chrispy]

Leonard mentioned that FFO is a good measure of measuring the companies progress now.  Here is what I got:

 

Year   FFO % Increase

2017   $528 8%

2016   $491 24%

2015   $396 16%

2014   $341 55%

2013   $220 52%

2012   $145 5%

2011   $138 -

 

I was finishing up in the grocery store during the conference call but I believe they said this year was lower because of a one-time charge.  Anyone else have more information on this?  It appears that the combination of 2017 being artificially low and the amount of capital deployed this year that next years FFO will be very large.

[gary17]

just going by memory here i believe it was taxes

they had to pay taxes in 2017 for 2016 sounded like

but they dont expect that'll happen again

[Liberty]

CFO said that if you adjust for the tax timing impact, this year's cash was up 17%.

[oddballstocks]

These guys are serial acquirers right?  Is there a metric showing cash generation from existing holdings verses cash generation including new purchases?

 

Because if the rate of acquisitions is accelerating then it would only make sense for cash flow to accelerate too.

 

A second question: "What's their secret sauce?"

 

I ask because I read a fascinating article on these guys and it left me with the impression that they're simply rolling up software companies.  If that's true then what's stopping someone else from just spending a ton of cash to buy a collection of software companies?  I feel like I'm missing the magic here.  Forget all of the financial metrics and stock related things.  What is it about how they run their business that's special?

 

[writser]

Good questions. It does look like a good business - cash flow generation is healthy, balance sheet isn't too bad, share count doesn't rise but it sure is priced like an excellent business. You roll up golf club membership, school transportation, winery, radiology and RV dealer software developers and suddenly massive cost savings / synergies appear? Must be one hell of an operator. I guess you can book an RV from the RV dealer to bring kids to school if the school bus breaks down?

 

[John Hjorth]

... If that's true then what's stopping someone else from just spending a ton of cash to buy a collection of software companies? ...

 

I'll leave the rest for Liberty to answer and reply, but the quoted. CSU isen't the only software company out there running by this model. The Swedish software company Vitec Software Group AB [stock: VITEC B.STO] operates the same way.

 

- - - o 0 o - - -

 

Now back to CSU here.

[Guest ajc]

 

 

Good questions. It does look like a good business - cash flow generation is healthy, balance sheet isn't too bad, share count doesn't rise but it sure is priced like an excellent business. You roll up golf club membership, school transportation, winery, radiology and RV dealer software developers and suddenly massive cost savings / synergies appear? Must be one hell of an operator. I guess you can book an RV from the RV dealer to bring kids to school if the school bus breaks down?

 

Looking forward to Liberty explaining how stupid I am.

 

 

 

Definitely waiting for him to offer a mass-buying deal on that experience. Liberty Prime for the masses.

 

 

 

[Liberty]

Anyone new to this company, I'd suggest reading all the president's letters, this thread, and the articles linked from it first. The model is pretty well descried, I think. But in general, it's not a secret model -- the CEO has said that the barrier to entry is a checkbook and a phone -- it's a "simple but hard" model, kind of like how Berkshire's model is clear for all to see, yet almost no one has done it because the secret sauce is discipline and rationality.

 

Short version is: Company that hasn't issued a single share since IPO and has net cash is buying super-sticky tiny cash cow software businesses that don't need capital for 4-6x EBITDA, then improving them via best practices and/or cutting low-return operations (commodity hardware sales, consulting, etc), and using their cashflow to buy more. Almost no one else can buy such tiny businesses and move the needle because their secret sauce is the ability to do good acquisitions in a disciplined and rational way at scale (tracking every single one since inception, calculating base rates, deploying capital across dozens of verticals and around the world, so can move to unloved industries/geographies to get lower prices, etc). They are tracking over 37,000 VMS businesses, keeping in touch with them so that when they decide to sell, they have a shot. Once in a while they get a bigger business, like Acceo recently or TSS a few years ago (TSS has been a big success -- you can track it because they don't own 100% of it and they have a put on the remaining part, so it has to be revalued based on fundamentals metrics and that has gone up a lot since). The secret sauce is it's orders of magnitude harder to deploy $100m over 50 small businesses than in one big one, but if you can do it, you can get much better prices and face less competition (tiny businesses are actually harder to buy than big ones because tend to be less "professionalized" and dressed up the way that big acquirers want). The last thing Vista or Thoma Bravo or Roper wants is to track tens of thousands of mom & pops operations and have to deal with dozens and dozens of $2-3m acquisitions... They're not set up for that. But if you have 200 business units, all you need is for these managers - who knows their vertical better than anyone - to buy a competitor every few years and you've already deployed a lot of capital in a decentralized way.

[Liberty]

Good questions. It does look like a good business - cash flow generation is healthy, balance sheet isn't too bad, share count doesn't rise but it sure is priced like an excellent business. You roll up golf club membership, school transportation, winery, radiology and RV dealer software developers and suddenly massive cost savings / synergies appear? Must be one hell of an operator. I guess you can book an RV from the RV dealer to bring kids to school if the school bus breaks down?

 

Looking forward to Liberty explaining how stupid I am.

 

There's no synergies. They actually break up their larger businesses into smaller ones because they believe that an entrepreneurial culture is more effective and bureaucracy hurts the businesses.

 

They've had ROICs in the 30% range for over a decade (on total capital employed, I'm not stripping out intangibles or goodwill). Turns out, small mission-critical software businesses in niches without much competition are actually great businesses. They just usually can't redeploy their capital, so that caps their ultimate value. But if you have a model that can use that capital and redeploy it at similarly high returns, then you have something even better.

[KCLarkin]

I ask because I read a fascinating article on these guys and it left me with the impression that they're simply rolling up software companies.

 

Can you share the article? News about CSU is very rare.

[KCLarkin]

These guys are serial acquirers right?  Is there a metric showing cash generation from existing holdings verses cash generation including new purchases?

 

Because if the rate of acquisitions is accelerating then it would only make sense for cash flow to accelerate too.

 

A second question: "What's their secret sauce?"

 

I ask because I read a fascinating article on these guys and it left me with the impression that they're simply rolling up software companies.  If that's true then what's stopping someone else from just spending a ton of cash to buy a collection of software companies?  I feel like I'm missing the magic here.  Forget all of the financial metrics and stock related things.  What is it about how they run their business that's special?

 

There is a lot of skepticism about "roll-ups". When Grant's did their short report on CSU, I did a quick "sanity check" to see if there were any games being played:

 

If you invested $10,000 ten years ago, you would have received $12,000 in dividends. And you now own a very large collection of companies with very little debt. We know that CSU doesn't issue any shares, so the model clearly worked in the past.

 

As to the secret sauce, Mark Leonard is a phenomenal CEO and capital allocator. Full stop. Certainly deserves to be in the conversation with Buffett and Malone. This is obviously personal opinion. But I have no reservations making that claim.

[oddballstocks]

Anyone new to this company, I'd suggest reading all the president's letters, this thread, and the articles linked from it first. The model is pretty well descried, I think. But in general, it's not a secret model -- the CEO has said that the barrier to entry is a checkbook and a phone -- it's a "simple but hard" model, kind of like how Berkshire's model is clear for all to see, yet almost no one has done it because the secret sauce is discipline and rationality.

 

Short version is: Company that hasn't issued a single share since IPO and has net cash is buying super-sticky tiny cash cow software businesses that don't need capital for 4-6x EBITDA, then improving them via best practices and/or cutting low-return operations (commodity hardware sales, consulting, etc), and using their cashflow to buy more. Almost no one else can buy such tiny businesses and move the needle because their secret sauce is the ability to do good acquisitions in a disciplined and rational way at scale (tracking every single one since inception, calculating base rates, deploying capital across dozens of verticals and around the world, so can move to unloved industries/geographies to get lower prices, etc). They are tracking over 37,000 VMS businesses, keeping in touch with them so that when they decide to sell, they have a shot. Once in a while they get a bigger business, like Acceo recently or TSS a few years ago (TSS has been a big success -- you can track it because they don't own 100% of it and they have a put on the remaining part, so it has to be revalued based on fundamentals metrics and that has gone up a lot since). The secret sauce is it's orders of magnitude harder to deploy $100m over 50 small businesses than in one big one, but if you can do it, you can get much better prices and face less competition (tiny businesses are actually harder to buy than big ones because tend to be less "professionalized" and dressed up the way that big acquirers want). The last thing Vista or Thoma Bravo or Roper wants is to track tens of thousands of mom & pops operations and have to deal with dozens and dozens of $2-3m acquisitions... They're not set up for that. But if you have 200 business units, all you need is for these managers - who knows their vertical better than anyone - to buy a competitor every few years and you've already deployed a lot of capital in a decentralized way.

 

I appreciate the sentiment, but I'm not interested in reading hundreds of pages just to read.  I was hoping that there was a back of the napkin thesis here instead of some story I needed to dig into to 'discover'. 

 

Seem the back of the napkin thesis is these guys are able to squeeze down their acquisition targets on price to generate high FCF yields on their purchase price.  They are buying hundreds of no growth companies (locked into niches) and pyramiding the cash up to buying bigger software companies.

 

The thing is the model is great.  If you start with $10m and buy companies with a 10% FCF yield, and reinvest that you'll grow at 10% forever even if your underlying companies are stagnant.  I get that.  I'm not sure the CEO is a genius for doing it.  I guess the question is what's the long game?  You obviously can't do this forever, so is the idea you jump in early and hop off before things slow?  Liberty, I know you've been on this train for a while, and congrats, you've been rewarded.  Seems the spoils go to those who discover this thing first.

 

I think BRK is a great example of what eventually happens.  You go from high returns to lower returns as you get bigger.  But those investors in early reaped the rewards from those high returns.  There is nothing bad about it.

 

I was intimiately familiar with another software company that purchased growth as well.  They purchased small companies, gutted them, kept the clients and shifted development offshore to earn a bigger margin.  By buying out their competitors their clients had no alternative when service went down the drain.  It's an effective strategy, not something I'd trumpet, but when you earn a salary and options based on your stock price it works.... This company I'm referencing is traded and Canadian as well...

 

I guess I'm trying to figure out what's special about CSU besides their numbers.  So far nothing of note besides the stock price and supposed genius of their CEO.

 

[Liberty]

I wasn't suggesting to "read just to read", but because I think it's an interesting company that I think you might enjoy learning about. Don't even read the thread, just read the shareholder letters.

 

How many companies really have a genius model when it comes down to it? If you are looking for that, you'll be disappointed all the time. It's mostly all of the same basic things applied well, in the end...

 

Constellation is great because they're very disciplined, very shareholder friendly, very long-term oriented, and operating in good businesses (fishing in the right pond). They also do something that is hard and has an easier alternative (between tracking thousands of tiny mom & pops businesses and buying dozens of them, and going to investment bankers to see larger businesses, almost all software acquirers do the latter). That's it.

 

How long can they keep going? Depends what you're looking for. If you're expecting them to repeat their early years, then yeah, that can't go on forever. But if you're looking for reasonable results, I think they can continue for a long time. It's a huge industry, they've made maybe 250 acquisitions over the past couple decades and there's tens of thousands of VMS businesses out there. They're just getting more into Europe and Scandinavia, just started a JV in Japan to look more over there, etc. They've just greatly increased the number of people who look at M&A full time because they knew that they were not even seeing tons of deals, they're also working on getting in front of more of the larger deals (that they almost never get because they're too disciplined on price, but if every few years they deploy a few hundred millions or a billion in a single deal, that helps).

 

In the past month and a half, they deployed more capital than in all of last year, so it seems to be working so far.

 

The CEO has also said at the last AGM that if they can't deploy all their cash, after long enough they'll start doing special dividends rather than lower their hurdles. That'd be fine with me too.

 

Seem the back of the napkin thesis is these guys are able to squeeze down their acquisition targets on price to generate high FCF yields on their purchase price.  They are buying hundreds of no growth companies (locked into niches) and pyramiding the cash up to buying bigger software companies.

 

Almost, not quite. They're not trying to stop buying tiny companies and move on to bigger companies. They've just kept scaling up their capability to buy more small companies while they look for the rare bigger companies that meet their hurdles (they also get a bunch of medium ones... All the press release companies I post here are $10-20m+ range). And the companies are not exactly no growth, many have pretty decent organic growth, especially for maintenance revs, which is the recurring and highest margin part.  Mostly around 1-2x GDP. But they also buy distressed assets and shrinking businesses sometimes, and will shut down parts of acquired businesses if those parts don't generate good returns, so the overall organic growth number is noisy (a couple years ago they bought some larger mining and real estate distressed companies that made overall organic look bad, but if they had their usual discipline buying those, they'll get nice IRRs). You can get more detail in some of the letters... But in the end, what matters to me is that they get good returns on their capital, not a certain number of growth. Chasing growth can destroy value, especially in niche markets; if they wanted to they could go after more growth but that might trigger a war with competitors that would just make the economics terrible for everyone. Best to be rational and keep your competitors rational.

[KCLarkin]

So far nothing of note besides the stock price and supposed genius of their CEO.

 

I don't claim Leonard is a genius. Just an extremely rational and disciplined capital allocator.

 

But there is clear evidence that these types of models can work for a very long time, if they have prudent management. ATD and MTY are two examples in Canada of sustained outperformance over decades with roll-up strategies. And I think Leonard is better even than Stanley Ma and Alain Bouchard (who should both be in the Canadian business hall of fame).

 

Anyway, you're not wrong. And that's why CSU was available for an attractive price for so long. It's now been "discovered" and market cap is closer to fair value.

 

--

As an example of his "genius", look at how he handled a request by one of his largest shareholders to add more women to the BoD at the last AGM (not sure if there is a recording avaliable). Just a masterclass in rationality, diplomacy, backbone, and human decency. This is not genius in the traditional sense, but still truly remarkable.

[oddballstocks]

I think most companies are unique.  Not genius model, but for example, the companies CSU is buying all fit this.  They fill some certain need very well.  It's a novel and unique need, and the users are clearly happy.

 

At a meta level I guess CSU is essentially arbitraging this.  They find small niche-y businesses that are private, buy them at a private multiple and by nature of now being public earn a public multiple on the money.

 

The concept is a unique value proposition.  If you own a business in a sales call a prospect says "why should we buy with you?" and you have to explain why you're unique.  But CSU isn't unique, the companies they own have this, but they themselves are just doing this private-public arbitrage.

 

I don't mean to belittle it or anything.  I have owned companies like this in the past, it's a valid thing.

 

The glassdoor reviews are sort of sad.  Not bad, just sad. Mostly because this is a company buying these little companies, squeezing them, or letting them run on auto-pilot and redirecting cash.

 

I get that as investors this is magical.  Maybe I have too much of a human element to me, but I've experienced being at these little companies, and I've worked for a CSU type company, and it's a shame.  There are so many clients that need solutions that just aren't getting served well, or served as well as they could.  I guess that's always the opportunity for a competitor.  I guess better worded, it's sad that they're buying all of this potential, and instead of re-investing to make it better they're just milking it.

 

So is the investment thesis basically that investors expect this to continue for a while?  The past has been good, and the future will be similar?  Is there key man risk here?

[KCLarkin]

I guess I'm trying to figure out what's special about CSU besides their numbers.  So far nothing of note besides the stock price and supposed genius of their CEO.

 

Let's ignore whether Mark Leonard is actually a genius.

 

With this business model, would an extremely capable and rational capital allocator be a sufficient ingredient to make a particular company "special". To me, the answer is clearly yes.

 

So the next question, is Mark Leonard an extremely capable capital allocator? You'll need to decide this for yourself. And the only way to do that is read the President's letters, listen to the calls, attend the AGM, and review the historical financials. There isn't any real shortcut here. Having owned the company since 2013, I am confident I know the answer.

[Liberty]

I think most companies are unique.  Not genius model, but for example, the companies CSU is buying all fit this.  They fill some certain need very well.  It's a novel and unique need, and the users are clearly happy.

 

At a meta level I guess CSU is essentially arbitraging this.  They find small niche-y businesses that are private, buy them at a private multiple and by nature of now being public earn a public multiple on the money.

 

The concept is a unique value proposition.  If you own a business in a sales call a prospect says "why should we buy with you?" and you have to explain why you're unique.  But CSU isn't unique, the companies they own have this, but they themselves are just doing this private-public arbitrage.

 

I don't mean to belittle it or anything.  I have owned companies like this in the past, it's a valid thing.

 

The glassdoor reviews are sort of sad.  Not bad, just sad. Mostly because this is a company buying these little companies, squeezing them, or letting them run on auto-pilot and redirecting cash.

 

I get that as investors this is magical.  Maybe I have too much of a human element to me, but I've experienced being at these little companies, and I've worked for a CSU type company, and it's a shame.  There are so many clients that need solutions that just aren't getting served well, or served as well as they could.  I guess that's always the opportunity for a competitor.  I guess better worded, it's sad that they're buying all of this potential, and instead of re-investing to make it better they're just milking it.

 

So is the investment thesis basically that investors expect this to continue for a while?  The past has been good, and the future will be similar?  Is there key man risk here?

 

What makes the model special is they combine niche VMS economics with ability to redeploy capital. The small VMS companies can't redeploy the vast majority of the capital that they generate at high rates, while CSU can, making it deserve a different valuation.

 

You're too human, eh?

 

Glassdoor is meaningless in a company this decentralized (on top of sample bias). Some businesses had bad working conditions before being acquired, and they might still do afterwards, and that's too bad. But the business unit is to blame, not HQ. Being acquired by CSU seems a heck of a lot better than being acquired by PE. CSU keeps businesses forever, provides autonomy, small teams, no bureaucracy, and provides ways for managers to grow (become capital allocators, do tuck-in acquisitions, invest in long-term organic growth projects, become a portfolio manager at the operating group level, etc). PE loads you with debt, stops investing for the long-term and flips you a few years after gutting you, often so you can repeat the cycle at a different PE firm... Seems to me like CSU is the acquirer of choice, which is one of the reason why so many small businesses sell to it even if they could get higher prices with PE. Not to mention that many, many CSU employees have become millionaires through stock ownership (one of the reasons the CEO has often talked down his stock price... doesn't want it to get overvalued and have his employees feel like they have to sell).