Constellation Software’s business is getting tougher, this portfolio manager says

For over half a decade now, Constellation Software (Constellation Software Stock Quote, Chart, News: TSX:CSU) has been a great stock to own, but for how much longer?

Guided as it is by a growth-by-acquisition strategy, the Canadian tech darling will likely find it harder to keep the party going, says Kash Pashootan, CEO and chief investment officer at First Avenue Investment Counsel, who chalks it up to a case of Constellation becoming a victim of its own success.

How good has Constellation been? Since June of 2013, its share price has risen 674 per cent. CSU is up 34 per cent in 2018 alone. Finding great acquisitions to add to its stable of companies has been the name of the game for Toronto-based Constellation. The company presently owns over 250, many of them startups that Constellation holds while they grow into profitable businesses.

But that pattern does have an end, says Pashootan, since the bigger Constellation gets, the more startups it needs to acquire in order to sustain its growth.

“There’s no question about execution from management’s perspective,” says Pashootan, to BNN Bloomberg. “This is an acquire, roll-in and grow type of story, and they’ve done it for a long time.”

“The niche area that they focus on is smaller acquisitions that the bigger players are just not interested in,” he says. “So when you’re doing acquisitions of $3 million, $5 million, it works when your business is small, but Constellation has grown significantly, and now, not only is it harder to find good deals but the bigger challenge that we feel is that it’s hard to move the needle when you’re acquiring a company that’s $3 million or $4 million and you’re three, four times the size you were a decade ago.”

“That’s a risk that’s more present today than it’s been in the past, and you just need to think about that,” Pashootan says.

Constellation’s first quarter 2018 revenue grew by 29 per cent compared to last year’s Q1 and stood at $719 million, while its adjusted EBITA rose to $159 million, a 21 per cent increase over Q1/17. The company’s cash flows from operations came in at $258 million, a further 42 per cent gain over a year prior, with the company announcing in April a $1.00 per share dividend payable on July 5, 2018.