Constellation Software has become one of Canada’s biggest publicly traded technology companies by playing the acquisition game a very different way than most.Frank Gunn/The Canadian Press
There are good stocks, damn good stocks and then there’s Constellation Software Inc. CSU-T.
Since its debut on the Toronto Stock Exchange in 2006, Constellation has gone on a run for the ages, arguably outclassing all contenders past and present, from pandemic tech darling Shopify Inc. SHOP-T, to the mighty blue-chip bank stocks, to former champions such as BlackBerry Ltd. BB-T and Nortel Networks Corp.
As of 2021 year end, Constellation’s stock has now posted positive returns in 15 consecutive calendar years. It has never had a down year. And since its IPO in 2006, Constellation’s shares have returned an average of 37 per cent annually. That beats even the U.S. tech and internet giants, such as Apple Inc. AAPL-Q and Amazon.com Inc. AMZN-Q over the same time frame.
It’s one thing to put up monster returns. To do it consistently for that long is monumental.
“I’ve been doing this for 22 years and I’ve never found a company that is quite the same,” said Richard Liley, an analyst at Leith Wheeler Investment Counsel, which has held shares of Constellation since the IPO. “It’s almost a purpose-built compounding machine. It compounds so fast, even if the stock looks like it’s overvalued, it quickly catches up.”
The company is equally unique for the manner in which it has grown. As a low-profile IT conglomerate of sorts, Constellation has spent years acquiring an arsenal of smaller software companies mostly serving niche businesses. Think library software, transit scheduling, marina management.
This is not the kind of empire-building deal making that quickens the pulse of an investment banker. Constellation has scooped up more than 650 companies over the years, at an average purchase price of well below $10-million, according to RBC Dominion Securities estimates. Sticking dogmatically to a piecemeal takeover approach devised by its founder Mark Leonard, Constellation has grown by bite-sized increments into one of Canada’s largest tech companies, with 125,000 customers in more than 100 countries.
“This is the gold standard of acquisition-driven companies,” Mr. Liley said. “When you find a company that does it the right way, it’s just so powerful.” Powerful enough for Constellation to rank as the best Canadian stock of all time? It’s difficult to find a more impressive winning streak.
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Start with Royal Bank of Canada Instrument RY-T, the cornerstone of the Canadian stock market. For many years, RBC has sat atop the TSX as the largest stock by market capitalization, its reign only periodically interrupted by the hot stock of the moment.
Going back to the early 1990s, RBC’s stock has compounded by roughly 16 per cent per year – less than half Constellation’s growth rate, albeit over a much longer time frame. Also, every third year or so, on average, tends to see RBC’s shares decline.
The last time that happened was in 2018, when RBC dropped by 9 per cent – the result of a rough patch for the global economy and hard times in the energy sector, as well as low mortgage growth amid a housing market correction. Constellation, on the other hand, gained 15 per cent that year, as the company deployed approximately $565-million in 52 acquisitions and generated so much cash that it paid shareholders a US$20-per-share special dividend.
The Canadian stock market, RBC included, also had disappointing years in 2015, as commodity prices retreated globally, and in 2011, over the European debt crisis. Constellation, meanwhile, posted calendar year gains of 67 per cent and 54 per cent, respectively. It even eked out a gain in 2008, when the global financial crisis sent the S&P/TSX Composite Index crashing by 35 per cent.
“There’s nothing remotely comparable in terms of durability and consistency in Canada, which has a lot of cyclical-type names,” said Tom Liston, a tech investor who, back in 2006, was one of the first equity analysts covering Constellation.
Consider how Constellation ranks up against other hot streaks in Canadian market history. From Shopify’s IPO in 2015 up until its peak last November, for example, shares in the e-commerce company posted a sizzling average annualized return of 90 per cent. But it has since gone into freefall, losing as much as half its value up to early February.
Constellation itself has not been immune to the recent convulsions in the tech sector globally, as inflation and rising interest rates have put growth stocks under pressure. The company’s shares declined by 15 per cent over the first few weeks of the year. For Kim Bolton, president of Black Swan Dexteritas, a Toronto-based hedge fund, that was the entry point he’d been waiting for.
“You rarely seem to get an opportunity to buy in at a cheaper valuation,” Mr. Bolton said. Constellation has since gained back about one-third of its lost value.
And since Constellation is a serial acquirer of other IT companies, a sell-off across the entire tech ecosystem is probably a net benefit for the company, Mr. Liley said. “One of Constellation’s best periods was after 2008, when companies were desperate to sell software divisions of larger businesses.”
Along with Shopify, another name that managed to usurp RBC as Canada’s largest is Valeant Pharmaceuticals International Inc. (now Bausch Health Cos. Inc. BHC-T). After merging with Biovail Corp. in 2010 and charting a course for aggressive growth through acquisitions, Valeant’s run lasted less than six years before its brutal reckoning. But it did manage to generate an average return of 82 per cent annualized over that time.
Then there is BlackBerry. Early smartphone dominance vaulted its stock to incredible heights, its annualized return averaging 54 per cent between its 1997 IPO and its peak in 2008. But there were big negative years in there, first when the dot-com bubble burst, and again in 2005, when the company faced a drawn-out legal battle over alleged U.S. patent infringements.
Nortel also needs a mention, considering it once accounted for more than one-third of the value of the Canadian benchmark index. In the 15 years up until Nortel’s great collapse got under way in 2000, its average annual return amounted to 28 per cent – well short of Constellation’s mark.
Constellation’s consistent outperformance reflects its extreme discipline, Mr. Liley said. It sticks to its investment criteria, it never overpays, and it mainly goes after companies that are generally too small to attract interest from private equity. These are software products with user bases that typically cannot operate without them, and when you put hundreds of them together, they spin off incredible amounts of cash.
The stock market’s graveyard has no shortage of growth-by-acquisition companies that were consumed by their own ambitions. As the company expands, the impulse is often to buy bigger and bigger. “Constellation did the opposite. They scaled up their team so that they can just do more small acquisitions,” Mr. Liley said. Clearly, Constellation’s stock cannot continue to rise at 37 per cent a year, indefinitely. But it has established a process that is repeatable over the long term. And its database of software companies has tens of thousands of potential targets.
Over the past year or so, Constellation has begun to stalk bigger game, targeting more deals in excess of $100-million. At the company’s annual general meeting last May, however, Mr. Leonard stressed that these were “side activities,” not to distract from the core focus on small and medium-sized businesses serving specific industries.
When pressed on the opportunity in large M&A, Mr. Leonard said, “I’m not sure it’s an opportunity. It’s an opportunity to fail here. We got good at something, and we should probably keep doing a lot of it.”
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