Bloomberg News

Constellation Software Helps Lead Tech Revival: Corporate Canada

May 06, 2013

Constellation Software Inc.’s (CSU) acquisition strategy has made it the third best-performing stock in Canada over the past five years, helping to lead a resurgence in the long-underperforming technology industry once dominated by smartphone maker BlackBerry. (BB)

Constellation, based in Toronto, has surged 483 percent in the five years through May 3, behind pharmacy services provider Catamaran Corp. and drugmaker Valeant Pharmaceuticals International Inc. among 237 companies in the benchmark Standard & Poor’s/TSX Composite Index.

It has gained 51 percent in the past 12 months as of May 3 for a market value of C$3.1 billion ($3.08 billion), second in the S&P/TSX Information Technology Index, which is on track for its first annual gain in four years. Constellation reached a record closing high of C$137.50 on April 30. The stock fell 0.1 percent to C$134.76 at 4 p.m. in Toronto today.

“They are the best allocators of capital in the Canadian universe of all the coverage I’ve ever had,” Tom Liston, director of research at Cantor Fitzgerald LP in Canada, said in a telephone interview from Toronto on April 29. “They have a very disciplined approach. They identify what’s a good business and they buy it. They pick businesses that are very sticky.”

The company’s success lies in its ability to grow through smart, strategic acquisitions, said Jason Donville, chief executive officer of Donville Kent Asset Management Inc., who holds Constellation as the top stock in his C$70 million DKAM Capital Ideas Fund.

“What Constellation Software is really good at is not growing an existing cash cow, but finding other cash cows at really good prices, that’s what their secret is,” Donville said in an interview at Bloomberg’s Toronto office April 30.

Staying Small

Constellation buys and operates software developers, typically with revenues of less than C$25 million, that then license software for niche markets including governments, health and leisure clubs and tourist attractions, Donville said.

As of March, it owned about 125 business units across 50 industries, with the largest employing 307 people and with an average of 44 employees, according to a letter addressed to shareholders on May 1.

“These business units are small for a reason,” Mark Leonard, founder and chairman, said in the letter. “The advantages of being agile and tight far outweigh economies of scale.”

Leonard and Jamal Baksh, chief financial officer, declined requests for an interview. Leonard is the fourth-biggest shareholder in Constellation with about a 6.7 percent stake, according to data compiled by Bloomberg.

Profit Estimates

The company reported a 31 percent increase in first-quarter sales to $256 million on May 1, as it completed seven acquisitions in the quarter worth $73 million, the company said in a statement. Profit was $1.57 a share, adjusted for certain items, short of analysts’ estimates of $1.76, according to a Bloomberg survey.

Constellation will double its size and earnings per share over the next five to 10 years while continuing to pay a dividend, Leonard said.

“Does Constellation Software have the ability to scale at the rates which it achieved during the last decade?,” Leonard said in the letter. “I don’t think we are sufficiently humble not to try.”

The company is similar to private equity investment firm Onex Corp., “but maybe a little more predictable,” Liston said. “Onex restructures a little more, owns opportunities with a little more upside.”

Emma Thompson, a spokeswoman with Onex, could not be reached for comment on the company’s strategy.

More Normal

Constellation, along with other technology stocks such as satellite maker MacDonald Dettwiler & Associates Ltd. (MDA) and information technology services provider CGI Group Inc. (GIB/A), are leading a renaissance in Canadian technology stocks, with the industry set to snap a three-year losing streak. In that time, the index had slumped 59 percent.

The industry is the best performing group among 10 in the benchmark S&P/TSX Composite Index (SPTSX) this year, rising 27 percent.

“Canada’s technology sector is starting to look more normal,” said Andrew Pyle, fund manager with ScotiaMcLeod Inc., on the phone from Peterborough, Ontario on April 26. He manages about C$210 million. “Normal, in terms of how we look at technology on the S&P 500. It’s not dominated by one company.”

Since the demise of former technology giant Nortel, the dominant company has been Waterloo, Ontario-based BlackBerry. It has plunged about 90 percent from its 2008 peak while competing with Apple Inc.’s iPhone and Google Inc.’s open-source Android platform.

Sadiq Adatia, chief investment officer with Sun Life Global Investments Inc., is unconvinced companies such as Constellation will rise to the level of dominance BlackBerry and Nortel once held.

More Trust

“They’re not global players,” said Adatia, whose Toronto-based firm manages C$6.4 billion. “RIM, which was a dominant player, had trouble, so some of these smaller companies in Canada will have even more trouble.”

If Canada’s technology industry is making a comeback, investors will need to see a longer track record and more successful companies, Adatia said.

“We still have to wait,” he said. “The world does not trust Canadian tech companies and that is something we need to be cognizant of. We may be first to things, and that’s fantastic, but the world catches up very quickly so we need to find a way to maintain that dominance.”

By buying smaller businesses, especially in niche markets, Constellation avoids competing with larger competitors and is left alone to grow, Donville said.

“They don’t get grown out of their space,” he said. “They’re a C$3 billion company that still acts like a C$125 million company.”

To contact the reporter on this story: Eric Lam in Toronto at elam87@bloomberg.net

To contact the editor responsible for this story: David Scanlan at dscanlan@bloomberg.net


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