VP at Constellation Software Inc
- Constellation Software's (TSE: CSU) unique and evolving M&A-focused business model emphasising smaller vertical software businesses, noting a recent emphasis on larger deals and potential hurdles there
- Macroeconomic backdrop's impact on operations and potential M&A opportunities, highlighting primary six metrics used to evaluate potential acquisition targets
- Most significant risks to the company, including growing competition in terms of operations and acquisitions
How has Constellation Software evolved as a company? I think of it as a hybrid investment and operating company that’s focused on historically smaller vertical software businesses, perhaps with an emphasis on the public sector. How would you describe the company as it stands today?
What sizes of business has Constellation historically focused on for acquisitions?
Constellation’s M&A activity of USD 5m-10m deals may not even register. The companies may not even externally disseminate those details and so the fact that historically, the company not only has focused on those businesses to acquire, but it’s built a very large business worth tens of billions of dollars, is an indication that it’s done this at a massive scale. How many of these companies would you say Constellation owns at this moment? What is the average number of acquisitions it makes in one year?
How might the macroeconomic backdrop affect Constellation from an operational perspective, meaning deal delays to pricing pressures, which will be common in software businesses? On the other hand, it would seem that the company might now have now a lot more opportunities to increase deal flow and volume because it’s a tougher economic time.
What broader themes are relevant to Constellation, besides macroeconomic factors?
There is strong interest in vertical software companies, which has been a subject of numerous Forum Interviews [for example, see Vertical Software – Construction Management Software Sector Update – Product Innovation & Competitive Dynamics – 11 August 2022]. A consistent theme is that there isn’t as much competition in vertical software, and so this is clearly something that Founder and CEO Mark Leonard seems to have figured out much earlier than others. However, to your point, it seems there’s more and more competition in the vertical software area. You noted that, in the 2010s, the company expanded its playbook to not just include M&A approaches and processes, but those related to operations as well. How has the company become better at not just developing best practices, but also having its constituent businesses actually align and work together to some extent, especially when it makes sense?
Is there a reason Constellation hasn’t included M&A, operational and alignment and cross-selling know-how to its playbook? Does the company want its companies to independently operate and thought it just complicates matters? Is there not enough of a benefit, as it does seem it invests, in some cases, in similar businesses across the portfolio?
You noted the 100 variables that a PE firm might have with respect to portfolio companies and how Constellation has six it focuses on. What are those key metrics?
You noted that over the last year, Constellation has indicated and followed through on its intent to consummate more larger deals. If historically the company has considered deals of USD 5m-10m, it’s a big jump to acquire Allscripts’ hospital business unit for USD 700m. How is the company approaching that strategy shift? It has brought in Farley Noble, SVP of its Large Acquisition Group in April 2021. He was previously with the company for more than 18 years in various CFO- and M&A-type roles into 2018.
The flip side of Constellation’s strategy shift to upmarket acquisitions would be hiring a new team to do different types of deals that might not be as profitable. Could that have a negative impact and disrupt the company model to some extent from a shareholder standpoint?
Something interesting about Constellation is that in many cases it seems it’s essentially looking for acquisition targets. The company is going to smaller targets and intentionally not change management. One of the primary criteria for being acquired by CSI is in fact “outstanding management”. Could you discuss that? It would seem that if you’re buying a company, the company might like keeping the name and some independence, but on the other hand, it might not like the changes that Constellation is looking to make in terms of cutting OPEX, for example. How do you strike that balance and how does the company deal with those types of issues?
Is there one metric that’s particularly important out of the six Constellation is particularly attuned to when identifying potential acquisition targets?
Constellation reported revenue growth of 29% 2021. In the 12 months ending in June 2022, revenues were up 27%. Expectations are for revenues to be up 29% in full-year 2022. That’s pretty significant and consistent high 20% growth but then the growth is expected to decelerate around 1,000bps in 2023. Does that reflect a more challenging macroeconomic backdrop, including higher interest rates and related borrowing costs?
What is your outlook for Constellation? What is its biggest opportunity and biggest risk? The latter might have something to do with the company reaching for assets that aren’t as undervalued salvageable as it might think.
You mentioned the NPV per deal a few times. What has been Constellation’s typical NPV range? What degradation could you see over the next couple of years?
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