CSU - Constellation Software

[frommi]

if CSU stops acquisition now... how sustainable are its existing software businesses ?

 

It'd be interesting to do an DCF analysis to see what CSU is worth , no future acquisitions, and only organic growth !

 

They are not able to stop it as far as i understood it, its in their DNA now since every new division is taught in capital allocation.

[gary17]

I'm not suggesting CSU should stop M and A activities. I love the business model.  but just for argument sake , in light of what's happening at VRX, I like to explore this hypothetical question.

 

IF it were to stop

 

a) is the business sustainable

B) how much cash can shareholders juice from this cash generating machine , reliably for how long?

 

if this is. very attractive number , then we know the cash we would have gotten is in better hands with Mark Leonard and company , then this would be a satisfactory investment. 

[bonechip1]

This might help Gary

From Q1 2015 cc:

 

Richard Tse - Cormark Securities

So Mark, I just want to get a high level of picture what you think the sustainable level or growth for this business could be here if we look out the next call it three to five years?

 

Mark Leonard - Chairman and President

It’s so hard to call, Richard, because it’s dependent upon acquisitions. Ex the acquisitions I would hope that we could grow organically in the GDP plus percent or two kind of range.

 

http://seekingalpha.com/article/3121856-constellation-software-cnswf-q1-2015-results-earnings-call-transcript?part=single

[gary17]

Thanks !!

 

saves me time to dig this  up !

 

So based on the last 3 quarters, I estimate current adjusted income is roughly $16US / share / year...  which is more or less free cash flow....

 

If it's not growing, and the organic growth rate is keeping up with inflation... may be that's about the same as the discount rate... so  I can almost estimate the current value of the sum of future earnings as about 30x 16USD x 1.3 = $624 CAD / share

 

If instead of giving the shareholders the cash.... they use it for acquisition and achieve 10 ~ 15% , we'd do well :)

 

[giofranchi]

in light of what's happening at VRX

 

Gary,

VRX has been accused of fraud…

That imo has nothing to do with the ability of growing both organically and through acquisitions. If you are able to grow both ways, what shouldn’t be liked about it? That’s the best business model as far as I am concerned because:

1) Usually it is tough to grow only organically at the same rate of those who are good at growing both organically and through acquisitions;

2) The ability to grow both ways puts less pressure on the business: if you strive too much in either strategy, you might end up making unnecessary mistakes… Instead, the right mix of organic growth and growth through acquisitions leaves the manager free to pursue both without the need to push too much in either strategy, because they complement each other;

3) Finally, when organic growth happens to falter a bit, growth through acquisitions might come to the rescue, and vice versa. In other words, though results in business are always lumpy, the right mix of organic growth and growth through acquisitions might mitigate those inevitable fluctuations.

This is CSU business model, and it is also VRX’s. If you ask me, the shorts have shown nothing against VRX’s business model. What they have is an accusation of fraud. My best guess is: if the accusation of fraud is proven unfounded, in a few months the media will get bored about VRX, we will get back to business as usual, and VRX’s stock price will swiftly recover. Of course, don’t ask me about the accusation of fraud, because my ideas are as confused as everyone else’s…

If VRX’s business model has something that I was never very comfortable with, it is its very high debt load… But CSU has no such load, therefore the comparison is pointless.

 

Cheers,

 

Gio

 

[giofranchi]

If it's not growing, and the organic growth rate is keeping up with inflation...

 

That is what has happened during the last two quarters… I don’t think it is indicative of the organic growth we might expect in the future… Historically they have achieved an higher rate of organic growth. We will see!

 

Cheers,

 

Gio

 

[Liberty]

The same thing that makes the VMS businesses resilient in downturns is what makes it hard to grow very fast organically; when a large fraction of your revenues are recurring (maintenance contracts, and now increasingly some SaaS), with churn rates in the single-digit range, it means that customers tend to stick around for 15-25 years. This makes it hard to rapidly gain market share at the expense of a competitor, unless they really screw up. And the niches where they operate don't tend to be in fast-growing, glamorous corners of the economy.

 

A lot of the organic growth actually comes from price increases. Over the past decade, I'd say they've been increasing prices about 5-6% a year on average.

[giofranchi]

The same thing that makes the VMS businesses resilient in downturns is what makes it hard to grow very fast organically

 

+1

 

Cheers,

 

Gio

[gary17]

I think a business that focuses its growth strategy mainly on acquisition lends itself to opportunities for fraudulent activities.... IMO!  This is not to say CSU is this.  I think FFH and BRK are classic examples of good and exceptional businesses that grow by deploying excess capital to acquire new businesses.  Folks in this business are clearly very intelligent and have a lot of energy - the key is if they have the integrity / ethics. 

 

Other than this share transfer I saw a few months ago to a numbered Ontario company controlled by Mark's adult children.... I see no 'weird' arrangements. 

 

But how well do we all know about the businesses that CSU own? What's their competitive position and sustainability ?    I guess no one was asking these questions until Hempton and Left started to.   

 

I know large tech companies like Microsoft and Apple do acquisitions as well; but they do to acquire new technologies for the purpose of maintaining a competitive position.

 

My point about CSU is simply that in light of what's happening with VRX; has anyone taken a very large magnifying glass to look at their business?    They've grown quite fast having 10 times their revenue from 165m to more than 1.6B in 10 years.   

 

Gary

[KCLarkin]

Gary, CSU largely pays cash to fund acquisitions. It is hard to fake cash. There is a small amount of debt, but I would argue that is more to support an unnecessay dividend. They don't issue shares. They have zero reliance on capital markets.

 

Frankly, CSU and that pharma co are not even remotely similar. One hint, look at the cash conversion cycle.

[gary17]

Gary, CSU largely pays cash to fund acquisitions. It is hard to fake cash. There is a small amount of debt, but I would argue that is more to support an unnecessay dividend. They don't issue shares. They have zero reliance on capital markets.

 

Frankly, CSU and that pharma co are not even remotely similar. One hint, look at the cash conversion cycle. Otherwise, leave CSU alone.

 

Hi KCLarkin, yes ! I realize they do; hence my question how sustainable their current businesses are if they were to stop M&A. 

 

I am not sure where I am going with this - perhaps no where LOL   

Just a box in my mind I need to check it off -   

 

 

Gary

[Liberty]

I think a business that focuses its growth strategy mainly on acquisition lends itself to opportunities for fraudulent activities.... IMO!  This is not to say CSU is this.  I think FFH and BRK are classic examples of good and exceptional businesses that grow by deploying excess capital to acquire new businesses.   

 

I know large tech companies like Microsoft and Apple do acquisitions as well; but they do to acquire new technologies for the purpose of maintaining a competitive position.

 

My point about CSU is simply that in light of what's happening with VRX; has anyone taken a very large magnifying glass to look at their financials?  They've grown quite fast having 10 times their revenue from 165m to more than 1.6B in 10 years.

 

Gary

 

Complexity certainly makes you more vulnerable to attacks. After all, 10 years ago Fairfax was accused of being the next Enron and a few decades prior Berkshire was investigated by the SEC because its cross-ownership structure (Bluechip stamps, etc) was so convoluted that it was hard to know what was going on.

 

It's important to do the work to build confidence in an idea, but it's also impossible to be 100% certain of anything in investing. It's a probabilistic game. Fairfax wasn't the next Enron, but David Sokol had a great reputation and was probably Buffett's successor according to many people, until he wasn't...

 

That said, I think CSU is less vulnerable than most. It's not easy to understand, but it's also not that easy to successfully attack, I think.

[giofranchi]

I think a business that focuses its growth strategy mainly on acquisition lends itself to opportunities for fraudulent activities.... IMO! 

 

Maybe… But Leonard’s integrity seems to me almost beyond doubt. His letters are among the best I have ever read, his compensation is probably unique, and the fact he has always used very little debt tells me he is very conservative in his dealings.

This is what I always look for. And when I find it, I invest.

Then, of course, you can never be 100% sure… And that’s why I never put all my eggs in just one basket! ;)

 

Cheers,

 

Gio

 

[KCLarkin]

hence my question how sustainable their current businesses are if they were to stop M&A.

 

My point was -- this is a false pretext. The pharma co needs to stop M&A because they have so much debt and are locked out of capital markets. Most of their cash flow will go to pay down debt over the next few years. CSU can happily pay cash. Worst case, they stop the useless dividend.

 

The main risk here is valuation.

 

--

I won't discuss the other important differences from the pharma co because I have banned myself from that other thread.

[vinod1]

I think a business that focuses its growth strategy mainly on acquisition lends itself to opportunities for fraudulent activities.... IMO! 

 

Maybe… But Leonard’s integrity seems to me almost beyond doubt. His letters are among the best I have ever read, his compensation is probably unique, and the fact he has always used very little debt tells me he is very conservative in his dealings.

This is what I always look for. And when I find it, I invest.

Then, of course, you can never be 100% sure… And that’s why I never put all my eggs in just one basket! ;)

 

Cheers,

 

Gio

 

+1

 

Add to that, take a look at the presentation of the income statement. It is to me the gold standard of how an income statement should be prepared. Almost in every other company I need to look at the foot notes to decipher or break down the details of the expenses, but at Constellation, there is hardly any need to do so. This is not something one would do if they are trying to hide something.

 

Vinod

[snowball82]

hence my question how sustainable their current businesses are if they were to stop M&A.

 

My point was -- this is a false pretext. The pharma co needs to stop M&A because they have so much debt and are locked out of capital markets. Most of their cash flow will go to pay down debt over the next few years. CSU can happily pay cash. Worst case, they stop the useless dividend.

 

The main risk here is valuation.

 

--

I won't discuss the other important differences from the pharma co because I have banned myself from that other thread.

 

Good point ! What do you think about the current valuation ? would you buy today ?

[gary17]

Hi Snowball82!  I think it is 'fairly' valued and I'd be a buy/holder - but won't be a full position. 

 

I think based on 4.67 USD / share  , annualized = $18 USD = $24 CAD / share

 

And today's share price = $550 CAD... this is trading about 23x P/E

 

If we use Graham formula ... 15 % growth rate..... 

 

v = 24 x (8.5 + 2 x 15) = $924/ share..... 

[Phaceliacapital]

I don't think Graham would ever plug in g = 15%...

[giofranchi]

I don't think Graham would ever plug in g = 15%...

 

Though I believe CSU deserves an higher multiple than the general market, I also agree with KCLarkin that valuation is the main risk here.

 

Cheers,

 

Gio

 

[KCLarkin]

Good point ! What do you think about the current valuation ? would you buy today ?

 

To clarify, I think there is a risk that Mr. Market reprices this stock at some point. I won't comment on current valuation as it highly depends on your growth assumptions. But I suspect the multiple will contract at some point. But if growth continues, you will have a lower multiple on much higher earnings.

 

I last bought in June @ $525 but that is only because I decided to average into my position. For now, I am holding with a 5% position and hoping for either a meaningful pullback or compounding to get me to a 10% position.

[Liberty]

New acquisiton: http://www.csisoftware.com/2015/11/constellation-softwares-jonas-division-completes-acquisition-of-par-springer-miller-systems/

[netnet]

At these prices I'm starting to get interested, as in they are no longer in the nose bleed section 8)

 

[PSV_Cannibal]

same here netnet... forward P/CF now in the teens instead of the twenties. 

 

Can anyone share the recent Veritas report that recommended this as a sell?  Curious to read their points.

[rishig]

same here netnet... forward P/CF now in the teens instead of the twenties. 

 

Can anyone share the recent Veritas report that recommended this as a sell?  Curious to read their points.

 

Adjusted net income (adjusting for amortization of intangibles) on TTM is ~$15USD or $20CAD. See page 12:

http://www.csisoftware.com/wp-content/uploads/2015/10/SR_Q3_2015.pdf

 

That gets you ~22x P/E. How do you get teens?

[KJP]

same here netnet... forward P/CF now in the teens instead of the twenties. 

 

Can anyone share the recent Veritas report that recommended this as a sell?  Curious to read their points.

 

Adjusted net income (adjusting for amortization of intangibles) on TTM is ~$15USD or $20CAD. See page 12:

http://www.csisoftware.com/wp-content/uploads/2015/10/SR_Q3_2015.pdf

 

That gets you ~22x P/E. How do you get teens?

 

I couldn't get to teens either.  But the comment was about a forward multiple, rather than TTM.  So, I assume there is some projected growth.