It’s a good time to buy Constellation Software, this investor says

Over the years there’s been plenty of praise heaped on Canadian software acquisition champ Constellation Software (Constellation Software Stock Quote, Charts, News, Analysts, Financials TSX:CSU), so much so that portfolio manager Barry Schwartz has had enough.

“There are just so many great things to like about the business, I don’t even want to talk about it anymore because it’s too good,” said Schwartz, tongue-in-cheek, speaking on BNN Bloomberg on Tuesday.

Schwartz, who is chief investment officer at Baskin Wealth Management, had named Constellation one of his top picks for the past 12 months and was rewarded with a big 42 per cent return over 2021, as were all of CSU’s shareholders.

But along with the share price gains, shareholders got a special gift from Constellation around this time last year in the form of shares of spin-out business Topicus. The Dutch company which, like Constellation, operates as a vertical market software provider and consolidator, was spun out on January 5 of last year, with CSU shareholders receiving about 1.9 Topicus shares for every Constellation share held. And since its debut on the TSX Venture Exchange, Topicus has registered about a double, although shares dropped significantly in trading on Tuesday.

Schwartz said investors should be on the lookout for repeats of Topicus-type deals from Constellation.

“This is not a software, organic growth business. This is a business of acquisitions, and there seems to be no end of the amount of acquisitions the company can make,” said Schwartz. “So many opportunities, they spun off a European version of their company called Topicus, and many speculate there could be more spin-offs going forward.”

“The Constellation Software team has continued to amaze investors,” he said. “The perception going in [to 2021] was there was no way these guys could continue to grow and make acquisitions and accelerate, and not only did they kill those perceptions, they shattered them. The company is going to have over $1 billion in acquisitions in 2021, the most ever. [Constellation President] Mark Leonard detailed that he wants to continue to make higher valued acquisitions as the company is generating so much free cash flow.”

As an example of Constellation’s approach to M&A, last week, Constellation reported on one of its six Operating Groups, the wholly-owned Volaris Group, which completed the acquisition of Datapro, a banking industry software company. Volaris happens to be the first company bought by Constellation Software over 25 years ago and has itself turned into an acquisition vehicle for vertical and niche market software businesses. And Volaris itself reported on Tuesday the acquisition of South African specialized software and digitally-led business solutions company AdaptIT. 

Following the Constellation playbook, Volaris has said it will act more as a guiding force in AdaptIT’s development rather than attempt to swallow up the latter. In a statement, Volaris said AdaptIT will help position Volaris “for growth across Africa and beyond,” while at the same time Volaris said AdaptIT will “continue to operate as an independent business unit inside Volaris Group.”

“I want to assure Adapt IT’s employees, customers and stakeholders that we have every intention to be a productive and positive force in Adapt IT’s future. This is a great company, and we see potential for growth,” said Michael Dufton, Portfolio Leader at Volaris Group, in a Tuesday press release. “We are ready to empower Adapt IT with resources, technology and best practices to support the next phase of the company’s evolution.”

As for Constellation, the company reported revenue up 30 per cent in its most recent quarter, its Q3 2021, delivered on November 3. Constellation’s $1.299 billion in revenue consisted of seven per cent in organic growth or five per cent after adjusting for foreign exchange rates. The company’s net income fell 13 per cent year-over-year to $107 million or $5.04 per diluted share and free cash flow available to shareholders hit $226 million for the quarter, up from $181 million a year earlier.

On the M&A front, CSU’s Q3 included $173 million of acquisitions including deferred payments, while post-third quarter the company said it has either completed or entered into agreement to acquire a number of businesses for aggregate consideration of $370 million including deferred payments.

As another form of investment for growth, Constellation announced in November that it was creating two $100-million venture capital funds called VMS Ventures with the aim of financing start-ups and rapidly growing vertical market software businesses many of whom had been incubated or identified by one of Constellation’s business units. 

Constellation said the aim of VMS Ventures will be to invest in businesses that “have the potential to become standalone business units within Constellation” and that the fund will be managed by Daan Dijkhuizen, continuing CEO of the Topicus Operating Group.

“Organic growth will be a critically important part of CSI’s enduring success,” said Leonard in a press release. “I’m delighted that Daan will continue to lead TOG and will take on the additional responsibility for the Fund. TOG has one of the best track records of sustained organic growth at scale that I’ve seen in the VMS industry. I’ll personally support the Fund and Daan as he focuses on leading Constellation’s larger organic growth efforts.”