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Is the dream run over for Constellation Software?

Constellation Software
Jon Zechner

Constellation Software (Constellation Software Stock Quote, Chart, News TSX:CSU) has been a dream of a stock for years now but the growth-by-acquisition company has been finding it more difficult of late to add to its stable of purchases.

That translates into a wakeup call for investors, says portfolio manager John Zechner, who advises that those of us lucky enough to have jumped in early should now be thinking about taking some profits.

“This has been the biggest winner on the TSX, certainly in technology, over the last ten years or so. It’s been a simple strategy — quiet, small businesses in technology, they buy them and roll them in and grow,” says Zechner, chairman and lead equity manager at J. Zechner Associates, in conversation with BNN Bloomberg on Monday.

“We don’t own it anymore. They’ve done the acquisition strategy and they’re getting squeezed —they’re having a harder time finding the acquisitions at the valuation, they’ve changed their criteria to lower the potential ROI they need to qualify those investments,” he says.

Constellation Software has made more than 250 acquisitions…

Founded in 1995, Constellation Software has been a serial acquirer of the highest rank, gobbling up startups at a prodigious rate. Numbering well over 250 acquisitions to date, Constellation is notoriously circumspect in divulging information on its purchases, although management did announce earlier this year that it was lowering its hurdle rate, the minimum rate of return expected from new acquisitions, on purchases over $100 million and that the pace of the company’s acquisitions was likely to slow down over 2019.

From its latest quarterly report, delivered in early August, Constellation says that it completed a number of acquisitions over its second quarter ended June 30 for a total cash consideration of $110 million. CSU’s second quarter featured revenue up 12 per cent to $846 million and adjusted EBITA up 19 per cent to $208 million. Both the top and bottom lines came in below analysts’ expectations for the quarter.

Zechner says that although Constellation has had a tonne of success with its strategy, that run may be coming to an end.

“I get it, it’s been a winner. But forget the history, where do you stand now? Do I really want to buy an acquisition-oriented company with almost no organic growth?”

“Not to compare it to something like a Biovail or Valeant in the way that these acquisitions hit a bad road after a while —they haven’t done that. They generate a lot of free cash flow, they have net cash on the balance sheet and they paid out a $20-per-share dividend,” Zechner says.

“I get it, it’s been a winner. But forget the history, where do you stand now? Do I really want to buy an acquisition-oriented company with almost no organic growth —probably two to three per cent organic growth— where acquisitions are getting tougher? It’s just gotten very expensive to go out there and buy anything now, so in that environment and at that sort of valuation, what’s the upside?” he said.

Last month, National Bank Financial analyst Richard Tse reiterated his “Sector Perform” rating for Constellation, saying that CSU’s ability to deploy capital and meet growth expectations is now more challenging.

“While there’s still half a year left, at this point, it appears the pace of capital deployment is lagging what’s required to maintain our forecast; as such, we’re tempering our expectations for the year,” Tse said.

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About The Author /

Jayson is a writer, researcher and educator with a PhD in political philosophy from the University of Ottawa. His interests range from bioethics and innovations in the health sciences to governance, social justice and the history of ideas.
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