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
- 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
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
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
See full slides below.
