Value Investing

Lily Miao Long Investment Thesis On Constellation Software [Slides]

Lily Miao’s long investment thesis on Constellation Software from the 2015 IRA Sohn Conference.

Constellation Software Inc

Long Investment Thesis

Current Price: $469.68 CAD

Jan 2017 Price Target: $700 CAD (27% IRR)

May 4, 2015

Lily Miao

2015 MBA Candidate, The Wharton School

Constellation Software Inc: Highlights

Constellation Software

  • Target price: $700 CAD in 2017 (27% IRR)
  • Excellent business with great moats trading at 8.6% 2017 FCF yield
  • Monopoly-like company with the benefits of a competitive market
  • Stellar CEO + mgmt team
  • History of smart capital allocation and ability to integrate acquisitions
  • Street underestimates ability to continue to grow through acquisitions

Excellent business with great moats

  • Vertical market software targets markets with only hundreds to thousands of customers
  • Software is too specialized and markets are too small to move the needle for larger software companies
  • Focus on mission critical software (e.g. accounting, production)
  • 85-90% is on premise, which has higher customer stickiness

Constellation has high barriers to entry

Monopoly-like company with the benefits of a competitive market

  • Portfolio of monopolies
  • CSU seeks to acquire market leader and then make tuck-in acquisitions to create a monopoly
  • Seeks fragmented verticals that lack access to capital
  • CSU business units within the same vertical are kept in friendly competition
  • Benefits from pricing power of a monopoly and superior product of a competitive market

Constellation Software

Stellar “Outsider” CEO / Founder + Management Team

  • Called a modern-day “Outsider” CEO by William Thorndike, author of The Outsiders
  • 11 years in VC prior to founding CSU
  • CSU stock has 47% annualized return since IPO and ROIC of 37%
  • Decentralized organization with deep talent pool who have been at the company for a long time. Based on my checks, CEO does not micromanage
  • Unique compensation structure – executives must use bonus to buy CSU shares on the open market, which are held in escrow for 4 years

Constellation Software

CSU directors and executives own ~11% of shares outstanding

History of smart capital allocation

  • FCF has largely been deployed into acquisitions and to pay dividends
  • Acquisition strategy: Create monopolies, hold forever, prefer distressed assets at distressed prices
  • Very disciplined buying with IRR hurdle in 20-30% range
  • Historically, paid 0.5-0.9x revenues vs. 2-2.5x median multiples in software M&A
  • Benefits from cyclicality, which creates buying opportunities, while diverse portfolio buffers CSU from idiosyncratic shocks

Constellation Software

See full slides below.