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Six reasons why you should own Constellation Software stock

Constellation Software

Fans of Canadian software conglomerate Constellation Software (Constellation Software Stock Quote, Charts, News, Analysts, Financials TSX:CSU) can get dewy-eyed thinking about how great the company is.

And why wouldn’t you when the results have been so consistently superb? For portfolio manager Jason Del Vicario, Constellation is simply a world class company and stock. Speaking on BNN Bloomberg on Wednesday, Del Vicario of Hillside Wealth Management explained why he chose CSU as one of his top picks exactly one year ago, starting with the nice 35 per cent return the stock has delivered over those 12 months.

“That’s just par for the course with Constellation Software,” said Del Vicario. “If you look at since they went public in 2006 I believe the compound rate of return of this security has been in the mid-30 per cent range, which is really outstanding.”

Founded back in 1996, Constellation has made a name for itself by more or less writing the playbook on M&A and how to become a successful serial acquirer without breaking the bank. Constellation’s M.O. has been to seek out value in software companies that hold strong positions in their respective spaces, providing vertical market software that has applications within a particular niche industry. Constellation’s acquisitions number close to a staggering 100 per year, with the bulk of them being smaller purchases under $10 million, although the company does shell out bigger on occasion.

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One of its biggest in recent years was Total Specific Solutions, a Dutch software business bought in 2013 for €240 million. That deal led to last year’s creation of sub-unit Topicus, which earlier this year Constellation spun out as a separate public company, giving CSU shareholders each a stake in the new entity. 

There have been worries grumbled from the sidelines over the years about Constellation’s strategy of buying companies and then plowing the generated cash back into further acquisitions, with the complaint being that some day CSU will either run out of good vertical market software companies to acquire or in the very least that the crop of potential acquisitions will get thin enough or expensive enough to make the CSU model fail.

That hasn’t happened yet, and management has said that there are a good 40,000 such vertical market companies worldwide still out there for the picking. At the same time, the company seems to have made a concession more recently in aid of keeping its acquisition machine going. In a February President’s Letter, CEO Mark Leonard said Constellation would be lowering the company’s hurdle rate, the rate of return on invested capital expected from a proposed acquisition, saying it could result in greater access to potential buys. 

“I used to argue that we needed to maintain our hurdle rates because dropping them for a few marginal capital deployments would cause the returns on our entire portfolio to drop. The evidence supported my contention, so we kept the rates high for small and mid-sized vertical market software (‘VMS’) acquisitions and made very few exceptions for large VMS acquisitions. The by-product of that discipline has been a perennial inability to invest all of the cash that we generate,” Leonard wrote.

The result has been that CSU will keep their free cash flow investment strategy for small and mid-sized acquisitions but lower the hurdle rate for larger purchases.

“If we are successful in acquiring one or two large VMS businesses per annum, then I anticipate that CSI’s return on investors’ capital will decrease, but we will not have to return any of our free cash flow to shareholders,” Leonard wrote.

All this is to say that Constellation’s game plan has had a little tinkering of late but that the company says investors can still expect similar growth at a similar rate going forward.

As for Del Vicario, listing off Constellation’s positive attributes is an easy task.

“I’ve had this as a top pick in the past and I’m sort of running out of things to say about them. I’ll just say that as Canadians we should be really proud that we have a company like this domestically. We look at companies across the planet and I can say that they stack up with the very best in the world and they check all of our boxes,” Del Vicario said.

“They’re extremely well run, the founder is still involved with the company, they don’t use a lot of debt, they spend very little money to generate their money, they have high and consistent returns on invested capital and they don’t issue shares,” he said.

“It is our largest position and it has served our clients very, very well over the last seven years,” Del Vicario said.

As for Constellation’s financials, they last reported in early August where their second quarter 2021 featured revenue up 35 per cent to $1.249 billion, with 14 per cent organic growth. Net income attributable to shareholders increased by seven per cent to $88 million or $4.16 per share.

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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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