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I’d take Constellation Software over Shopify any day, this fund manager says

Constellation Software

Constellation Software
Barry Schwartz
Shopify’s (Shopify Stock Quote, Chart, News TSX:SHOP) returns in recent years speak for themselves but for a Canadian tech success story that still has some life in it, portfolio manager Barry Schwartz is picking Constellation Software (Constellation Software Stock Quote, Chart, News TSX:CSU).

“At the end of the day, I’ll buy Constellation Software ten times versus a Shopify,” said Schwartz, chief investment officer at Baskin Wealth Management, who spoke on BNN Bloomberg on Thursday, where he gave Constellation as one of his Top Picks for the next 12 months.

“[Constellation] has a reasonable valuation, a great balance sheet and good tailwinds in an improving economy,” Schwartz said.

One is a veritable hype machine while the other is quite the opposite, as Shopify has been the star investors have been hitching their wagons to for years now — and in greater numbers, too. Currently at a $163-billion market cap, SHOP is tops in the Canadian markets, unseating Royal Bank earlier this year and so far maintaining that position, as investors have pushed up Shopify’s share price by an incredible 160 per cent in 2020.

The buzz around Shopify is all about the acceleration in e-commerce growth, spurred on this year by COVID-19 and about to break all records for volume over the holiday season. And as retailers big and small move their business online, it’s Shopify’s platform that many are using to get to their customers.

Shopify just about doubled its revenue over the third quarter of 2020, as total sales on its platform, the company’s Gross Merchant Volume, grew by 109 per cent year-over-year to $30.9 billion.

“Despite the heightened uncertainty surrounding the macro environment, Shopify remains uniquely positioned to level the playing field for entrepreneurs during this period of rapid change in the retail landscape,” said Shopify in its Q3 press release at the end of October.

And so, while Shopify has the glitz and glamour of a company poised for even greater things, investors might be hard-pressed to see Constellation Software as a better buy. Yes, CSU is up an impressive 27 per cent for the year so far, but even on a longer-term scale, Shopify seems to have been the better bet. Since the start of 2016, Constellation has returned 178 per cent, while SHOP is up 3728 per cent.

But it’s the Constellation business model that keeps investors like Schwartz tuning in, one which for decades now has been its own brand of selective serial acquisition. The company looks to buy up software businesses in niche verticals, scouring the planet for well-run, profitable operations that own a big chunk of their often limited markets. Over its 25 years, CSU has gobbled up over 500 such businesses, using heir profits to fund further acquisitions.

The strategy has been hugely successful, although there are rumblings that finding those tuck-ins has become more of a challenge for Constellation in recent years. In May 2019, the company lowered its hurdle rate, the minimum rate of return on an investment, for new acquisitions to $100 million, which the company said would allow it to be more price competitive on larger transactions.

Constellation seems to have taken a bit of a hit in 2020 to its business, as well, as witnessed by its latest quarterly report, its Q3 delivered in early November. There, CSU posted revenue up 15 per cent to $1.00 billion but organic growth was negative one per cent and negative three per cent after adjusting for foreign exchange. The company did complete acquisitions totaling $123 in cash over the quarter, though, and cash flow from operations grew by 32 per cent to $234 million. Net income for the quarter was $122 million compared to $82 million a year earlier.

On COVID-19, Constellation said in the Q3 press release that the pandemic has adversely impacted many of its business units’ operations.

The future impacts of the pandemic and any resulting economic impact are largely unknown and rapidly evolving. It is possible that the COVID-19 pandemic, the measures taken by the governments of countries affected and the resulting economic impact may continue to adversely affect the Company’s results of operations, cash flows and financial position as well as its customers in future periods, and this impact could be material,” Constellation said.

But even with the slowdown, Schwartz is still a convert.

“[Constellation CEO] Mark Leonard is probably one of the greatest CEOs and greatest businessmen that Canada has ever produced,” added Schwartz. “And Constellation Software, in rolling up small software companies, probably its best growth days are behind it, but it’s still a great business and I still think you’re going to compound capital tremendously.”

“All it does is continue to buy software companies, use the free cash flow it generates and keeps on buying more,” Schwartz said. “It may spin off a number of its business. I think that’s the end game for Constellation Software, that it eventually breaks itself up and creates these many spin offs, which would be faster and more energized and get better growth.”

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About The Author /

Jayson MacLean
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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