For many years, Constellation Software (Constellation Software Stock Quote, Chart TSX:CSU) has been a gem of a stock to own, but what if you’re on the outside looking in?
Even at today’s lofty prices —CSU is up 31 per cent year-to-date— investors may be tempted to climb aboard. But Stephen Takacsy, CEO and chief investment officer for Lester Asset Management cautions that this is one success story that you’d be better off watching from a distance.
“Constellation has been a darling stock. It’s been one of the top performers for a long time by buying small little software companies, orphans companies, and they just keep consolidating. They don’t really squeeze out too many synergies or integrate them too much. They’re just buying cash flow at a low price,” said Takacsy, to BNN Bloomberg Monday.
“[But] the stock is trading at a very high price. For us, even though we missed this stock over the years, it wasn’t the business model we were looking for. We find it really expensive, and to move the needle they’re going to have to make bigger and bigger acquisitions,” he says.
Last month, Constellation announced it would be lowering its hurdle rate on acquisitions over $100 million. According to management, lowering the hurdle rate —which accounts for the minimum rate of return a company expects from a new investmen — will allow it to be more price competitive on larger purchases. Further, in its latest quarterly commentary, CSU management projected that the pace of acquisitions is likely to decrease during 2019.
At the same time, Constellation manages to keep growing its earnings, delivering in May adjusted first quarter EPS of $5.97 per share on revenue of $819 million, a 14 per cent year-over-year increase in its top line. Adjusted EBITA of $179 million was also a 13-per-cent year-over-year increase. (All figures in US dollars.)
Takacsy says that shareholders who have benefited from CSU gains in recent years —the stock is up 365 per cent over the past five years— should think about taking some profits at this point in time.
“I would be taking money off the table with this one, for sure,” Takacsy says. “We prefer looking at small software companies ourselves and then realizing the big gains once they’re sold to bigger players.”