CA - Right Tail Capital - Constellation Software: Can Generate 15%+ IRR For Several Years
2023-10-19 08:15:00 ET
Summary
- Constellation Software is a niche software business that has shown impressive growth and returns on capital.
- The company has been successful in retaining customers and making disciplined acquisitions.
- Recent capital deployment and acquisitions suggest potential for significant value creation and continued growth.
The following segment was excerpted from this fund letter.
Constellation Software ( OTCPK:CNSWF )
Constellation Software buys and builds niche software businesses which provide mission-critical solutions. Current President Mark Leonard has produced a track record of incredible growth and returns on capital and today has an enterprise value of ~$46B.
Constellation has proven itself well over the last almost 30 years. As I wrote in last year’s letter , “Building a business from scratch to $34B over 27 years is an eye-popping result.” By retaining most of its customers each year and being incredibly disciplined on the prices it pays for M&A, Constellation has generated fantastic returns on capital. The company has also treated its shareholders fairly, not issuing any shares since its mid-2000s IPO.
The key question continues to be how much capital the company can deploy and at what rates of return. I’ve been impressed by the ~$2B of capital the company has invested over the last year – this is one of the rare times the company has found good enough deals to outspend their current free cash flow.
While the future returns from these deals are hard to know, the situation surrounding this capital deployment seems ripe for significant value creation. Constellation has continued to do dozens of small deals where they’ve had tremendous success and there’s typically less competition for the assets.
Interestingly, Constellation has recently closed on two larger corporate carveouts related to the ICE/Black Knight acquisition. These assets Optimal Blue and Empower were originally highlighted by ICE as 2 of Black Knight’s 4 Key Offerings. ICE was likely required to divest some assets by the FTC to close the Black Knight acquisition.
Constellation’s balance sheet and willingness to act quickly was helpful in closing the deals. And they appear to be getting a fantastic deal - Black Knight appeared to pay ~30x EV/EBITDA for Optimal Blue while Constellation is paying <7x EV/EBITDA!
As the business grows, the 25% CAGR in FCF/share over the last decade will likely decelerate. Interestingly, the total return of our Constellation Software investment has been ~50% since we discussed it in our Q3 2022 letter. At recent prices, I continue to believe Constellation Software can generate north of a 15% IRR for several years (vs. ~30% IRR over the past decade).
And we won’t be upset if management continues to surprise us with better-than-expected capital deployment opportunities.
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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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Right Tail Capital - Constellation Software: Can Generate 15%+ IRR For Several Years