In-depth Economic-Financial Analysis Constellation Software Inc.

IMPORTANT: Click here to obtain the Economic-Financial Analysis document generated, where you will find all the calculations, ratios, forecasts, graphs, evaluations, and other data of interest presented in this post.

• Qualitative analysis
  • Business strategy, organizational structure, competitive advantages, management, qualities of its products and services, etc
  • Sector analysis
  • Macroeconomic analysis

• Quantitative analysis
  • Search for long-term trends.
  • Historical evolution of the company.Analysis of individual items (Revenues, Balance Sheet, Profit and Loss Statement, Cash Flows).
  • Ratio analysis.
  • Projections of future growth
  • Recommendations
• Final valuation

Financial health assessment

Constellation Software Inc.

In order to obtain a global approach to the company, we can introduce Constellation Software as a management company born in 1995, whose objective is to be able to supply business software to both public and private sector companies.

The company’s segments serve different markets, including the communications sector, asset management companies, tour operators, insurance companies, healthcare, hospitality, credit unions, textile sector, community assistance, notary offices, etc., and it is present in more than 60 vertical markets.

The company consists of six operating groups in Canada, North America, Europe, Australia, South America and Africa, with more than 25,000 employees and sales in excess of $4 billion.

Constellation has managed to present itself as one of the most recognized companies worldwide, justified by its growth both in terms of share price and revenues, going from managing $25 million to figures in excess of $43 billion.

Its success has been the result of its acquisition strategy, with a large number of brands working for the group.

For example, Constellation acquired Public Transit Solutions in 2009 for $3 million, generating more than $35 million in operating cash flow today.

The proportion of inorganic growth presented in the following image is approximately 75% in relation to its organic growth.

Constellation has managed to achieve annualized revenue growth of over 20% in almost all the years under consideration, surpassing this level even during the 2008 financial crisis, with a growth of 30%, proving to be an anti-crisis company.

This fact can be explained by its reputation as a software company, a service considered inelastic for the client, since in times of crisis, its provision continues to be essential to maintain the economic activity of the different companies.

In addition, Constellation’s strategy allows it to take advantage of weak market situations to make acquisitions at lower multiples, thus expanding the company’s margins in the long term.

Business strategies

Inorganic growth

Mark Leonard (CEO of the company) tries to buy distressed market leaders with solvable problems, promising improved internal management, higher growth, and building a very interesting appreciation potential.

When evaluating companies, Constellation has two types of filters, “Good Companies,” and “Exceptional Companies,” set out in the table below.

As for the management of the acquired organizations, Constellation’s methodology is to preserve its management team, giving them the freedom to make their own decisions, receiving financial, operational, and logistical support, as well as state-of-the-art technology developed by Constellation, in order to re-direct the business strategy with the objective of expanding its profit margins.

This philosophy relies on the experience of the management team in the acquired company, trusting that its management will reflect a skill in the different areas of the company, fostering innovation without renouncing to market synergies.

When acquiring companies, a very remarkable aspect of Constellation is the multiples at which it acquires companies, using a “Value” investment philosophy, resulting in a very significant improvement in capital returns.

On the other hand, Constellation qualifies itself as a “Buy & Hold” company, denying the management any possibility of sale with the advantage that this generates against investment funds or other competitors, as they try to develop the company through a long-term vision, without being its objective the future liquidation of the company in question.

Constellation has made more than 600 acquisitions, with estimates that support the future growth of this figure, trying to take advantage of companies that present a relevant position in the niche in which they operate, coupled with a potential for growth within its “Maintenance income” item, which we will see in detail below.

Organic growth

The company’s revenues consist of “Software licenses”, “Hardware sales”, “Professional services”, and “Maintenance and other recurring revenues”, with the geographic origin of these revenues as of 2020 being very varied, with the US leading (43.6%), Europe and UK (34.3%), Canada (12.4%), and other countries (9.7%).

Revenues in “Software licensing” are obtained after a premium is charged for the sale of Constellation products.
Revenues from “Hardware sales” consist of revenues from the sale of technology components to customers.

Professional services revenues consist of fee-based revenues, i.e. implementation and integration services, consulting, product training and customized support.

Finally, maintenance and other recurring revenues represent fees received after customer support, i.e. after-sales services, including fees derived from subscriptions, combined software/support contracts, transactions, cloud products and other software services.
This item is the most important one for Constellation’s management, trying to increase customer satisfaction in order to increase its retention rate, thus generating a recurrence in the company’s revenues.

In this way, after its increase, the company would see the cash flows generated by the group increase, with the objective of being able to finance its acquisition operations, originating a virtuous circle in the strategy formulated by Constellation.

This peculiarity, together with an updated product policy and its after-sales service, manages to satisfy any need that the customer may demand, generating a weight of the item “Maintenance income” over the total income of 80%.

This strategy has managed to generate an incredible return of 12,824.54%, contemplated through the image, not only at a quotation level, but also at a quantitative level, which we will see later on through the analysis established in this essay.

Analysis by business unit

Products and services

The very specific type of software provided by Constellation to its customers generates a high replacement cost, due to the learning cost generated after implementing the new software and the resources required to undertake such a change. In this way, Constellation generates high dependency rates among its customers.

Through the following illustration, we can see how the company managed to increase its prices above the inflationary level in the period between 2007 and 2016, exhibiting the high pricing power that the company has, obtaining great benefits in a highly competitive market, thanks to its focus strategy.

Such strategy manages to seek competitive advantages within specific segments of the industry, trying to generate maximum profit by adapting to the needs of its customers, without losing quality in its products offered.

In addition, by producing such characteristic niche products, it is very difficult for its competitors to try to replicate them, leading to a loss of interest from large technology corporations due to their high degree of specialization.

Clients

Constellation has a portfolio of more than 130,000 customers in more than 100 countries, a figure that tends to increase due to the solid growth offered by the company, allowing this geographic diversification, a reduction in risk.

At the corporate level, public organizations are more likely to maintain the service and products offered by Constellation, representing around 70% of total revenues, justified by the non-competition of the public sector, being more likely to accept the prices set by the company.

The fundamental characteristic that explains the constant increase in customer demand is the high fragmentation of the market, with a multitude of small companies trying to solve the needs generated by consumers.

By having such a large number of companies working under its brand, it gives the company the possibility of earning revenue in more than 40 different markets, diversifying risks, and maintaining Constellation’s power over its customers due to its dependence on the software generated by the company.

Revenue streams

It is worth highlighting the importance of the company’s revenue streams, since the growing demand for customers in the sector, together with the increase in renewals and new contracts, the company’s pricing capacity and the low rate of customer churn (4% according to its annual accounts up to 2016), generate recurring cash flows for the group, offering scalability in the company’s business model, by financing its acquisitions with this item..

Operational groups

The decentralization of power is another of the company’s key factors for obtaining higher returns, involving six operating groups.

Volaris, Harris, Jonas, Vela, Perseus and Topicus are its operating groups, all of them operating in the same way as their parent company Constellation does, with competition among them trying to generate the highest possible returns on capital.

Analyzing various letters and press conferences from the different senior executives of each group, we can observe the alignment of their strategy with that set by Constellation, with inorganic growth being the most noteworthy variable.

• “I spend 60% of my time on acquisitions (M&A), 20% on day-to-day tasks, and the rest on coaching tasks with employees and middle management” (Robin, CEO of Topicus).
• “I spend 70% on M&A and the rest on coaching with employees. Talent is key and we need to spend more time on future leaders” (Dexter, CEO Perseus).
• I spend 60% on M&A. Every quarter we review the numbers for each business unit. Once a year we have a physical meeting” (Jeff McKee, CEO Jonas);
• “50% on M&A, 30% on coaching and 20% on strategy and other managerial aspects” (Jeff Bender, CEO of Harris).
• “50% on M&A” (Mark Miller, CEO of Volaris).

Major subsidiary division, Topicus.

The Topicus operating group is a software provider specialized in vertical markets (as well as Constellation Software), headquartered in the Netherlands.

Topicus was acquired as of 2013 for €240 million, to be spun off in January 2021, following a full buyout of its shares, acting as an independent company through the Total Specific Solutions group and its subsidiary TPCS Holding B.V.

This spin-off presents a very important revaluation potential, since its market offers a fragmentation even more marked by the great regularization that Europe presents and the decrease in size per country, assuming a possible revaluation in the profitability offered by Topicus, and with it, greater benefits for the group.

This fact allows us to observe another great advantage offered by Constellation compared to the sector, since due to its high capitalization and the level of acquisitions presented, it offers the possibility of obtaining a greater number of spin-offs in the future, with the growth potential that this entails for the company’s future profits.

Organizational structure

Constellation uses a decentralized structure, allowing the management of each acquired company to focus on those sectors in which they have a strong knowledge, understanding the industry and its different needs, allowing them to develop their operating margins.

In this way, Constellation will be able to provide a better service to the client, proving to be able to obtain a shorter response time to the demands generated by the sector.

Within its organizational management, there are two main figures, a business unit director, trying to optimize local opportunities and ensuring compliance with the objectives set, and portfolio managers, seeking efficiency in capital allocation by locating companies to acquire and continue generating profits.

Through this model, even with a capitalization of 43 billion, acquiring companies of less than 10 million is still feasible, so its structure will allow Constellation to continue gaining market share, albeit to a lesser extent, as will be discussed in this essay.

Management team

Mark Leonard is the current CEO of the company, with more than 11 years of industry experience through investment funds and corporate banking.

This experience has provided him with a solid background in operational and capital allocation efficiency, focusing on aspects such as cash generation, high ROIC returns, and a high reinvestment rate.

Much of the exponential growth experienced by the company has been driven by his and his management team’s decision making, coupled with his capital allocation efficiency and passion for managing the organization, as we will see below.

As we can see, the company’s top management is fully aligned with the shareholder, with Mark Leonard at the head, obtaining a total of 2.03% of the company’s shares, equivalent to 897 million dollars invested.

On the other hand, it is worth mentioning the salary obtained by Mark of a single dollar generated in compensation for services rendered to the company.

It is also worth mentioning the obligation of his management to reinvest at least 75% of his variable salary (amount dependent on the performance of the business) in shares of the company itself, with the prohibition of selling these within a period of 4 years.

Therefore, we can see a very strong commitment by the management to the proper management of the company, proving to be a good indicator of expected future profitability, as being influenced by the performance of Constellation, we can corroborate the good critical thinking they will take when implementing their decisions, impacting positively on our estimates.

Acknowledgments

• Position number 1451 in the global ranking of best companies published in Forbes magazine, between 2000 and 2021.
• Position number 440 in the ranking of the world’s best employers, 2020.
• Position number 25 in the ranking of best digital companies, 2018.
• Position number 22 in the ranking of best innovative companies, 2017.

Qualitative assessment

In relation to the qualitative aspects seen so far, an estimate of the company’s viability has been projected, giving a numerical value of 0 or 1 to the most dissuasive variables collected in this study, where Constellation has managed to obtain a score of 9.29/10.

The capital structure presented by Constellation was the variable that was most taken into account when evaluating the study, justified by the fact that it is the basis of any growth strategy undertaken by the company’s management.

Next come the variables related to the products and services offered by the company, followed by the management of its board of directors.

The score achieved allows observing the good management and scalability of its business model, with key features and competitive advantages that distinguish the company, being its pricing power, high cash flow generation, long-term profit generation, efficient capital allocation and management alignment, some of the most remarkable aspects.

In addition, it can be seen how Constellation manages to generate catalysts in almost all of the exposures shown, reducing its exposure and resulting in all these variables being influential for the future viability of Constellation’s economic model.

Sector analysis

Constellation establishes its economic activity within the service sector, focused on the subsector of information technology or ICT, whose area specializes in software and computer services.

Despite the fact that the Canadian market has obtained a percentage of sales of 12.4% of total revenues, we consider it appropriate to study the sector within this market, as it is mainly influenced by it, and it also presents a potentially bullish situation in the projections analyzed, as will be explained below.

Services sector

The service sector represents 68% of Canada’s GDP economy, employing more than 79% of the active population, growing at a relentless pace (as can be seen in the following illustration) and shifting the trend of the economy accordingly to the growth of this sector.

Information technology and telecommunications

Within the services sector, we locate the information technology and telecommunications subsector, better known as ICT, which, according to “Innovation, Science and Economic Development Canada”, accounted for 5.1% of Canadian GDP and 3.7% of Canada’s workforce, equivalent to some 670 thousand workers.

As we can see, the ICT subsector is made up of four areas to be addressed, with software and computer services (Constellation’s specialized area) being the most important, with a weight of 47.6% of the GDP generated by the ICT sector.

Fields such as 5G, cloud technologies, analytics branch, digital economy, etc. reflect a growth in annualized GDP since 2014 of almost 4%, with more than 40 thousand companies working in this subsector.

Even in 2020, with the economic crisis suffered by the pandemic, ICT grew at rates of 2.9% of GDP, while the Canadian economy fell by -5.1%, proving to be a sector considered anti-crisis, like Constellation at the enterprise level.

To Constellation’s advantage, the software and computer services area was the segment that experienced the greatest growth in revenues, with 41.6% of the total generated by ICT, with an annualized growth of 5.65% for the sector.

Through the illustration, we can observe the growth of the different areas of the ICT subsector, whose growth has varied significantly throughout the year 2020, being the area of software and information systems the one with the highest rates of income (9.4% growth), employment (4.9%), GDP (5.5%) and investment in R&D (3.8%) with respect to the rest.

Software and IT services

In this area, we can include computer services, data processing, software development and communications, etc., representing 2% of the Canadian GDP and 47.6% of the GDP of the ICT subsector.

This area has reached sales of more than 50 billion Canadian dollars, projecting a wide margin for improvement, since according to “Stats”, Internet access is not yet complete in the country, with a total of 6% of Canadians without access to the Internet.

In addition, as explained in previous chapters, vertical markets in software and IT services are highly specialized, generating high barriers to entry (as they are highly fragmented industries) and increasing demands in terms of new customer needs.

Competitors

Although Constellation does not have strong competition, the objective of the analysis is to measure the viability of the company’s future sales due to a possible loss of market share caused by the development of a competitor.

The lack of competition is justifiable to the strategy set by the company, being considered rare due to the great development experienced in inorganic growth, cash flow generated by the company and high rates of return obtained, coupled with the large size that Constellation has, making it really difficult to compete against it.

To this fact, we must add the consolidation phase in which it is in the market, because due to the huge market capitalization experienced by Constellation, it cannot undertake acquisitions or growth strategies that can expand its margins faster, because little by little, they are decreasing the number of opportunities to acquire after not seeing their profits reflected in the group’s profits.

Therefore, comparing the company with small-cap companies offers an inequality in comparable terms, since the phase in which the companies find themselves has already been experienced by Constellation, currently tending to slow down their ratios as they consolidate in the sector.

However, we will proceed to analyze companies such as Roper Technologies, Enghouse Systems, Vitec Software, Jack Henry and various venture capital funds, which, although not very important for the growth of the company, could generate fluctuations in their results.

• Venture capital funds

Private equity funds seek to improve the efficiency of companies by developing their growth, in order to liquidate them for maximum profitability.

As Constellation has a “Buy & Hold” philosophy, it generates a competitive advantage over these entities, as its intention is to invest in the company in the long term, normally generating greater confidence in the shareholders of the company, giving them more freedom to continue making their own decisions.

As a negative aspect, we have the price at which this acquisition is paid, since private equity funds charge higher prices than Constellation, losing many of the disputes between the two due to the lower remuneration presented.

• Jack Henry & Associates

This company seeks to provide technology software solutions and payment processing services to community banks and other companies in the financial sector.

They have a portfolio of more than 9,000 clients, thanks to their strategy of acquiring companies in vertical markets, with the particularity of carrying out their activity only in the financial sector.

On a quantitative level, Jack Henry & Associates has greater solvency in its accounts, presenting liquidity ratios above those of Constellation, with a lower use of financial debt and ratios similar to those of Constellation, with the exception of ROE, where Constellation clearly benefits.

In terms of margins relative to sales, Jack Henry is ahead in net margin, being surpassed by Constellation in cash flow margin.

As for the goodwill presented by the company, as of 2020, it contains a value of 686,334, with a percentage over the level of assets of 29.42%, while Constellation, with goodwill of 432 million, contains only 10% of total assets, again being outperformed by Jack Henry & Associates.

• Roper Technologies

Roper Technologies is an industrial company, containing a wide range of products and services in more than 100 countries.

The company is currently undergoing a transformation process as it seeks to reinvent itself by offering hardware products focused on niche vertical markets.

Quantitatively, the company’s liquidity ratios are in line with those of Constellation, as well as debt levels used. However, it is outperformed by Constellation in terms of financial profitability, although it generates higher levels of return on equity.

In terms of sales margins, the company manages to exceed the levels presented by Constellation in net margin, but not in free cash flow.

• Enghouse Systems

Enghouse is another company focused on different vertical markets, with special mention to the financial sector, utilities and telecommunications.

The company concentrates its strategy on inorganic growth, showing very good performance after the results obtained by the company. However, the cash levels generated after its acquisitions also fail to exceed those of Constellation.

We could place Enghouse as one of the main competitors to be taken into account, as the company is ahead of Constellation in terms of liquidity ratios and debt levels.
On the other hand, margins are at the same level, with a discrepancy in ratios, as Enghouse achieves higher growth in return on equity, while Constellation achieves higher growth in financial ratios (to a much greater extent).

Enghouse’s working capital contains a value of 217,426, with a percentage of assets of 53.51%, clearly exceeding Constellation’s level of 10%.

The key that differentiates one company from the other lies in its organizational model, with Enghouse presenting a centralized model, trying to generate market synergies, and Constellation having a decentralized model, more focused on finding good businesses that make the most of the cash flows for the group.

• Vitec Software

Vitec Software presents itself as an industry leader in the Norwegian vertical markets, supplying business software through niche markets, and growing through acquisitions, exactly like the strategy implemented by Constellation.

In terms of the main areas in which it operates, we can classify its offerings into software solutions, consulting services and support services.

With respect to its ratios, Vitec presents mixed results, as it manages to outperform Constellation in net margin, return on equity and lower level of indebtedness, but surpassed in the rest of the metrics such as financial profitability and liquidity levels.

• Open Text Corporation

Open Text Corporation is the largest software company in Canada, and may be the only company that could show fluctuations in the market share obtained by Constellation, developing business management software, allowing interaction with SAP.

However, despite its large presence in the national market, it could only be compared in terms of information software, so an increase in its market share would not significantly affect Constellation either.

In terms of the ratios presented by the company, Open text generates a better result in liquidity and net margin generation, being outperformed in the rest of the metrics analyzed by Constellation.

Qualitative assessment

At the sector level, we witness the potential marked by this sector, generating an upward trend in the different areas in which Constellation operates.

This growth is justifiable to the qualities analyzed in this essay, where we can observe the different variables taken into account, managing to generate a score of 9.28/10, justified by the boom in the sector, and the ICT and software areas, found in the economic activity of the company.

Although there are competitors in the sector such as Jack Henry, Vitec or Enghouse Systems, whose growth prospects may affect Constellation’s market share, the level of capitalization marked by the company and its consolidation in the sector make it impossible to compare this giant with high-growth companies.

In addition, the deferred income generated in higher proportion compared to its competitors is detrimental to the company’s liquidity and leverage levels.

Constellation, therefore, offers a very high market potential after having verified the variables that can continue to generate a positive trend in the sector, being able to take advantage of the opportunities that arise due to its market power, to continue consolidating itself in the sector through future opportunities that may arise.

Macroeconomic analysis

PESTEL Analysis

Through this analysis, general aspects of possible macroeconomic variables that could alter the company’s main activity will be analyzed.

Despite the fact that Constellation is a brand that operates internationally, and has only a 14.4% share of the Canadian market, we have analyzed both global variables and variables of the country itself, since its headquarters are located there, and it is mainly affected by possible changes that may occur.

In addition, as it has been presented as a potentially bullish market (as seen in section II. ), its exposure has been analyzed in order to establish a possible good future opportunity presented in this country.

It is important to point out that only those variables that have the greatest impact on the company will be taken into account, as it is highly beneficial to obtain an estimate of possible external variables that could have an impact on the business activity, especially now with the fiscal policies in place.

Political factors.

In reference to the measures carried out by governments and Central Banks, we can observe how to date, they have tried to boost the economy by carrying out expansionary measures, trying to make the economy grow in the short term.

However, due to the level of inflation generated, they have been forced to change their strategy through the use of restrictive policies, which we will see below, negatively affecting Constellation’s interests.

In terms of international trade, Canada is a member of the World Trade Organization and has a good track record of growth with a multitude of global partners.

Canada’s judiciary is isolated from the other representative bodies, so this is a positive factor in favor of non-politicization of the measures in place.

As for the country’s corruption, according to the “Canadian Public Sector Corruption Perceptions Index”, it is at a level well below average, with the inhabitants of Canada having a very low perception of corruption in their government.

In reference to the regulatory aspect, Canada has few restrictive measures on its economy, favoring free trade, and is considered one of the most important countries to take into account in the creation of business due to the ease of its procedures, positioning Canada in the 14th position out of 141 countries shown by the last “Competitiveness Index” as of 2019, representing for Constellation an opportunity to attract new clients.

Economic factors.

The CPI rate generated in Canada as of November 2021 was 4.7%, which is a very negative aspect for the economy, as it tends to result in higher expenses in line with the level of inflation generated.

It is true that, since Constellation has pricing power, it will try to pass on these costs directly to the consumer. However, this measure will reduce the company’s customer base.

This increase in inflation levels has prompted the Federal Reserve to raise interest rates to 2.1% by the end of 2024, resulting in higher financing costs for companies.

On the other hand, the level of savings generated after the pandemic produced an unusual increase in the different economies, now normalized growth, benefiting Constellation by an increase in its sales levels.

In terms of taxes, Canada ranks 21st out of the 38 countries analyzed by the OECD in 2020, making it less attractive for investment in the country, with a level of 34.4% above the average (33.5%).

Another negative aspect of Canada is its high level of indebtedness. As of 2020, the country has a public debt of 1,692,725 million, making it one of the countries with the highest debt in the world (debt ratio of 117.46% of GDP).

This fact may reflect a tax increase in the long term to cope with the excess debt generated, implying a possible reduction in profits for Constellation.

However, the risk premium presented by Canada with respect to the U.S. has shown a historical downward trend, with a substantial increase generated by the pandemic, standing at 1,537 points as of October 1, 2021.

This reduction in Canada’s risk premium allows companies to have more financing at lower costs, which is a very positive aspect to take into account.

As for Canada’s GDP volume, we are also facing a really positive aspect, as Canada’s economy is considered one of the most important in the world by GDP volume, standing at around €37,919.

Through the following illustration, we can observe the trend in volume of GDP per capita in Canada, offering a very favorable growth for the country’s economy, with an average salary as of 2020, of around 37,446€ per year, maintaining the 19th position out of a total of 42 countries analyzed by the newspaper Expansión.

Social, technological and environmental factors

With respect to the demographics of the country, Canada presents a positive trend generated in large part by the increase in immigration, coupled with the high level of quality of life that the country presents (ranked number 1 according to the report of the best countries of 2021), generating for Constellation, a higher rate of potential customers in the future.

On the other hand, as has already been mentioned throughout this essay, Canada offers room for improvement in terms of accessibility to the connection network, which could once again provide an opportunity to obtain a larger customer base.

As for research and development, the Canadian government is committed to the development of this area, providing aid to build a technological ecosystem that is a leader in innovation, benefiting our company as can be seen in the subsidies received by the government in its annual accounts.

With respect to the environment, Canada is a signatory to the Paris climate agreement, and there is a high level of activism on the part of the country’s inhabitants on this issue.

Therefore, although Constellation’s main activity does not involve environmental areas, the company should try to generate a strategy based on products or services that can contribute to sustainability.

Risks

• Pandemic risk

The evolution of the pandemic is considered one of the major risks to be taken into account in order to preserve Constellation’s profits, as depending on its evolution, expansionary or recessionary measures will be taken to control the effects generated by the pandemic.

The Canadian economy fell by 7.1% as of 2020, the largest economic contraction seen since 1945, caused by a slowdown in consumption and activity.

However, the virus is showing signs of weakening, as the final stage of any pathogenic agent goes through a slowdown in mortality, in order to increase its contagious force, giving the virus the possibility of not being extinguished together with the affected individual.

Precisely in this phase we find ourselves on December 28, 2021, with a very reduced entry in UCIS, but at a vertiginous rate of contagion produced by the new “Omicron” variant.

Countries whose infections by the new variant (such as Germany or South Africa) are already in a process of deceleration, have been able to experience an exponential growth in new cases with very low mortality, having to stabilize in the same way in which the infections occurred.

It is precisely this stage where we are currently, being able to see the virus in one of its final cycles of expansion, offering a parallelism with the event occurred in 1918 before the “Spanish Flu”, which followed the same pattern, marked by three major peaks of infections and offering herd immunity two years after its inception, as well as the stage in which we are currently.

Therefore, although we do not know when the virus will die out, we can be confident that there will not be an increase in the mortality of the pathogen, without experiencing situations as harmful to the economy as those seen in previous years.

• Risk of acquisitions

Acquisitions represent the company’s main growth driver, and a slowdown in this variable could create a difficult situation for Constellation.

Until now, Constellation has been making acquisitions which, thanks to the company’s decentralized model, have had an impact on the group’s profits.

However, this situation tends to be reversed after the high level of capitalization shown by Constellation, making it difficult for the company to maintain its profit margins, as it would have to make a greater number of acquisitions, or carry them out in greater proportions.

Both solutions offer the same problem, as one results in a smaller scope on its profits, and the other in a reduction of companies to be valued as there are fewer large-cap companies.

Even the company’s CEO, Mark Leonard, has communicated this message in several press releases, so if Constellation wants to preserve its financial ratios, it will have to consider these two options.

Another problem caused by this situation is Constellation’s obligation to pay higher multiples for companies in a situation where it will have to make acquisitions, decreasing its return on capital, not only because of the need to invest more capital to influence its profits, but also because of the overvaluation that exists in the market.

According to the “Buffet Indicator” shown in “Illustration 10”, the market is in a situation of overvaluation, leading to a decrease in Constellation’s buying pace in recent years, as it is incompatible for the company to make acquisitions above its intrinsic value.

Constellation must therefore prevent these exposures in order to continue its normal pace of growth, obtaining catalysts in the more than 40,000 acquisition opportunities operating in the various vertical markets, in addition to having a strategic alliance with the company Hiraki Tsushin, belonging to Japan, through which Constellation could continue to expand geographically in the Asian market, managing to generate even more market opportunities.

• Interest rate risk

Interest rate risk is another of the major risks that the company presents when it comes to affecting the company’s accounts.

As analyzed in the macroeconomic section, the high level of inflation has led to an increase in the interest rates set by the central banks, resulting in an increase in costs in two ways: on the one hand, the costs generated by inflation, and on the other, the increase in the cost of financing caused by this increase in interest rates.

In addition, with rising interest rates, there is usually a rotation of capital into fixed income, directly affecting Constellation’s market capitalization.

However, the yield on the U.S. 10-year bond is currently 1.5%, well below the interest rate set by the Fed for 2024 (2.1%), so there could be variations in both the rate hike and the increase in the bond yield.

However, this is still a “negative” aspect for the company, as whether there is a correction or another one, they will see their costs increase (with their level of fixation as a catalyst).

Macroeconomic valuation

Reviewing the variables presented in this essay, we can corroborate that there is not a good macroeconomic situation, since there are particularities that generate a difficult situation for companies, mainly at the inflationary level, the country’s debt levels, and restrictive policies carried out by central banks.

However, Constellation presents catalysts that manage to minimize these impacts, with a greater number of positive variables than negative ones, such as the good historical economic development, low risk premium, growth in its demographics, favorable commercial policies, etc., which generate a rating of 7.5/10.

In its calculation, economic variables have been considered as the element with the greatest impact, being in this section where the least advantages have been generated.

This is followed by political factors, followed by technological and social variables, all of which have characteristics that can boost the growth obtained in macroeconomic variables.

DAFO

Weaknesses.

Internal areas that Constellation should refine, as they limit capabilities that other competitors could take advantage of and differentiate:

• Artificial Intelligence and Machine Learning. Constellation has strong capabilities in data science and related software. However, the company’s accounts do not reflect a significant investment in the field of Artificial Intelligence, which is one of the most important aspects in the development of new technologies.
• As we will see below, until 2018 Constellation did not make use of debt to finance its activities, changing its trend from this date, presenting a potential devaluation in its business results due to the increase in interest rates raised.

Threats.

External setbacks that could hinder Constellation’s objectives, including the following:

• Social inequality. Globally, a growing generation of inequality is being experienced, which may affect the company’s income, as it would decrease customer demand for the products and services offered.
• The software industry is a market with high regulatory changes, as it is considered an “unknown” subject, always trying to benefit the small consumer through laws in favor of these, so Constellation must remain aware of any possible variation in the sector.
• Atypical events. The conflict between Russia and Ukraine, the trade war between China and the United States, high inflation levels, consequences generated by the “Brexit”, etc. have a direct impact on the company’s interests, and Constellation must remain aware of any event, trying to minimize impacts on the organization’s objectives.
• Reduction in the level of acquisitions. The growing overvaluation of the market, together with the size of the company’s capitalization, has reduced the company’s rate of acquisitions, directly affecting its results, and presenting a great difficulty for the future, as it is the company’s main growth engine.

Strengths.

Characteristics that allow Constellation to create a competitive advantage over the market in which it operates, classified as follows:

• Human Resources. For Constellation’s management, employees are one of the company’s main attributes, being indisputable the quality of the management teams of each acquired company, with a really high value of experience.
• Physical resources. Constellation has a very broad portfolio of products and companies working under its brand, which allows the company to enter different market segments and focus on very specific niches.
• Financial resources. As we will see below, Constellation has a really positive cash generation, generating returns well above the sector, with the objective of generating cash to reinvest in the company.
• Brand value. As we have seen throughout the essay, if there is one thing that characterizes the company, it is the amount of competitive advantages it has, exhibiting its power over the market segments in which it operates.
• Company management. Again, as we have been able to establish throughout this essay, Constellation’s management has played a fundamental role in the growth presented by the company, with management teams aligned with Constellation’s objectives, and a CEO focused on creating value for the group.

Opportunities.

Advantages presented externally to generate opportunities for expansion or consolidation in the sector, distinguishing the following:

• Geographic expansion. The expected performance of the sector shown in this trial, coupled with the company’s very small market share in the Canadian market (12.4%), means that there is a potential opportunity for expansion within its domestic market in the coming years.
• Entry costs. The boom in the use of digital marketing has allowed companies to optimize costs in entering new markets, using digital media and data to estimate whether such entry could have a positive impact on the organization’s profits, and Constellation could make use of it.
• Asian market. Thanks to the strategic alliance with the company Hiraki Tsushin, Constellation will be able to generate potential customers, obtain new acquisitions and continue to expand the cash flows originated to date.

Quantitative analysis

The estimates presented below have been proposed based on the historical growth of the individual-level items set out in the annual accounts of Constellation Software Inc. as of September 2021.

Regarding the methodology chosen for its calculation, the estimate for the fourth quarter of 2021 has been made based on the growth obtained in the Q4 results from 2016 to 2020, thus obtaining an estimated Q4 result in 2021, and with this, the annualized result of the company as of 2021, since we did not have the relevant information for this last quarter of the year.

Once the annualized results for 2021 have been obtained, we will proceed to estimate the remaining years using the historical average between 2016 and 2020 without taking into account 2021, since it would not be consistent to make a projection on an estimate made (without being the actual Q4 results).

In addition, the results obtained in the first three quarters have been atypical for the company, due to the large outlay made in the Topicus acquisition (thus reducing its profit margins), as well as a rebound in sales produced by the tailwinds generated after the pandemic.

Thus, the projections show a sustainable development of the company, justified by the good management of its board and the growth of the sector, in addition to tolerating macroeconomic events analyzed in which Constellation did not have a catalyst.

To try to make a more realistic analysis, we will project graphs omitting the year 2020, date of origin of the economic stagnation produced by the pandemic, applying a linear propensity (obtaining the trend movement of the item) and polynomial (weighting with greater importance the different fluctuations that have been made), averaging both to estimate the final trend of the item analyzed.

Finally, as regards the table of projections attached to each section of this paper, a green symbol indicates a projection in line with the history of the item, and a yellow symbol indicates a change in trend, which we will try to justify.

IFRS 16 (NIIF 16).

It is important to comment on the application of IFRS 16 (IFRS 16) in the company as of January 1, 2019.

This methodology causes the creation of new items in “Balance sheet” and “Cash flows”, being necessary to apply the relevant changes described below.

The regulation has become mandatory for all listed companies, whose purpose for the reader is to try to assess the effect of the leases made by the company within its accounts, providing greater certainty in the calculations established by the company.

For this purpose, Constellation must record the future payments contained in lease contracts at present value as a liability, while the “rights of use” associated with the leased asset will be translated as an asset of equivalent value, making its transactions more visible.

The method used by Constellation to measure its lease liabilities has been discounted payments, using an average incremental borrowing rate of 3%.

As a result of this measure, we have normalized the growth of some items, trying to make their estimation realistic, as there could be divergences in the company’s liabilities trying to compare its results with previous periods.

REVENUES.

Analyzing the growth in sales generated by the company, it can be seen how its development between 2016 and 2020, experienced a growth of 16.90%, with the first quarter being the one with the highest increase compared to the other three (19.21%).

We can see how the trend in sales of the company tends to increase, supporting the estimates made in this essay.

Despite not being included in the graph, sales in 2020 showed a growth rate of 13.7% with respect to the previous year, a level below the historical level due to the impact of the pandemic on its activity, with the licensing item being the most affected (due to the reduction in patents carried out by the company after the appearance of COVID).

However, by 2021, revenues are likely to increase in line with historical growth, with an increase of 26.5% compared to 2020 if the estimates generated in Q4 are met, justifying this increase to the normalization of growth compared to the previous year, and the favorable conditions following the pandemic.

As for “Maintenance and other recurring revenues”, it has been the item that has experienced the highest growth, with an annualized 19.06%, justified by being the most relevant item for the company.

The remaining items have also achieved sustainable growth, but at lower rates, with “Professional services” being the second fastest growing item (14.70%), followed by “Licenses” (13.06%), and “Hardware and other services” (3.43%).

Regarding the increase obtained by the items as a percentage of sales, it should be noted that the only item that has obtained a positive performance has been the item “Maintenance and other recurring revenues”, whose development has increased from 65.9% in 2016, to 70.9% as of 2020, again, consolidating the strategy of the management with respect to this item.

The item “Hardware and other services”, in addition to being the item that has experienced the lowest annualized growth, is also the item that has lost the highest percentage with respect to total revenue (from 7%, to 4.3%), followed by “Licenses” (from 6.7% to 5.9%) and “Professional services” (from 20.4% to 20.1%).

Projections

From this table, it can be seen how the estimates made in the model follow the historical growth line marked by the company, with a slight upturn in total sales (17.44%), due to the increase in the growing demand for software, and the company’s potential development in the Asian market.

In addition, another influential factor is the estimated cash flows expected to be generated by the acquired companies, providing the group with higher revenues.

On an individual level, the item “Maintenance and other recurring revenues” is expected to continue its upward trend with respect to total sales obtained, generating a weight of 74.8% as of 2025, compared to 70.9% in 2020, credited to the company’s strategy of being able to generate higher returns in this item.

On the other hand, the rest of the items will follow the historical trend as a percentage of sales, except for a notable decrease in the “Hardware & Other” item, due to a reduction in components as a result of the growing use of cloud services.

BALANCE

Assets

• Short-term assets

With respect to the company’s balance sheet, we can see how all the current asset items shown by the company follow a linear upward trend, with “Inventories” being the item that has experienced the lowest growth (8.23%).

This fact is atypical, because even though we are dealing with a company in the services sector focused on software, with digitized products and subscription services, it is considered one of the most relevant items in assets, with Constellation obtaining only 0.7% of the weight on the total current assets of the company.

Projections for this item follow a downward trend as a percentage of sales for 2025 of 0.4%, justified by an increase in cloud services, resulting in a lower demand for inventory by the company.

The “Accounts receivable” item, originated by the sale of products and services, has maintained a historical growth rate of 18.67%, growth in line with our estimates, increasing its weight with respect to sales to 11.9% by 2025, compared to 11.4% in 2021.

On the other hand, the item “Cash and cash equivalents” has played a fundamental role, with an annualized growth of 20.89%, being the most relevant item in the company’s current assets, with an average percentage over total current assets of 32.71%.

The item “Other assets” has experienced the highest historical growth (22.84%), due to the sub-items “Prepayments” and “Other current assets”, with the latter accounting for 55.3% of the total item.

All these variations have generated a historical return on short-term assets of 19.58%, growth well below the estimates of 26.89%, justified by an increase in the amount of cash generated by the company, achieving an increase in the weight of current assets from 36.2% as of 2020 to 39.75% in 2025.

• Long-term assets

With respect to long-term assets, the item “Intangible assets” is the most important item for the Group, with a percentage over total assets of 53.2%, leading to the so-called “Knowledge economy”, providing benefits for Constellation in the form of increased sales, productivity gains and possible cost reductions.

This item reflects, according to note 6 of the notes to the financial statements, assets in the form of technology, customer portfolio, non-competition agreements, trademarks and goodwill.

In terms of its calculation methodology, Constellation uses the income approach to value its intangibles, a technique that calculates the fair value of an asset based on the cash flows expected to be achieved over its useful life.

Analyzing the data provided as of September 30, 2021, we can see how the subheading with the highest carrying amount is “Assets in customer portfolio”, with $1,292 million (42.98% of the total), giving us an idea of the value generated through the level of users that the company has.

Next we find “Technological assets”, which, despite being the largest investment, is also the one with the highest accumulated amortization cost and loss of value, generating a book value of 1,119 million dollars (37.22% of the total), thus showing the capacity of the business to generate value through the company’s technological operations.

Finally, the third most representative subheading of intangible assets is “Goodwill”, with a total of US$568 million (18.89% of the total).

This value shows us the power the company has in generating future profits thanks to the value shown by its intangibles, reflecting the strong brand power of Constellation and the amount of competitive advantages the company presents, obtaining a higher potential market value than it reflects in its accounting.

With respect to its calculation, the goodwill is attributable to the company’s practices of improving flows in its acquired companies, in addition to the creation of synergies and other intangible assets, such as the experience generated in its employees.

Its methodology is simple, as Constellation records variances when the purchase price of the asset paid for the acquisition exceeds the fair value assigned to the identified tangible and intangible assets.

In this way, there is no amortization in the item “Goodwill”, but it is reviewed annually (or extraordinarily in the event of an unusual event), checking the possible impairment that could be established in its value in discounted cash flows, being lower than the book value of the asset.

Returning again to the intangible assets item, we have established an increase in our estimates of 25.83% compared to the historical 23.68%, justified by the importance that it will have for the company to continue generating value that may represent competitive advantages and benefits derived in the company’s economic activity.

On the other hand, the item “Correct use of assets”, obtains the second position in relation to the weight obtained as of 2021, with a normalized growth (as it is an item generated from the adoption of IFRS 16) of 7.26%, recording the necessary variations in the accounting through the new model implemented.

All this has led to an annualized historical growth in long-term assets of 25.91%, growth above the established projections (24.60%) due to the increase in the items already justified.

• Total assets

Confirming the trend marked by the company’s total assets and the variability shown in the different asset items, we can establish an estimated growth over total assets of 25.49%, slightly higher than its historical figure of 23.43%.

Liabilities

In relation to the company’s liabilities, we can observe how the balance sheet again presents items under the influence of the “IFRS 16” methodology, with the name “Lease obligations” implemented as of January 2019.

• Short-term liabilities

Within the company’s current liabilities, there is the item “Deferred income”, which has obtained a greater relevance in this test, due to the deviations in the level of ratios obtained by the company.

The purpose of this item is to be able to account for the capital obtained through the underwriting model established by the company. In this way, said income is not understood as profit until the service guaranteed by Constellation has been produced, being kept in this item until this fact occurs and it can be transferred to the item “Accounts receivable” already mentioned in the current assets.

This accounting methodology will generate a deviation in the results and growth obtained by the company, as it will seem to have in liabilities a figure of the real one, since it blurs the metrics by containing a “hidden asset” within its liability accounts, which we will see in greater detail in the “RATIOS” section.

The item, therefore, is the one that reflects the greatest importance in current liabilities (29% of total liabilities), achieving a historical growth of 19.26%.

The items that have shown the highest growth have been “Accounts payable from acquisition retention” (49.41%), and “Redeemable preferred securities (39.65% annualized), both related to the acquisitions undertaken by the company, justifying once again its implemented strategy.

As a result, Constellation has obtained a historical growth in its short-term liabilities of 23.50%, with an estimated growth slightly higher than its historical growth of 24.13%.

• Long-term liabilities

With regard to long-term liabilities, the items that have shown the greatest growth have been “Non-recourse debt to Constellation Software Inc.” (transaction costs between Topicus and Constellation) and “Other liabilities” (contingent consideration and other deferred income, with growth rates of 47.15% and 32.03%, respectively).

In addition, it is worth noting the timid decrease shown by the company’s long-term liabilities, which are always trying to generate the same level of debt, with a development of -0.10%.

The increase in practically all long-term liabilities, with the consequent large increase in the item “Other assets”, has generated an estimated growth of 25.37%, a level above the historical figure of 23.63%, increasing its relevance with respect to the company’s total liabilities.

• Total liabilities

As for the total liabilities generated by Constellation, we can observe the upward trend marked by its history, with 23.55%, slightly higher than the growth of the company’s assets, which at first glance could imply a negative financial situation of the entity.

However, it is worth highlighting the item “Deferred income” as the cause of this deviation, as Constellation does not have any financial problems in its accounts.

To better understand the impact of this variable, we have proceeded to evaluate the “Working capital” obtained by the company, which, taking into account the item “Deferred income” as a liability, obtains a negative result as of 2020 of -451.7 million dollars.

If we recalculate this item as part of the company’s short-term assets, we obtain a working capital of 1462 million dollars as of 2020, thus visualizing the numerical difference between the two scenarios.

Equity

In terms of equity, we can see how the share capital item has remained intact over the years, without having the need to undertake capital increases in search of financing by diluting the value of the investors’ shares.

With respect to the item “Retained earnings”, a major importance can be observed with respect to the total net equity of the company (93% as of 2020), with an annualized growth of 25.56%, showing the company’s capacity to obtain net profits.

Through this item, we can highlight the capital allocation carried out by the management, which shows us a return for every $1 invested in the company of $1.44 of profit in relation to the net profits obtained, showing us again the value of the company.

The development estimates made in the item “Retained earnings” have been increased for the coming years, obtaining a growth of 27.40%, justified by the potential need to acquire companies at higher multiples, the need to undertake larger acquisitions and the preservation of capital in view of the increase in interest rates.

Finally, the new items “Other equity” and “Minority interests”, reflecting the profits obtained by its subsidiary Topicus after its acquisition, as it controls more than 50% of its shareholding, should be highlighted.

Since there is no established history for its estimation, its growth has been normalized through the profits shown to date, being conservative and having projected a growth of 17.05%, in line with that reflected in its cash flow generation.

However, this spin-off presents a very significant potential for revaluation, as its market offers a more marked fragmentation due to the strong regulation in Europe, together with a reduction in the size of its countries, which could multiply the profitability offered by Topicus, and with it, higher profits for the group.

The company managed to increase its profit from 100 million dollars to 180 million dollars in less than three years, obtaining a historical growth in its sales and EBITDA metrics of 28% and 29% respectively, showing us the potential for revaluation of this item.

For this reason, despite the expected decrease, future growth of this item is expected, achieving estimates of 26% in 2025, compared to 24% in 2020.

Valuation

Through the data shown, we can observe how the items of “Net equity” and “Financial debt” are those that have experienced a greater variation in relation to the history presented.

In relation to the “Equity” item, as we have already mentioned, the increase was due to the spin-off of the Topicus company, which generated profits in line with the historical performance.

On the other hand, the decrease in the use of debt made by the company is due to the increase of the new items “Lease obligations” both short and long term, trying to normalize their growth as they become recurrent items as a result of the implementation of the “IFRS16” methodology.

The item “Total assets” has been increased due to the increase in cash that the company will obtain after analyzing its cash flows as described in section V. The increase in intangible assets previously justified, achieving an estimated growth of 25.49%, a level above that established in total liabilities by an estimated 24.60%.

Income statement

Costs of goods and services

Within the item costs in goods produced, we have “Personnel”, “Hardware” and “Licenses, maintenance and professional services” costs.

Of all of them, “Personnel costs” is the most important item with respect to total costs incurred (82.7% as of 2020), corroborated by the importance of developers in terms of the methodologies and techniques used to optimize and improve the software offered to customers.

Therefore, in the coming years, an increase in their importance is expected, due to the progressive evolution of this technology, accounting for 85.7% of the total costs incurred as of 2025.

With respect to the “Hardware” item, as already mentioned in section II. As mentioned in section II. above, its use has been reduced due to the widespread use of cloud servers, optimizing costs in the acquisition of large servers, from 3.9% in 2020 to 1.9% in 2025.

With regard to the item “Licenses, maintenance and professional services”, already explained in section II. The item “Licenses, maintenance and professional services”, already explained in section II. above, shows a decrease from 13.4% of total costs incurred in 2020 to 12.4% in 2025.

Due to the increase in the weight of the most relevant cost (“Personnel costs”), an estimated growth of 17.15% has been obtained, above its historical 16.75%, maintaining its weight with respect to sales due to the increase in the same proportion in these.

This fact explains why the gross margin estimated in our projections has not suffered any alterations in its variability, obtaining a growth in estimated gross profit slightly higher than the historical figure presented (13.93% compared to 17.13%).

Operating expenses

The decrease in the operating expenses item as of 2020, with a -1.8% decrease compared to the previous year, maintaining a historical figure of 20.09%, is very remarkable.

This fact is generated as a result of a substantial decrease in the item “Travel, telecommunications, supplies and software and equipment”, which, due to the weight it represents, has driven the decrease in total operating expenses throughout its history, with this item obtaining a percentage as of 2016 over total expenses of 7.3%, compared to 4.7% in 2021 and 2.6% estimated for 2025.

Linked to these is “Other income/expenses, net”, with a very marked decrease in 2020 of -82.2% with respect to the previous year, justified by a generalized reduction of expenses in the subheadings “Advertising and promotion” (-17%), “Recruitment and training” (-37%), “Contingent consideration” (-42%) and “Other expenses, net” (-4%), in order to optimize costs after the effects shown by the economic crisis following the pandemic.

Only the subheading “Insolvency expenses” increased in this group (+104%) due to the difficult situation that the companies affected by the closure of the activity had to go through.

Establishing the relevant estimates for these items, it has been decided to contemplate the results set for the year 2020, due to the change in the habit of behavior experienced in all business activities, trying to optimize costs and obtaining a significant reduction in the item “Operating expenses”.

Similarly, following the same justification, the item “Occupancy” has been reflected, with a deceleration in its history, going from a weight of 2.9% of total expenses, to 1.1% for 2020, and 0.3% for 2025.

On the other hand, the disproportionate increase in the depreciation item in 2019 compared to the previous year (228.6%) was due to the adoption of the “IFRS16” accounting methodology, through the implementation of the “IFRS 16” leasing model. For the estimation of this item, the levels have been normalized to a rate obtained from its last two years of 13.04%.

As for the “Amortization of intangible assets”, we can see how the item is increasing over the years, justifiable as it has increased in a similar proportion to the item “Intangible assets”, obtaining an annualized yield of 20.59%, with a future growth with respect to total expenses of 12.4% as of 2020, to 14% in 2025.

Finally, the cost optimization generated by the company as of 2020, and the consequent normalization of this, has decreased the weight of Constellation’s operating expenses with respect to total expenses, from 23.7% in 2020 to 21.8% as of 2025, while decreasing the growth of this item from 20.09% historically to an estimated 15.14% in 2025.

Financial indicators

For all the justified variations, we witness a reduction in the company’s estimated total expenses, having included the optimization carried out by Constellation in 2020, betting on the consequent reduction of unnecessary expenses to further increase the profitability of its net margin.

The relevant estimates confirm a forward-looking development in expenses of 16.70% compared to its historical 18.60%, which has a direct impact on the company’s estimated “EBIT” (20.68%), also maintaining projections above its historical normalized (due to the cost optimization appreciated and the development of the items occurred after the implementation of “IFRS16”) of 18.41%.

The same applies to EBITDA, which, after normalizing its growth to the same extent, we estimate a potential of 20.10% for 2025, compared to the company’s historical 19.05%.

As for expenses under the heading “Other income / net expenses”, it is difficult to forecast its evolution, since it shows a very high variability.

However, the expected growth of the item has been normalized, due to the exponential growth of the year 2021 due to the purchase of Topicus in Q1, attributable to the “Purchase obligations” that Constellation has maintained on Topicus and the “Expenses for redeemable preferred securities”.

Coming to the net margin offered by the company, we can see how its accounts show negative earnings of -177.59 million in the first quarter of 2021, due to the purchase of Topicus, which, if the Q4 estimates are met, will result in a decrease in 2021 of -51.5%.

However, it should be noted that this result is unusual, as it is the first time in its history that Constellation has shown negative margins.

With all this, the company has achieved a historical net margin growth of 20.36%, growth below the projected value for the coming years of 22.99%, mainly due to cost reductions in the company’s production cycle.

Projections

With all the variables analyzed through the profit and loss account presented by the company, we can observe a linear trend in practically all the estimates made, with the exception of operating expenses and the net margin..

This is the result of the company’s normalization of cost optimization, resulting in a reduction in total expenses generated, and positively affecting the expected growth of the net margin, achieving a future yield of 22.99% by 2025, compared to its historical figure of 20.36%.

CASH FLOWS

Operating cash flows

The items relating to operating cash flows have already been detailed in the “Income statement” section, with the exception of the items “Income taxes paid” and “Change in non-cash working capital”.

The item “Income taxes paid” does not mean an income, but a recovery of an expense deducted from income, whose estimated growth has been obtained assuming its historical annualized 16.9%, starting from levels corresponding to the year 2020, after having experienced a disproportionate increase in the year 2021 due to the losses in net margin in the first four months of the year.

With reference to the item “Change in non-cash operating working capital”, it shows a very high variability, as it contains a high level of sub-items, such as “Non-invoiced current income”, “Current assets”, “Non-current assets”, “Accounts payable” and “Current accrued liabilities”, “Accounts receivable”, “Inventories”, “Other non-current liabilities”, “Current deferred income” and “Current provisions”.

However, after 2020, the company has maintained a positive trend in all quarters, so, for normalization, we have projected the growth obtained between 2016 and 2019 (19.29%), justified by bullish projections with respect to the items “Accounts receivable”, “Deferred income” and “Current accruals”.

With all this, the operating cash flows as of 2020, managed to obtain an increase compared to the previous year of 54%, being its historical of 16.03%, justified by the growth of the net margin items, and the punctual increase of the item “Variation in non-cash operating working capital”.

Therefore, we have tried to isolate this year from our projections, obtaining a total growth generated in operating cash flows of 20.11% compared to 16.03%, highlighting the expected good future growth of the profits obtained through the company’s main economic activity.

Investment flows

In relation to investing cash flows, we can observe how the most relevant item is “Acquisition of companies, net of cash acquired”, confirming once again the growth strategy implemented by the company.

It can be seen how in 2020, due to the overvaluation experienced by the stock market, the item experienced a decrease compared to the previous year due to the few investment opportunities at low multiples offered by the market.

However, growth after the acquisition of Topicus as of 2021 shot up considerably, normalizing its growth rate to 33.03% annualized, raising the forecast for this item by 40.53%.

With all this, we have estimated a level of growth in line with its history, carrying out a slight increase expected due to the requirement to make acquisitions at higher multiples, the higher capitalization of the acquired companies and greater acquisition opportunities due to the potential Asian market contemplated by the company.

On the other hand, the item “Cash obtained after acquired businesses”, as of 2021, obtained a one-time increase due to cash retentions made after the Topicus acquisition ($98) and a contingent consideration at fair value ($13), both figures accrued over the first three quarters of 2021.

Cash retentions are adjusted for items such as working capital or net tangible asset valuations defined in the management agreements, and claims under representations and warranties in the purchase and sale agreements.

Contingent consideration is payable based on the achievement of certain financial targets in periods subsequent to acquisition.

Therefore, as it is considered to be a very subjective item without a high historical value, it has been normalized to the figure set for the period of activity contemplated as of 2020.
Finally, the item “Post-acquisition settlement payments, net of income” shows a historical and projected growth of 42.05%.

This item, together with “Acquisition of companies, net of cash acquired”, are those with the greatest weight with respect to the total, generating a historical growth in investment cash flows of 40.85%, and estimated future growth of 44.34% as of 2025.

Financing flows

The weight of financing flows does not offer a particularly relevant level, with only the item “Dividends paid” standing out.

Constellation has always maintained the same dividend per share level of $1 throughout its history, with the increase in 2019 being an exceptional situation, with an increase of 498% over the previous year.

Analyzing its justification, we can attribute this increase to the few acquisition opportunities at reasonable prices that the market contained, trying to dispose of cash in favor of the shareholder, without being able to reinvest these flows in new acquisitions.

The objective has been to distribute the excess liquidity that had been generated until then, trying to generate welfare among its partners and increase the company’s reputation for such an increase in dividends.

Although the company made a good corporate decision due to the lack of opportunities in the market, from a present perspective, the decision was unfortunate for the company, since the dividend was produced before the economic crisis caused by Covid-19, when there were plenty of profitable opportunities after many companies were weakened by the losses caused by the closure of their activity.

The estimated projections have isolated this event, maintaining the stability presented in its history, in spite of generating certain doubts in its distribution, since according to several press releases issued by the company, they may eliminate this dividend if they manage to find profitable opportunities in the market.

After normalizing the growth in dividends, and a normalized linear stability in the rest of the items, we obtain an estimated financing cash flow rate of 15.66%, a level below the historical level presented by the company at 20.40%.

This projection has been carried out after a normalization at the level of growth in the items “Proceeds from the issuance of term debt” and “non-recourse credit lines to CSI”, by foreseeing a normalization at the level of debt generated and “Distribution to minority owners of TSS”, by mere stabilization of the item as it does not present a representative history.

Projections

As a result of the items analyzed, we can confirm the positive growth that the “Operating cash flows” item will experience by expanding profitability margins and recurring income on its acquisitions undertaken..

On the other hand, an increase in Constellation’s investment level is expected, especially in terms of acquisition, either through an increase in multiples paid by the company, or in an increase of companies to be acquired for the potential Asian market, leading the item “Cash flows from investments” to expand its growth line.

The marked reduction in the growth of the item “Cash flows from financing” is due to the stabilization of items trying to obtain a realistic estimate in accordance with the numbers presented, in addition to following a forecast decrease in debt.

All these variables have contributed to increase the cash flow estimates, generating an estimated growth of 22.50% compared to the historical 20.89%, essentially marked by the strong weight of operating cash flows over total cash.

RATIOS

In order to obtain a good analysis of Constellation’s financial health, the analysis will try to combine the historical ratio shown by the company between 2016 and 2020, together with the growth obtained in the same period, trying to minimize biases and estimate the most realistic projection possible..

Liquidity ratios.

The Working Capital obtained by Constellation presents negative figures when considering as liabilities the “Deferred income” presented by Constellation generated through its subscription service, resulting inefficient to carry out its study as it includes negative figures.

However, considering this item as current assets of the company, we would obtain a positive working capital, registering a value as of 2021 of 1462.25 million, generating a working capital turnover in relation to revenues of 1.97X, thus showing financial soundness in its accounts.

Furthermore, in the estimated projections for the period from 2021 to 2025, a positive value has been obtained in all years, once again demonstrating the company’s viability in the future.

The liquidity ratio presented by the company is not efficient, as it shows an annualized decrease of -3.2%, together with its historical ratio of 0.8X compared to the 0.86X of the competition. Furthermore, it is recommended that the ratio be between 1.5-1.7, so Constellation’s current assets should be increased to improve its solvency in the short term.

As for the acid test ratio, Constellation once again has a decrease in its historical -2.5%, coupled with a historical ratio of 0.73X compared to 0.91X for the sector. This ratio is again far from the optimal value of 1X, so that, once again, the company shows its inefficiency in its short-term solvency.

Analyzing the immediate cash ratio presented by the company, its figure is close to the optimal value of 0.3X, located at 0.36X, so the company’s cash generated is in a good position.

The collateral ratio offered by Constellation is actually positive, with a historical ratio of 1.33X, a figure above the industry optimal value of 1X.

As for the company’s financial autonomy ratio, it is adequate, as the company’s historical ratio is at 0.33X, which is above the industry’s optimal value of 0.3X.

However, an optimal level is considered to be above 0.7X, so in order to confirm its financial independence, Constellation should reduce its total liabilities or increase its equity.

Debt ratios.

The company’s leverage ratio, or debt to assets ratio, presents a ratio well above the level of its competitors at 0.36X, while Constellation’s historical ratio is 0.75X, so Constellation should increase its weight in assets to offset items and stabilize its financial situation.

As for the company’s debt ratio, it offers a very similar result to the leverage ratio, as Constellation presents a historical of 0.76X, compared to the 0.35X of the sector, with a percentage of debt much higher than its equity compared to the sector.

The Net Debt / EBITDA ratio has changed its trend in the last two years, a fact explained by the company’s increased use of financial debt. Nevertheless, it offers a historical level of 0.03X compared to the 0.14X of the sector.

Profitability ratios.

Analyzing the company’s ROA, we can see how the profitability generated by Constellation is much higher than that of its competitors, growing at a rate of 26.2% and standing at a historical ratio of 0.11X, compared to the 0.07X of the sector, showing the efficiency in the management of its assets.

With respect to ROE, the company has a ratio well above average, at 0.43X compared to 0.16X for the sector, corroborating Constellation’s clear competitive advantage over its competitors.

Relating both metrics we can confirm the positive operating leverage of the company (ROE > ROA), being able to generate a higher level of indebtedness to obtain higher returns.
The company’s ROIC ratio is at higher levels than those of the sector (0.17X vs. 0.15X), demonstrating the company’s capacity for growth.

As for Constellation’s ROS, the company offers a profit per unit of sales of 0.16X, a multiple above the optimal level for the sector (located at 0.15X), confirming the company’s competitiveness in the market in which it operates.

This great profitability shown in the company’s profitability ratios can also be seen through the increase in CAPEX growth obtained by Constellation, with an annualized growth of 13.56%, offering great expansion potential for the company.

Profit margins.

Constellation offers a very poor historical average net margin, at 0.1X versus 0.14X for the sector, so the company should optimize costs (as estimates have been projected) in order to obtain higher profitability in terms of the company’s net margin.

In terms of EBITDA margin, Constellation has managed to obtain a historical ratio of 0.27X versus 0.22X for the sector, providing a great possibility of profit growth for the organization.

Regarding FCF margin, the company is well above the industry level, with an average ratio of 0.24X compared to the 0.16X of its competitors, offering a very significant growth potential in cash flow generation for the coming years.

Financing costs.

Regarding financing costs, assuming a normalization of the company’s situation, Constellation would not use debt, as shown in the projections made after the analysis, so the cost of external financing is zero.

As for the cost of own financing, the company has an average figure of 0.13X, which is lower than the financial profitability (0.43X), confirming the company’s good asset management.

However, as of 2019, there was an exceptional increase in the level of own financing, justified by the issuance of the special dividend issued by the company, resulting in a figure of 0.74X.

Therefore, although the cost of own financing may be seen as a very low multiple, it has a much higher level than that of its competitors, being 0.04X in the case of Enghouse, 0.0097X presented by Jack & Henry, 0.02X by Roper, and 0.05X in Open text, as they are companies that prefer to continue reinvesting their cash flows in the company itself, trying to increase its value via organic or inorganic, but not through dividends, since this strategy is more focused on already consolidated companies.

Metric recommendations obtained

This table provides an overview of the metrics obtained by Constellation compared to its main competitors.

The company differs greatly in the results offered with respect to the valuation it has been obtaining throughout this test, justified by the item “Deferred income”.

However, it is possible that its competitors may be as influenced as Constellation in the achievement of these metrics.

However, the companies analyzed are small-cap companies, which contain a level of deferred income well below those set by Constellation with respect to its liabilities, generating an imbalance when trying to balance assets with liabilities, clearly disadvantaging Constellation.

In other words, the higher the level of deferred income, the higher the level of liabilities, and therefore the greater the difference with respect to its assets, offering a clear inequality in comparable terms.
If we make a valuation without taking this into account, we can conclude with a score of 6.25/10, showing the company’s financial health to be positive but not marked, despite having assets well below its actual figures.

However, if we consider this strong distortion, we can see how the variables considered as negative are precisely those that are affected by the value of assets and liabilities generated by the company, with the exception of the net margin, which, due to the high amount of net profit in relation to sales, lowers its multiple.

With respect to the ratios obtained through the growth estimates presented, we obtain the values generated in “Table 11”, observing once again how the ratios that are influenced by the level of assets and liabilities of the company, continue to be weakened due to the estimated level of deferred income of the company.

However, the liquidity level has managed to increase slightly, due to the estimated cash increase projection, and the consequent future growth of the company’s short-term assets, generating a greater margin between both variables, especially the one offered by the immediate cash ratio. (as it is mostly influenced by the company’s cash).

On the other hand, a substantial improvement can also be observed in the company’s net margin, as well as in the FCF margin, since the estimates show an acceleration with respect to both metrics (justified in sections IV. and V. of this essay).

As a negative aspect, it is worth highlighting the unfavorable trend in the returns on capital presented by the company, due to an expected decrease in the rate of acquisitions, justified after the contributions established in the qualitative analysis.

However, as already mentioned, everything will depend on the pace of acquisitions that the company will be able to offer, together with the potential for expansion in the Asian market.

CONCLUSION AND RELEVANT RECOMMENDATIONS.

Once the complete report on Constellation Software Inc. has been presented, we can generate a clear idea of the advantages offered by the company, both at the level of yields generated in its different items and its consequent historical evolution, as well as in the figures obtained in the financial analysis presented.

At the economic level, the estimated growth of the sector and the macroeconomic variables analyzed manage to sustain the growth generated by the company.

However, it is the organization itself that is responsible for this performance, both in terms of profitability and operating margins, obtaining a recurrence that is extremely beneficial for the objectives set by the management.

At a qualitative level, Constellation has managed to obtain, after the results presented in its production cycle, characteristics that make it stand out from its competitors, with unique qualities generating strengths and competitive advantages that allow the company to consolidate its position in the market.

However, the accounting of the subscription service presented by the company does not allow a glimpse of its long-term growth potential, since it treats as liabilities revenues obtained on a recurring basis, negatively impacting the liquidity and leverage ratios presented by the company.
Avoiding this fact and contemplating a correct valuation of the metrics obtained, we were able to corroborate the company’s capacity to generate value.

In relevance to the metrics established by the company in recent years, it is overwhelming all growth established in its accounts, obtaining sales returns close to 20%, average financial returns of 40X, and a historical growth in net margin of 20%, as well as the return generated in its EBITDA.

Therefore, our projections have followed the line of this growth, with qualitative variables that allow its future development and a corporate culture aligned with the interests of the company, being one of the leading brands in the sector.

This level of growth comes after Constellation has catalysts that minimize negative impacts on the company’s results, the most remarkable being the potential Asian market presented after the strategic alliance, as it provides greater opportunities to enter new segments, brand expansion, and potential viable cash generation opportunities in line with its growth.

On the other hand, it is difficult to establish recommendations about a company with the cash generation capacity presented, having analyzed practically all the items shown in its accounts and confirming the alignment presented in its growth strategy.

However, there are small particularities that can improve the company’s performance, beyond the margins generated.

As for the equity capital obtained, it is understood that its figure may be considered relatively small in relation to the profits retained by the company, and part of these profits may be used to pay dividends, with the aim of having a larger amount of financing available in the future, thanks to the entry of more capital into the company.

The strategy seems clear, as due to the historical performance and current metrics of the company, it would be a very powerful alternative for investors seeking a stable long-term return, positively impacting Constellation’s capitalization by increasing its value.

However, the growth generated through its acquisition strategy has led to a rethinking of this approach, and a merger between the two strategies could be established.

Due to the potential difficulty shown by the company in preserving the number of acquisitions contemplated, they may declare growth through this approach as their primary objective (as it has demonstrated its ability to generate profits), leaving the aforementioned strategy in dividends in the background.

In the case of not presenting acquisition alternatives due to variables that could interfere with this proposal, they could generate a dividend more consistent with the results obtained by the company.

In addition, this proposal is totally viable for the company, since Constellation offers both a very high level of “Retained earnings” and profits, presenting the possibility of recognizing the dividends it wishes to undertake, declaring 100% of the paid-up capital.

In this way, they would reduce risks in the event that this value proposition does not have a positive impact on the company’s profits, in addition to being able to observe the trend of this strategy, minimizing possible contingencies after its implementation.

Another strategy to be undertaken by the company is to carry out a capital increase, due to the very high price per share figure presented by the company, obtaining financing through the investor, thus avoiding the rate hike presented by the Federal Reserve.

However, the company will have to accompany this capital increase with a share premium, defraying the additional cost to the shareholder, or by issuing preferential subscription rights, in order to offset the depreciation generated by the capital increase.

However, there is another possibility in case this strategy is not aligned with the company’s objectives (due to its mentality of providing the highest possible value to the investor), seeing effective the implementation of a Split to lower the share price, without affecting the investor or the level of capitalization of the company, generating greater entry opportunities for investors who cannot afford to invest 2,346CAD on December 31, 2021.

As a result of the information presented in this essay, it remains to highlight the company’s ability to create value, achieving truly surprising returns, corroborating the viability of its business model, presenting high advantages that make Constellation have a highly qualified capital allocation efficiency, achieving almost all of the proposed objectives in line with the growth carried out by the company.

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