Constellation Software has more runway yet, this investor says

A few years back, the knock against Canadian software consolidator par excellence Constellation Software (Constellation Software Stock Quote, Charts, News, Analysts, Financials TSX:CSU) was that, sure, they’re great at buying businesses and plowing the cash flow back into acquisitions, but there must be an end to that process once the field of targets thins out. 

Are we there yet? Not even close, says portfolio manager Barry Schwartz, who thinks CSU remains a hidden gem in the Canadian market.

“This is still, in our opinion, an undiscovered company in the sense that it’s only listed on the Canadian stock exchange [and thus] it’s too hard for non-Canadian investors to purchase,” said Schwartz, chief investment officer at Baskin Wealth Management, who spoke on BNN Bloomberg on Monday.

“There’s still a tremendous runway of growth,” he said. “[They have] a brilliant management team, and we look forward to many, many more acquisitions to come. I think they own about 650 companies and they’ve said they could acquire up to 100,000 companies in that kind of environment over the years.”

Constellation buys niche, vertical market software firms, ones which cater to the needs of a particular type of business and a particular function, and the company makes dozens of such smallish purchases every year, with a long track record of success through its model. 

At the same time, management announced in 2019 that it was lowering its hurdle rate, which gives a minimum rate of return on investment, in an attempt to open its model up to a greater number of potential acquisitions. That made some a little concerned about CSU’s future growth, but so far the company hasn’t really blinked. Constellation, which is set to report its fourth quarter and full 2022 earnings on March 29, saw its 2021 revenue grow by 29 per cent, including seven per cent organic growth, even as net income dropped from $436 million to $310 million.

Schwartz says Constellation’s ability to keep delivering make it a good bet in today’s difficult market.

“It’s a really a safe harbour in a stormy environment,” he said. “Lots of cash flow being generated, and the software products that it sells through all these businesses people just don’t get rid of them unless they go bankrupt. Once you’re married to software for a long time, you’re stuck with it and it’s very hard to change,” he said.