Constellation Software is money in the bank, this fund manager says

If you’re looking for a long-term hold in Canadian tech then Constellation Software (Constellation Software Stock Quote, Chart, News, Analysts, Financials TSX:CSU) should definitely be on your radar. So says Jason Del Vicario of Hillside Wealth Management who likes not only Constellation but its recent spin-off Topicus (Topicus Stock Quote, Chart, News, Analysts, Financials TSXV:TOI) which Del Vicario says could do even better than CSU over the next ten years.

Software consolidator Constellation has been running on the same game plan for years, buying small vertical market software companies providing so-called mission critical software solutions globally. Over the years CSU has completed over 500 such acquisitions, buying the top names in their respective niche verticals and then using its clout and breadth to grow the business and expand into new markets. The resulting cash flow is then plowed back into more acquisitions and the cycle repeats.

The strategy has worked wonders for Constellation, which has grown its revenue from $631 million in 2010 to almost $4 billion for 2020 while taking earnings from $4.12 per share in 2010 to $20.59 per share this past year.

Constellation’s shareholders have certainly been rewarded, with CSU climbing from $69 in March of 2010 to now $1,674 per share —that’s a 2,430-per-cent return over a ten-year period.

Shareholders were given a special treat last month when Constellation spun out recently acquired Topicus, giving CSU owners about 1.9 Topicus shares for every Constellation share as a dividend-in-kind. Constellation bought Netherlands-based software company Total Specific Solutions BV (or TSS) in 2013 and that subsidiary recently acquired Topicus BV, a Dutch information service company focusing on sectors such as healthcare, education and finance.

Topicus was singled out by Constellation founder Mark Leonard for its ability to grow without using outside shareholder funding. Leonard said the spin-out was part of the intention since a purchase agreement was struck last year.

“The plan to create a publicly listed operating group made up of Topicus and TSS was a key part of our discussions with the Topicus founders,” Leonard said in a May 2020 press release. “They didn’t want their legacy disappearing into the craw of an omnivorous conglomerate. While they knew that Topicus would have autonomy within Constellation, they also wanted identity. The public listing is expected to afford our Netherlands-based businesses a platform from which to celebrate their culture and achievements.”

Vicario says Topicus is an attractive company, to say nothing of CSU itself.

“Constellation Software is an absolutely fabulous business with world class management, and I’ve covered them extensively,” said Del Vicario, portfolio manager at Hillside, who spoke on BNN Bloomberg on Monday.

“Part of the [Topicus] acquisition understanding was that the Dutch owners of Topicus and TSS wanted to retain ownership of those businesses and they wanted to have their own entity trading on an exchange, you know, something to be proud of. So, Constellation Software said, ‘Sure we’ll spin these two out.’ And we now see Topicus trading on the Venture Exchange.”

Del Vicario thinks that Topicus will likely be a success, in part because Constellation is retaining ownership and board positions with the spin-off.

“I have a sneaking suspicion that if we look back in ten years Topicus will outperform Constellation Software, and there’s a whole slew of reasons for this but basically we have kept the Topicus shares that we were given and we would love to add to the position,” Del Vicario said.

Del Vicario said the expected selloff of Topicus once the spin-off was complete didn’t happen, which has made it tougher for investors to now get into the stock, which so its debut on February 2 at $66.00 per share has risen six per cent.

“We’ve been waiting for it to come down —we thought there would be a lot of forced selling, with maybe equity fund managers not able to own Venture shares or maybe not able to own a foreign security, but that really hasn’t happened,” Del Vicario said.

“The company is, I would argue, a bit expensive. I think their free cash flow yield is sub three per cent, which is fairly pricey,” Del Vicario said. “So, long story short, we’ve kept our shares and we are looking for an opportune time to add to our shares, let’s say sub $60 or ideally sub $50, but I don’t know if we’ll ever get there.”

“If you have at least a five or ten-year time horizon, I think you would do well owning either Topicus or Constellation Software. They are extremely well run,” he said.

Constellation last delivered earnings on February 12 where its fourth quarter 2020 results saw revenue grow by 14 per cent year-over-year to $1.091 billion and net income climb 62 per cent to $149 million or $7.02 per diluted share. Over the quarter, Constellation made a number of acquisitions for a total consideration of $239 million.