Stay away from Constellation Software, this portfolio manager says

Heck no, says portfolio manager Brian Madden, who sees no reason to put money on this growth-by-acquisition story.

Constellation got roped into the broader tech selloff over the past two months but the Toronto-based company began its downturn early, as investors responded to an earnings miss at the end of July, immediately dropping the stock by eight per cent.

And while over the past five years CSU has been nothing but gold for shareholders, Madden, senior vice-president and portfolio manager at Goodreid Investment Counsel, is more than a little circumspect about the company’s prospects going forward.

“Looking at it right now, the concern I would have with it — and this has been a perennial concern — is that the transparency is their disclosure is really not very good. They don’t talk much on their conference calls about particular verticals or how individual business units are doing, so it’s sort of a giant ‘Trust me’ story and that’s a little bit tough to swallow,” says Madden, in conversation with BNN Bloomberg.

Madden says, “This is not especially an organic growth story, this is absolutely a growth-by-acquisition story. And there’s nothing wrong with that —we own a number of companies where acquisitions play a role in their growth. But here’s the problem: interest rates are rising and, more importantly, credit spreads are rising. If you were to look at a graph of, say, high yield spreads or investment-grade credit spreads, they’ve blown out a lot but they’re nowhere near a prior peak, so they can blow out a low further if we have any waning economic momentum.”

“And so, the universe of potential acquisitions that look accretive shrinks with each tick up in credit spreads, and that could be what’s weighing on investors in this stock and causing concern, and I would share that concern,” says Madden.

“I think you have to hand it to their management team for taking a very small, obscure company ten years ago that was maybe a $500-million market cap and rolling it up to one of the biggest software companies on the TSX,” says Madden, “[But] I would not be a buyer, in spite of the pullback.”