Constellation Software is still a pass, says National Bank

After reviewing the company’s latest acquisition announcement, National Bank analyst Richard Tse is sticking with his “Sector Perform” rating on Constellation Software (Constellation Software Stock Quote, Charts, News, Analysts, Financials TSX:CSU). In a Thursday report to clients, Tse said that while the new purchase raises some questions, he believes Constellation has the proven wherewithal to make the software and services assets turn out to CSU’s benefit.

With over 200 offices and 12,000 employees worldwide, Toronto-based Constellation Software acquires, manages and builds vertical market software (‘‘VMS’’) solutions that address specific needs of customers across diverse verticals.

Tse’s latest update on the company comes after Constellation announced its intent to acquire the assets of Hospitals and Large Physician Practices business segment from Chicago-based Allscripts Healthcare Solutions, which will be done through Constellation’s Harris Computer Corporation subsidiary.

“Based on what we gathered from the Allscripts conference call this morning, the assets being sold are not strategic to Allscripts any longer,” Tse said. “Notably, Allscripts also pointed to declining growth profiles for the assets being sold. While a negative growth profile could be perceived as negative, that’s not the case for Constellation in our opinion given the company’s expertise in driving operating synergies with sustained cash flow.”

The deal, which Tse notes to include a suite of integrated clinical and financial management solutions like Allscripts’ Sunrise, Paragon, Allscripts TouchWorks, Allscripts Opal and dbMotion solutions, comes at a total consideration of $700 million, with $670 million in cash due upon closing and the remaining $30 million contingent on performance for two years after closing; the deal is expected to close sometime in the second quarter of 2022.

“We have been watching and admiring the hospitals and large physician practices franchise for many years,” said Jeff Bender, CEO of Harris Computer Corporation in the company’s March 2 press release. “We believe that we are the perfect forever home for the many talented employees and loyal customers that are the backbone of the franchise.  We are excited to begin the next chapter in our Harris story, continuing to serve those who serve us in the communities where we live, by partnering with healthcare professionals to deliver care that improves lives.”

Tse views the acquisition as an attractive value proposition, given that it will be a 50-50 financing between cash and debt. According to company management, the Allscripts assets involved in the deal generated $927.6 million in revenue in its 2021 fiscal year with $145.2 million in adjusted EBITDA, putting the deal at 0.75x F21 sales and 4.8x F21 EBITDA on a trailing basis.

At the same time, Tse also noted that Allscripts indicated on the conference call that it was selling the assets because they were not strategic, were capital intensive and were showing negative growth in the last two years. Yet, Tse believes the assets will find a home within Constellation’s universe.

“Our initial review of this EHR software market would seem to corroborate that from a product perspective with independent reviews pointing to stronger suites from other names with increased scale by some through consolidation,” Tse said. “That said, we think that’s fine for Constellation given its acquisition growth model and more importantly, its prowess in driving synergies from mature companies.”

After eclipsing $5 billion in revenue in 2021, Tse projects more growth for Constellation through the 2022 fiscal year, as his revenue projection of $5.86 billion represents a potential year-over-year increase of 14.7 per cent. The double-digit growth projections continue into 2023, as Tse forecasts revenue of $6.76 billion for a potential year-over-year increase of 15.5 per cent.

Constellation’s valuation also appears solid, as Tse forecasts the EV/Sales multiple to drop from 7.3x in 2021 to 6.4x in 2022, then to a projected 5.5x in 2023.

Meanwhile, after the company reported $1.51 billion in EBITDA in 2021, Tse charts further increases in that category as well, setting a 2022 projection of $1.71 billion for an implied margin of 29.3 per cent, then growing it to a projected $1.95 billion in 2023, though the implied margin dips to 28.8 per cent.

In terms of valuation, Tse projects the company’s EV/EBITDA multiple to drop from 24.8x in 2021 to 21.9x in 2022, then to a projected 19.3x in 2023.

Overall, Tse continues to believe Constellation Software has a fair market value for investors, and that the deal with Allscripts is a positive one.

“Given CSU’s consistent execution and acquisitive prowess, we believe the transaction is positive for Constellation particularly given the assets are expected to generate $50-$60 million in FCF through F22,” Tse said.

Constellation Software’s stock price has rocketed to a 33.6 per cent return for investors over the last 12 months, though it has come back down to Earth in 2022 with a 6.9 per cent loss. The stock has been above $2,000/share since August 3, and it hit a 52-week high of $2,372.76/share on December 29.

With the reiterated “Sector Perform” rating, Tse also maintained a target price of $2,350/share on CSU for a projected one-year return of 6.3 per cent.