For Odlum Brown analyst Steven Zicherman, Constellation Software Inc. (CSU–TSX) is definitely a star. Based in Toronto, Constellation Software buys, runs and grows business software. It boasts more than 30,000 customers in 30 countries.
Not only is Mr. Zicherman recommending it as a “buy”, but he’s doing so with a 12-month price target of $350 a share. He writes:
“Since its founding, Constellation has bought more than 210 companies — typically, small-to-medium outfits making software for various niche markets. Such markets include transit systems, utilities, food services and golf course management.
We like Constellation because of its strong competitive position, as well as its high revenue visibility. Indeed, 60 per cent of its revenue is recurring.
We also like the company’s strong management team — a team that’s racked up an impressive track record on the acquisition trail.
Because niche markets tend to be small, they don’t usually play host to such mega-software vendors as IBM Corp. (IBM–NYSE) and Oracle Corp. (ORCL–NYSE). So, Constellation faces only limited competition from the big boys, while enjoying strong positioning against smaller players.
Indeed, the latter are frequently weighed down by a fragmented market share, as well as only modest sources of capital.
As suggested, Constellation’s growth is highly dependent on acquisitions. As a result, the company targets outfits with the biggest market share, or whose share thereof is getting bigger. Constellation also typically seeks companies with growth potential, low rates of customer attrition, as well as a diversified customer base.
For its part, Constellation has been able to add tremendous value thanks to its acquisitions. And, over the last 10 years, the company has averaged a 26 per cent return on its invested capital. Since 2003, Constellation has succeeded in growing both revenue and cash flow per share at a compounded rate of 30 per cent a year.
For our part, we see the business growing by 20-25 per cent annually, fueled by organic growth of five per cent, as well as growth through acquisitions of 15-20 per cent.
Not only does Constellation believe it can double in size and profitability over the next five to 10 years, it also believes it can do so while continuing to pay a dividend.
In the meantime, the company’s capital allocation is first-class. Its management is also decentralized and its head office is small.
In addition, both shareholder and management interests are appropriately aligned. Indeed, a corporate bonus plan is driven by both revenue growth and return on invested capital. Moreover, compensation for senior managers includes share ownership requirements with significant hold periods.
In sum, Constellation Software is an excellent business, as well as one that trades at a fair price.”
Investor’s Digest of Canada, MPL Communications Inc.
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