CNSWF - Topicus: Why I Like This Europe-Focused Compounder

Summary

• Topicus, the Europe-focused serial VMS-acquirer spun out from Constellation Software, is one of my highest conviction investments for the next decade.
• As a serial acquirer of small, profitable tech companies, I believe Topicus has a long runway of growth ahead of them as they consolidate ownership of niche companies with high moats.
• Despite its larger size, Constellation trades at a premium to Topicus. Constellation trades at 8.1x EV/Sales whereas Topicus trades at just 7.1x.

Introduction

Topicus (TOITF), the Europe-focused serial VMS-acquirer spun out from Constellation Software (CNSWF), is one of my highest conviction investments for the next decade. As a serial acquirer of small, profitable, tech companies I believe Topicus has a long runway of growth ahead of them as they consolidate ownership of niche companies with high moats.

While its history as a public company is short I have confidence in its long-term ability to generate value for shareholders, so long as they hold true to the fundamental tactics employed by CSI founder Mark Leonard.

Within this article I'll:

• Provide an overview of the Vertical Market Software ((VMS)) industry
• Review the operational and financial performance of Topicus
• Share some of the risks facing Topicus
• Provide my price target for shares

Vertical Market Software

Before you can understand whether Topicus is a good investment it's important to understand the industry fundamentals that drive the performance of the companies Topicus acquires, that being small VMS companies.

At a high level, vertical market software is software that is designed to serve a specific industry or market segment, it's a niche product. Unlike horizontal market software, which is designed to be used by a wide range of businesses and organizations, vertical market software is tailored to the specific needs and requirements of a particular industry or market segment.

Software like Windows ( MSFT ), Photoshop ( ADBE ), and Salesforce ( CRM ) are good examples of horizontal market software products.

Some examples of vertical market software include:

• Healthcare software: designed specifically for the healthcare industry and used by hospitals and clinics to manage patient records, schedule appointments, and track billing.
• Construction software: designed just for the construction industry which is used by builders, architects, and contractors to manage project schedules, budgets, and resources.

Vertical market software can provide a number of benefits to businesses and organizations and is therefore often quite a sticky purchase. Because it is tailored to the specific needs of a particular industry or market segment, it can be more tailored to the needs of the client than horizontal market software which can help their customers build a competitive advantage.

Topicus

Incidentally, pulling from the examples above, Topicus offers VMS software tailored to both the healthcare and construction industries (as well as many others). To read more about how Topicus solves problems for patients and practitioners I would suggest reading over this page from their website. To get an idea of how they can help those involved in construction take a look at one of their acquired companies, QPS, which specializes in maritime software.

Like the company it spun out from, Topicus uses substantially all of its FCF to acquire other VMS companies. The main differences between Topicus and Constellation are:

• Regional Focus - Topicus is Europe-focused, and CSI has a worldwide focus.
• Size - Topicus, with a market cap of $4.6B, is much smaller than CSI which is around ~$37B at the time of writing.

While some may view Topicus' Europe focus as a limiting factor, I do not believe this is the case. The European market is incredibly fractured, both by language, and culture, it's my view that localized skills are required to succeed. Topicus' focus on Europe may allow them to gain a competitive edge compared to other companies who may be investing from abroad and are less familiar with the various languages and cultures in Europe.

Financials

For a company like Topicus the three financial metrics I am most concerned with are revenue growth and return on invested capital.

Revenue Growth

Given the emphasis both companies have on M&A revenue growth can be choppy as various acquisitions move at different speeds and no two companies are alike. When Topicus was first spun out revenue was growing over 45% but has rapidly slowed down to 14%, much below Constellation's growth rate of 38%. While this is suboptimal, I'm not sure that this is a permanent trend. Given the smaller size, Topicus should theoretically have a much longer runway on acquisitions before reversion to the mean occurs.

That said, revenue growth is a metric I will continue to pay close attention to over time to see if it rebounds as I expect. Lacking a rebound, I may be forced to reassess but for now, I will give them the benefit of the doubt.

Returns on Invested Capital

Given Topicus' short life as a public company it's difficult to assess how its ROIC has performed, but if we are to assume that the metrics are similar to Constellation, then their returns are best in class. I believe that this is a fair assumption to make, and perhaps even understates their performance, given that valuations in Europe are often lower than in the states, where there is a more "growth-savvy" investor class.

Again, as a new company, I will continue to monitor how their ROIC performs over time. If it deviates strongly from Constellation's performance over a sustained period of time I will consider changing my view on the company.

Risks

Topicus is still partially owned by Constellation, which also controls the majority of its board and a super-voting share. This means, that as an individual shareholder, you have little ability to influence the direction of the company and must place your faith in the management team. For me personally, I am comfortable trusting Mark Leonard and his disciples with my money.

Another risk is the potential for new HMS software products that may create smaller "modules" that could compete directly with VMS companies. Given the small size of many of these markets and the high cost of development and marketing, I believe this risk to be largely mitigated.

Conclusion

Topicus is an excellent company, while it is still a relatively young company on the public markets, I believe it has all the ingredients for success that Constellation had when it was Topicus's size just a few years back.

History doesn't repeat itself... but it often rhymes.

Despite its larger size, Constellation trades at a premium to Topicus. Constellation trades at 8.13x EV/Sales whereas Topicus trades at 7.07x.

For Topicus to reach parity with Constellation its shares would have to trade up 15%. Therefore, I find today's prices relatively interesting and may continue to add to my position.

I rate Topicus a strong-buy and I am setting my 1-yr price target to $64.

Thank You Reader!

I hope you enjoyed my article about Topicus, this company is truly one of my highest conviction picks for the next year, and the next decade! Compounders like this one make up the core of my portfolio. If you have any comments or questions about the article or Topicus feel free to chime off in the comments below. Cheers!

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