Constellation Software is still too pricy, says Industrial Alliance

A new joint venture in Japan is being received well by Industrial Alliance Securities analyst Blair Abernethy, but he still thinks Constellation Software’s (Constellation Software Stock Quote, Chart, News: TSX:CSU) valuation is too rich to recommend the stock.

On December 30, Constellation Software announced it had entered into an agreement with Hikari Tsushin Inc. for the incorporation, management and operation of a joint venture company. The joint venture company, which will be named Constellation Software Japan, will seek to invest in, acquire and manage vertical market software companies with a primary place of business in Japan.

Abernethy says he likes the move, but doesn’t think the scale is enough to make a big difference.

“We are positive on this move as it opens up another avenue of growth and investment opportunity for CSU, although we do not expect the Japanese region to be a material contributor to CSU’s results in the near term,” says the analyst. “We suspect that CSU may be in a better position now to secure some larger transactions in Japan as competition from US-based private equity investors is likely less intense than it has been recently in Europe and the US.”

In a research update to clients today, Abernethy maintained his “Hold” rating and one-year price target of $570.00 on Constellation Software, a target that implied a return of -7.2 per cent at the time of publication. The analyst explained the reasoning behind his rating and target price.

“Our C$570 target price remains unchanged and is based on a blended four-factor approach, which includes P/E multiples, EV/FCF, EV/Recurring and Maintenance revenue, and our DCF. Based on our 2017 estimate, in our view, CSU is trading at a relatively rich ~5.8x forward EV/Recurring revenue.”

Abernethy thinks Constellation will generate EBITDA of $539.8-million on revenue of $2.12-billion in fiscal 2016. He expects these numbers will improve to EBITDA of $615-million on a topline of $2.36-billion the following year.