Great Company at a Fair Price: Constellation Software
Constellation Software is a Canada based conglomerate owning a collection of vertical market software (VMS) businesses. That is, businesses who sell software for a specific vertical market, often in quite unique niches which includes real estate, communications, healthcare and many other areas
Vertical softwares, in our opinion, enjoy excellent economics and possess high switching cost advantage due to its scalability and stickiness of its revenue. Once a software is built, it needs to be maintained with very little incremental capital and hence as the software expands its user base, it is highly scalable with margin expansion. These software updates are performed and managed by the same company that builds it.
Commonly, these software businesses generate revenue from recurring subscriptions where users get ongoing support and help from the software companies. This subscription model provides consistent and regular revenue streams. Also, users are reluctant to move and change their existing and whole systems unless it is fundamentally wrong (Why fix it when it ain’t broken) as it will involve a lot of effort, time and resources to re- train the end users to use a new system. This high switching cost feature is a key competitive advantage which many VMS businesses under Constellation possess.
With hundreds of VMS businesses serving both private and public sectors, Constellation is very well-diversified with solid revenue streams.
Mark Leonard, the President and Chairman of Constellation Software, is one of the world’s greatest managers. Under his guidance, Constellation has compounded shareholders' money at over 40% per annum for more than 20 years. If you invested in Constellation Software from the beginning, you have experienced a 100 bagger. That is, 100 times your initial investment. This is an extraordinary achievement. Despite these enormous gains, this is not the end of the story. Mark and his team have recently cancelled their special dividends (some might consider this a criminal offence in Australia) with the intent of investing more of their cash flow to grow the business.
The secret sauce of Constellation is not dissimilar to Berkshire Hathaway. They provide a permanent home for businesses. This offer of a secure home for owners wishing to sell their business is counter to much of the short termism of the private equity market. The industry norm of adding leverage and “ripping the guts out” of a business in the hope to resell it within a few years contrasts the exceptional culture and acquisition strategy at Constellation which have contributed significantly to its growth and share price gains in the last 20 years
Constellation Software is another great business with forecast solid compound growth.