Constellation Software is a software conglomerate based in Toronto, Canada. It is traded on the Toronto Stock Exchange and is a component of the S&P/TSX 60 index. Mark Leonard, a former venture capitalist, launched the firm in 1995

  • It all started with an initial $25 million investment from OMERS (a pension fund) and Mark Leonard's former Ventures West Capital partners in 1995
  • The company went public in 2006
  • The group has six operating units that serve consumers in more than 100 different markets and generating consolidated revenues exceeding $4 billion
  • It counts over 25,000 workers throughout North America, Europe, Australia, South America, and Africa

CONSOLIDATION GAME

Mark Leonard has turned Constellation into a world-leading consolidator of vertical market software (VMS) companies. Most of Constellation's businesses create products to help other businesses run their own operations. Today, it supplies its software to over 60 industries, ranging from health care to law to public transportation. Here are some of its businesses:

  • Jonas Club Management, situated in Markham, Ontario, creates the software that manages golf courses' payroll, tee-time reservations, and food-and-beverage operations
  • Emphasys develops software for a variety of public housing agencies
  • The Conasys Homeowner Care Platform was built specifically for new home builders and developers, offering fully interactive homeowner- and builder-specific portals

Constellation's acquisitions are typically small as these generally stay under the $100 million mark. This small acquisition size and niche positioning of many of its business help it to stay shielded from larger software companies and private equity funds.


BUY, PROFIT, REPEAT... WHAT ABOUT COMPETITION?

Constellation's basic approach has the advantage of returning any cash generated by its mom-and-pop acquisitions to the company for reinvestment in future ventures. The operations of Constellation Software can thus be summarised in two points:

  1. Bring acquired enterprises up to speed in terms of operational efficiency by introducing them to the "Constellation way of running a business"
  2. Find new targets and acquire these

Constellation has shown it can efficiently integrate new businesses. However, the rise of many private equity firms means that Constellation is now up against a new set of aggressive adversaries.

  • An activist investor pushed Redknee Solutions, a Canadian telecom services business, to sell itself in August 2016. Constellation made an offer to invest $80-million in Redknee. It appeared to be a done sale until ESW Capital, a tech-focused Texas hedge fund, came in with a $83 million offer
  • In similar fashion, Constellation had been outbid by Symphony Technology Group, another PE firm, for the recruiting software company Bond International Software two months earlier

High valuations for larger private software companies are pulling private equity funds downstream into Constellation's backyard, which in turn is pushing prices even higher, according to analysts. This makes it more difficult for Constellation to undertake the low-cost transactions on which it has built its business.


STAYING RELEVANT

In order to deploy its cash, the firms needs to find larger deals. To do so, it is forming a small, dedicated team to seek major VMS acquisitions and work with M&A brokers. This is meant to help Constellation be invited to the table of major deals in the coming years.

"Between 40 and 70 large VMS businesses are sold each year. The vast majority of these transactions are marketed to prospective buyers by less than a dozen major merger and acquisition (“M&A”) brokers."

"Over the last five years, we were aware of about 80% of the large VMS businesses that were sold, but their brokers only invited us to participate in 16% of the sales processes." Mark Leonard, Constellation President's Letter 2021


THE MARKET

Constellation software is active in the SaaS and global software markets. These are expected to grow by around 8% each year over the 2020 to 2025 period and are being pushed forward by growing digitisation rates and the lasting need for businesses to adapt to post-pandemic changes.

According to the Business Research Company, the global software as a service (SaaS) market is expected to grow from $225.6 billion in 2020 to $436.9 billion in 2025 at a CAGR of more than 12%.

  • The growth is mainly due to the companies rearranging their operations and recovering from the COVID-19 impact
  • Rapid changes in market business dynamics are expected to benefit the software as a service (SaaS) market, as digitisation brought in and accelerated by the pandemic has a lasting impact (e.g. online ordering at restaurants)

According to Technavio, the market for small and midsize business (SMB) software is set to grow at a CAGR of 7.4% from 2020 to 2025.

  • The rapid growth in the volume of enterprise data and the growing reliance on financial management, the implementation of business automation and cloud computing help push the market forward
  • 35% of the market's growth will originate from North America during the period

EXPERIENCED MANAGEMENT

Constellation Software (CSI) is lead by Mark Leonard, he founded CSI in 1995. Prior to founding CSI, he worked in the venture capital business. He holds a MBA from the University of Western Ontario.

Mark Leonard

  • President and Chairman of the Board
  • Prior to founding CSI, Mr. Leonard worked in the venture capital business for eleven years
  • Holds a BSc. from the University of Guelph, and a MBA from the University of Western Ontario

Jamal Baksh

  • Jamal is the Chief Financial Officer of the group
  • Has been with CSI since 2003 when he joined as Controller of the Jonas Operating Group. Prior to assuming this role, he has served in a number of senior executive roles within Jonas and Constellation including Vice President of Finance for Constellation reporting to the Chief Financial Officer
  • Is a Certified Management Accountant and holds an Honours Bachelor of Mathematics degree from the University of Waterloo

Mark Miller

  • Director, Chief Operating Officer, Constellation Software Inc., Chief Executive Officer, Volaris Group, and Chief Executive Officer, Trapeze Group
  • Has been with CSI for well over 20 years. He currently spends the majority of his time as the Chief Executive Officer of Volaris Operating Group and Trapeze Operating Group, but also acts as CSI's Chief Operating Officer
  • Received a B.Sc. in Statistics and a B.Sc. in Mathematics from McMaster University in Hamilton, Ontario. In addition, he has attended the Executive Marketing Program at the Ivey Business School at the University of Western Ontario

Bernard Anzarouth

  • Chief Investment Officer and joined CSI in 1995
  • Works closely with CSI's VMS businesses to identify and pursue opportunities for platform and tuck-in acquisitions and to establish licensing or distribution arrangements
  • Before joining CSI, Mr. Anzarouth was AVP Business Development for Ascom Inc., a Swiss-based technology corporation from 1993 to 1994. Prior to that Mr. Anzarouth held various positions with IBM
  • Holds a B.Eng. in Electrical/Computer Engineering from McGill University and an MBA from the European Institute of Business Administration (INSEAD).

TAKE A BREATH

So… This is a lot of information. Let’s summarise:

  1. Constellation Software is a software conglomerate based in Canada. It is traded on the Toronto Stock Exchange and is a component of the S&P/TSX 60 index
  2. Mark Leonard has turned Constellation into a world-leading consolidator of vertical market software (VMS) companies. Most of Constellation's businesses create products to help other businesses run their own operations
  3. Today, it supplies its software to over 60 industries, ranging from health care to law to public transportation, through its six operating units
  4. Constellation's basic approach has the advantage of returning any cash generated by its mom-and-pop acquisitions to the company for reinvestment in future ventures
  5. Constellation has shown it can efficiently integrate new businesses. However, the rise of many private equity firms means that Constellation is now up against a new set of aggressive adversaries.
  6. In order to deploy its cash, the firms needs to find larger deals. In order to do so, it is forming a small, dedicated team to seek major VMS acquisitions and work with M&A brokers
  7. This is meant to help Constellation be invited to the table of major deals in the coming years
  8. Constellation software is active in the SaaS and global software markets. These are expected to grow by around 8% each year over the 2020 to 2025 period and pushed forward by growing digitisation rates and the lasting need for businesses to adapt to post-pandemic changes

FINANCIAL CHECK

Total revenue for the quarter ended September 30, 2021 was $1,299 million, an increase of 30%, or $296 million, compared to $1,003 million for the comparable period in 2020. For the first nine months of 2021 total revenues were $3,724 million, an increase of 29%, or $846 million, compared to $2,878 million for the comparable period in 2020. The increase for both the three and nine month periods compared to the same periods in the prior year is primarily attributable to growth from acquisitions as the Company experienced organic growth of 7% and 9% respectively.

  • Net income attributable to common shareholders decreased 13% to $107 million ($5.04 on a diluted per share basis) from $122 million ($5.76 on a diluted per share basis) in Q3 2020
  • A number of acquisitions were completed for aggregate cash consideration of $126 million (which includes acquired cash). Deferred payments associated with these acquisitions have an estimated value of $47 million resulting in total consideration of $173 million
  • Cash flows from operations were $292 million, an increase of 25%, or $58 million, compared to $234 million for the comparable period in 2020
  • Free cash flow available to shareholders increased $45 million to $226 million compared to $181 million for the same period in 2020
  • Subsequent to September 30, 2021, CSI completed or entered into agreements to acquire a number of businesses for aggregate cash consideration of $329 million

THE BOTTOM LINE

The Good

  • Constellation Software is a holding company that focusses on relatively small and niche targets within the software industry
  • It constantly scouts for new targets, improves their operational efficiency and then uses the cash flow these businesses generate to take over additional targets
  • Its niche positioning enables CSI to stay relatively shielded from larger private equity funds and technology companies

The Bad

  • Still, competition is heating up and CSI was recently outbid in several acquisitions

THE STAKE

We have a position in Constellation Software. Constellation Software manages to find and acquire new targets on a relatively recurrent basis. This helps the business grow its sales by 30% from a $ 1B basis.

  • We will increase if it manages to sustain its sales growth over time while demonstrating it can acquire larger targets at a fair valuation
  • We will sell our stake if it is outbid by funds and technology groups in its next acquisition processes

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Disclaimer

Please note that this article does not constitute investment advice in any form. This article is not a research report and is not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products.

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