CSU - Constellation Software

[Poor Charlie]

It's inspiring (& telling) that Mark Leonard, after all his and CSU's success, still wants to learn from people like Jack Henry.

 

BTW, for those interested the JKHY book (You Don't Know Jack) that Leonard mentions is a good read.  It was (is? Might have gone up after the ML mention) available on AMZN for under $1.

 

Interesting factoid:  When Jack was expanding JKHY he was so cautious/conservative that he built the new office so that it doubled as a home for his son.  If things went bad he could shut the business down and convert the office into a home.  Talk about contingency planning.

 

 

[Jurgis]

BTW, for those interested the JKHY book (You Don't Know Jack) that Leonard mentions is a good read.  It was (is? Might have gone up after the ML mention) available on AMZN for under $1.

 

Bought the book for Kindle for $0.99 http://smile.amazon.com/Bought-Love-Dont-Know-Jack-ebook/dp/B00KEGP65O/ref=sr_1_4?s=books&ie=UTF8&qid=1461784742&sr=1-4&keywords=you+don%27t+know+jack

 

Edit: Hold on. Must be wrong book. This one is about Wohl Capital.

 

Edit 2: No copies left, ML fans on rampage: http://smile.amazon.com/You-Dont-Know-Jack-Jerry/dp/0977601838/ref=sr_1_1?s=books&ie=UTF8&qid=1461785106&sr=1-1&keywords=you+don%27t+know+jack+or+jerry

 

Edit 3: The Wohl Capital book is probably still better.

[Picasso]

Don't forget to do a review on this forum of that first Jack book.  I want to see a nice long review.  Lots of details...

[KCLarkin]

The last statement is, well, ironic and CEO's are not supposed do irony.  CSU shareholders are precisely in this position at a 60 P/E and 6X revenues. Basically he is saying, well guys I'm growing the company but you have no margin of safety.  Plus I'm not working as hard as I used to, so....

 

He is saying that  CSU is a great company but the stock is overpriced, there is no margin of safety, and growth and ROIC are likely to slow. He has said similar things at much lower prices, so you need to do your own work.

[KCLarkin]

He speaks directly to the problem, referencing another software company he admires that is also acquisitive and well run:

...

The last statement is, well, ironic and CEO's are not supposed do irony.  CSU shareholders are precisely in this position at a 60 P/E and 6X revenues. Basically he is saying, well guys I'm growing the company but you have no margin of safety.  Plus I'm not working as hard as I used to, so....

 

For fun, I took a quick look at the JKHY 2001 annual report. It looks like it was actually trading at 10x sales. I think the 5-6x he is referring to is actually CSU.

 

In many ways, CSU is much better (purely based on numbers). JKHY had really high capex and stock dilution (options weren't expensed back then). CSU has float. So CSU has much better ROIC.

 

JKHY had better organic growth and probably a longer runway.

 

I will spend some more time on this once earning season quiets down.

[Poor Charlie]

In many ways, CSU is much better (purely based on numbers). JKHY had really high capex and stock dilution (options weren't expensed back then). CSU has float. So CSU has much better ROIC.

 

Dilution - JKHY's dilution is par for the course in the software industry.  Many good/great software businesses (ADBE/MSFT/ADSK/ORCL/VRSK/etc) all went crazy with stock options.  The adjustments that had to be made to prior years' earnings when they began expensing them in 04/05 was absurd (just take a look at MSFT's AR from that period).

 

Capex -  Core processing systems normally invest around 5%-10% of revenue in capex which I agree is high.  However, contracts are multi-year and retention is close to 100% (excluding attrition due to M&A).  This gives them a ton of visibility into the returns they will be getting on incremental capital investments (returns have been around 25% with low variance for decades).  Also consider that software companies with decent organic growth and strong market positions often have to make surprisingly large capex commitments.  VRSK, with as close to a bulletproof business as you can get, usually invests between 4%-10% of sales in capex. 

 

JKHY had better organic growth and probably a longer runway.

 

In general I tend to favor growing business with high (and highly visible) incremental returns over no-growth businesses with low (or negative) capital requirements.  Retaining capital at 25% returns even if you're only growing at mid-to-high single digits is incredibly valuable over a multi-year period. 

 

 

 

 

 

[KCLarkin]

In general I tend to favor growing business with high (and highly visible) incremental returns over no-growth businesses with low (or negative) capital requirements.  Retaining capital at 25% returns even if you're only growing at mid-to-high single digits is incredibly valuable over a multi-year period. 

 

I'm just trying to reverse engineer the mistake that investors made when they bought JKHY at 10x sales in 2001. Am I making the same mistake buying CSU at the current price. One obvious difference is that JKHY had basically no FCF if you factor in dilution.

 

But this is really back of the envelope stuff. Not making any judgement on JKHY. Just saying that it is not immediately obvious that JKHY's lost decade is directly relevant to CSU shareholders.

[KCLarkin]

Just returned from the AGM. Great Q&A. I didn't keep notes, but one question that might interest the board. Mark was asked about investing in public companies (discussed in his letter). His rationale is that CSU has lot's of cash to deploy during downturns but it is hard to buy whole businesses at the bottom (presumably sellers are reluctant at the bottom). Much easier to buy shares of publicly traded vertical software at the bottom.

 

Also, he really dislikes buybacks. So any cash returns are likely to be special dividends (which would make the DE shares more enticing). DE shares won't be listed. He doesn't want to create arbitrage situation.

 

They really emphasized the pyramid structure of capital allocation. Pushing down capital allocation knowledge deeper into the organization.

 

He wasn't asked about the over-valuation alluded to in the letter, but he said he wants to foster a shareholder base that will carefully follow the company and then buy in size (he mentioned a 10% portfolio weighting). He encouraged waiting for dips though. This was in response to a question about a stock split to make the stock more appealing to retail investors.

 

Snowball, anything to add?

 

--

Unfortunately, I missed the dip in the stock price since I was at the AGM. So my 10% weighting will need to wait.

[Liberty]

Thanks for sharing, KCLarkin. I'm considering going to the AGM next year.. or maybe the Fairfax one just because there will probably be more people from the board and Twitter. Not decided yet.

[KCLarkin]

I'm considering going to the AGM next year.. or maybe the Fairfax one just because there will probably be more people from the board and Twitter. Not decided yet.

 

Two very different events. Fairfax is a great event for value groupies with many social events. CSU is very specific to the company. It is a great opportunity to hear from the managers of the various business units. But the audience is a bunch of white guys in suits sitting in a law office boardroom. You will have way more fun at Fairfax.

 

[gary17]

the lesson these days seems to be to buy good / strong businesses that will endure over time, but never overpay -   

it's the message repeated by so many great investors & i often forget

 

i am amazed to learn when Ichan bought Apple - and now sold - still made $2B      nice

 

 

[Liberty]

Good writeup on CSU by @jnvest (on Twitter):

 

http://www.jnvestor.com/csu/

[snowball82]

Just returned from the AGM. Great Q&A. I didn't keep notes, but one question that might interest the board. Mark was asked about investing in public companies (discussed in his letter). His rationale is that CSU has lot's of cash to deploy during downturns but it is hard to buy whole businesses at the bottom (presumably sellers are reluctant at the bottom). Much easier to buy shares of publicly traded vertical software at the bottom.

 

Also, he really dislikes buybacks. So any cash returns are likely to be special dividends (which would make the DE shares more enticing). DE shares won't be listed. He doesn't want to create arbitrage situation.

 

They really emphasized the pyramid structure of capital allocation. Pushing down capital allocation knowledge deeper into the organization.

 

He wasn't asked about the over-valuation alluded to in the letter, but he said he wants to foster a shareholder base that will carefully follow the company and then buy in size (he mentioned a 10% portfolio weighting). He encouraged waiting for dips though. This was in response to a question about a stock split to make the stock more appealing to retail investors.

 

Snowball, anything to add?

 

--

Unfortunately, I missed the dip in the stock price since I was at the AGM. So my 10% weighting will need to wait.

 

KC,

 

You added most importants points.

 

That said I have doubt about the enterprise culture when Leonard will leave.

 

For now, the management seems honest, they said we can't repeat past return over next years.

 

So we have to think about valuation. Leonard himself said he thinks the current stock price is too high and investors should only buy on big dips.

 

What are your expected return at this price $ 495  ?

 

 

[netnet]

Two year old profile of Leonard, will remove if this has been posted before:

 

http://www.theglobeandmail.com/report-on-business/rob-magazine/the-most-successful-canadian-dealmaker-youve-never-heard-of-and-will-never-see/article18134950/?page=all

 

Here are the first few paragraphs:

 

Globe and Mail Magazine, April 2014,

by Chidley

 

In this age of zero privacy, Mark Leonard has managed to maintain a practically unthinkable level of anonymity for just about any individual—let alone an IT executive who runs one of Canada’s most dynamic, fastest-growing and most acquisitive software companies, and who has been compared favourably with Warren Buffett and Prem Watsa. So it’s no surprise that Leonard would probably prefer not to be the subject of a profile in this magazine. For that matter, he would prefer not to be the subject of a profile in any magazine. Or newspaper. Or trade publication. Or television show (you know, if there were a television show devoted to profiling Canadian business leaders). No, the founder, president and chairman of Constellation Software Inc.—a Toronto-based, publicly traded software company with a $5-billion-plus market cap and one of the best-performing stocks on the TSX—would prefer not to be profiled at all. And so far, in the nearly 20-year history of Constellation, he’s done a pretty good job of staying out of the spotlight.

 

In fact, you could say he’s done a strangely effective job of it. Search “Mark Leonard” on Google Images and you get nowhere. Scan the Web, or even the company’s website, for basic biographical information and you’ll find, well, not much. One source from England, where Leonard sits on corporate boards, says that he was born in 1956. A person close to Constellation says he was born in the United Kingdom; another seems to think he comes from South Africa, but “I really can’t remember.” The company’s online bio-graphy (no photo) notes that “Mr. Leonard founded CSI in 1995,” and before that worked in “the venture capital business for eleven years”; it also records that he has a BSc from the University of Guelph and “a MBA” from Western University. And that’s about it. Social media? Well, he’s on LinkedIn (no photo, of course), which duly notes his job title and that he attended Western’s Ivey Business School from 1980 to 1982. At the time of this writing, he had 311 LinkedIn connections—so somebody knows him. And what do those people have to say? “He is probably the most intensely private individual in IT,” says one long-time associate who, like nearly everybody else contacted for this article, spoke on condition of anonymity. “He’s one of the smartest tech executives I’ve met in my entire career.”

 

And there’s an irony in that. Because if anyone is deserving of whatever celebrity the business pages can bestow on a Canadian corporate leader, then Leonard is probably the guy.

 

With an initial $25-million investment from OMERS and his old associates at Ventures West Capital in 1995, he has built Constellation into a world-leading consolidator of vertical market software (VMS) companies—firms that create products to help run businesses in specific industries. Over the years, Constellation has made scores of acquisitions and, through its six operating groups, now provides software to over 60 industries, from health care to law to public transit. For instance, Markham, Ontario-based Jonas Club Management makes the programs that run golf courses’ payroll, tee-time reservations and food-and-beverage operations. Emphasys makes software for various public housing authorities. Constellation’s customers need the kind of stuff that’s too specialized to merit much attention from the big guns of enterprise software, and all these VMS firms under its umbrella give Constellation a strong competitive position in the North American marketplace—that is, there isn’t much competition at all.

 

Typically, Constellation’s acquisitions are small—in the $2-million to $4-million range—but add them all up, slip in a dose of Constellation’s financial and oper-ational discipline, and you have a company with $1.2 billion (U.S.) in sales in 2013 and an EBITDA margin of 20%. A tidy proxy for Leonard’s accomplishment lies in the company’s stock performance: From its initial public offering in 2006 to the end of the first quarter of this year, CSI returned more than 1,300%. Add in dividends and that number soars to 1,535%. That’s equivalent to a compound annual return of almost 43%.

[Phaceliacapital]

fyi:

 

https://janav.files.wordpress.com/2016/05/constellationsoftware.pdf

[magno111]

That write up is funny.

 

He forgot to adjust the FX. CSU reports on USD but trades on CAD...

 

That would mean a 1200$ share price in 2020 more than 15% CAGR...

 

 

[netnet]

That write up is funny.

 

He forgot to adjust the FX. CSU reports on USD but trades on CAD...

 

That would mean a 1200$ share price in 2020 more than 15% CAGR...

 

Funny how? incorrect or odd or wierdly forgot to do the currency conversion?

[Liberty]

http://www.marketwired.com/press-release/constellation-software-inc-cash-offer-for-bond-international-software-plc-bond-tsx-csu-2138921.htm

 

Constellation Software Inc. (TSX:CSU) ("Constellation" or the "Company") today announced its firm intention to make a cash offer through a wholly owned subsidiary for all the issued share capital of Bond that Constellation and parties acting in concert with Constellation (the "CSI Group") do not currently own at a price of £1.05 per ordinary share. The offer values the existing issued ordinary share capital of Bond at approximately £44 million in aggregate.

 

The CSI Group collectively own 12,475,911 Bond Shares representing approximately 29.6 per cent of the existing issued ordinary share capital of Bond. In addition the CSI Group owns 100% of the non-voting convertible shares outstanding in Bond.

 

A bit less expensive than when the intention to bid was first announced a month ago thanks to Brexit...

[Shooter MacGavin]

I've been doing a lot of work on this name recently.  I tracked it for a few years but I just thought it was too complicated and I wasn't sure how they were growing 30%+ a year.  And I generally didn't understand the software space.  The math finally clicked and i'm much poorer for not seeing it earlier.

 

capex lite / negative working capital due to upfront revenue payments / highly fragmented market with tons of ability to deploy capital internally and through acquisitions / high recurring revenue businesses / phenomenal CEO and management....all of these combine to make for a fantastic compounding machine, with Berkshire like returns.

 

I think in one earnings call they said they were tracking over 25k vertical eligible software acquisition targets and growing.  it's very likely to me that they will be able to keep plowing 100% (plus leverage) of available capital (including deferred revenue but excluding dividends) into acquisitions and organic initiatives for at least the next 5-7 years.

 

It seems to me if I normalize earnings, then this stock is trading at ~20x TTM earnings and ~17x NTM earnings.  If they maintain low to mid single digit organic revenue growth, and acquire other software companies at even 12-15% hurdle rates on average ( I know they target 25%+), then I don't see how this company's earnings don't grow at least 20% a year for a while (and my base case is much higher)...

 

in other words, it seems relatively cheap right now.  Anyone disagree? Also anyone have any idea roughly what margins organic revenue from new initiatives comes in at?  Is it just sales commissions they have to pay?

 

Thanks for your feedback. 

 

[Liberty]

I think the last time I heard it mentioned, they were tracking 30k VMS businesses now. The acquisition of TSS has opened new possibilities in Europe where they were less active before, and they've been trying to teach capital allocation/M&A to more of their operating units so that more smaller acquisitions can happen while management keeps looking for bigger one (said they'd like something of the size of TSS every year or two). Now that they've raised more long-term capital with the debentures and upsized the revolver, they certainly have more dry powder. They've also restarted their public securities investment program, which I think did pretty well in the past. Of course, it always depends on what opportunities are available...

 

It varies by unit, but they certainly have high incremental margins, and they are highest on maintenance revenue, which grows organically faster than the overall (they mentioned that they tend to drop professional service revenues after an acquisition if those aren't profitable, while other companies tend to use them as a marketing tool -- so this can depress overall reported organic numbers after acquisitions even if they're actually cutting unprofitable stuff, increasing overall margins). a year or two ago in the president's letter, the CEO mentioned that if he assumed organic growth 2.5% higher than consensus of analyst models, the estimate of IV doubled.

[Shooter MacGavin]

Liberty,

 

Very helpful.  Thank you.

 

I'm trying to dig in on the economics for software sales commissions.  it's making my head spin!  And further complicated with SaaS sales.  The punchline is that there will be sales commissions paid out on maintenance revenues for a number of years.  But still i think that's the only real incremental cost to their organic growth.

 

[Liberty]

Q2: http://www.csisoftware.com/wp-content/uploads/2016/07/PR_Q2_2016.pdf

 

Q2 2016 Headlines:

 Revenue grew 19% (2% organic growth, 3% after adjusting for changes in foreign exchange rates) to $529 million compared to $444 million in Q2 2015.

 Adjusted EBITA increased $32 million or 32% to $131 million as compared to $99 million in Q2 2015.

 Adjusted Net Income increased 13% to $90 million ($4.24 on a diluted per share basis) from $80 million ($3.76 on a diluted per share basis) in Q2 2015.

 Net income increased 68% to $55 million ($2.60 on a diluted per share basis) from $33 million ($1.54 on a diluted per share basis) in Q2 2015.

 Ten acquisitions were completed for aggregate cash consideration of $49 million (which includes acquired cash). Deferred payments associated with these acquisitions have an estimated value of $5 million.

 Cash flows from operations were $73 million, an increase of 14%, or $9 million, compared to $64 million for the comparable period in 2015.

[gary17]

excellent results ?????

[Shooter MacGavin]

a quarterly read in which there are a series of acquisitions is pretty difficult to really process. It looks like organic growth ex-fx at 3% is fine and CSU is able to keep plowing money into acquisitions.  We'll see if Bond International closes.

 

Adj. EBITA up 32% / organic revenue up 3% ex-fx, and maintenance revenue up 20%+ is kinda what my brain is focusing on.

 

looks like adjusted Net income is up 13%  vs. 32% for EBITA.  it doesn't exclude the impact of the derivative fx gains, and there was an unusual tax accrual in the quarter.....but on an annualized basis , the normalized tax rate should level be mid teens.

 

so a pretty good quarter overall.

 

 

[Liberty]

Bid for Bond International in the UK:

 

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