Canada’s hottest tech stock is hitting new highs. Here’s why
Constellation Software Inc.’s CSU-T share price has surged to record highs after shaking off a lull in 2022, and there’s at least one good reason to stick with this rally: The company is picking off acquisitions at a brisk pace.
Constellation is a consolidator within the tech sector. It buys mostly small companies that develop vertical market software (VMS), or software that is tailored for specific industries, and generally holds these companies over the long term.
The parent company offers expertise to help these smaller units grow within an extensive network, following hundreds of acquisitions over the past three decades.
Successful deals translate into rising cash flow, and cash is then used to finance additional deals. In 2007, Constellation generated nearly $35-million in cash from its operations; by 2022, this number had risen to nearly $1.3-billion.
The good news is that the company appears to be having no trouble finding attractive acquisitions. The total value of deals in 2022 increased to more than $1.6-billion, up from about $1.2-billion in 2021 and $531-million in 2020.
According to Stephanie Price, an analyst at CIBC World Markets, the fact that deals are now exceeding cash flow means that the company is exploring new financing and structuring arrangements while focusing on larger deals.
What’s more, the combined value of deals over the past six months was 45 per cent greater than expectations, according to Paul Treiber, an analyst at RBC Dominion Securities. The gain offers evidence that the company’s acquisition model is “scaling,” Mr. Treiber said in a note.
Investors are clearly showing renewed confidence in the stock, which is up 21 per cent in 2023 and up 39 per cent from a recent low in November.
And for anyone who has embraced Constellation’s acquisition model (it is in the HotList of stocks compiled by the Globe Investing Club), the latest deal-making offers a good sign that the model is working.
“The acceleration in the pace of acquisitions since 2020 is quite notable, and this is apromising sign for free cash flow generation in the years ahead,” Michael Gielkens partner at Netherlands-based Tresor Capital, said in an e-mail.
The flurry of deals comes amid a sluggish period for mergers and acquisitions moregenerally, as higher interest rates and economic uncertainty have weighed heavily.According to the consultancy Bain & Co., the value of deals announced globally in2022 fell 36 per cent from a record high in 2021, with high-priced mega deals bearing the brunt of the downturn.
Constellation doesn’t do mega deals, though. And its ability to finance takeovers with internally generated cash, rather than debt, puts it on firmer ground in a rough economy.
It also helps that the company enjoys a good reputation among tech entrepreneurs who may be struggling in today’s tumultuous environment for the tech sector and provide a pipeline for additional partnerships.
Mr. Gielkens estimates that if Constellation can continue to invest in attractive deals at the current pace, it will compound its cash flow at an impressive rate, generating shareholder returns in the mid-to-high teens over the next couple of years.
But should new investors worry about arriving late to this bullish story?
Constellation has not split its stock since an initial public offering priced the shares at$17 in 2006. On Thursday, the shares closed at a record high of $2,583.96, providing a clear measure of how much the stock has gained over the long term.
It is also reasonable to feel concerned about Constellation’s future growth trajectory as it gets larger. The company is now valued at $54-billion, making it the 16th most valuable company in Canada, ahead of financial giants such as Canadian ImperialBank of Commerce and Manulife Financial Corp.
Still, there may be little standing in the way of continued growth.
Mr. Gielkens estimates that there are more than 50,000 VMS targets globally, whichsuggests that Constellation has plenty of tech companies to pursue.
Analysts are forecasting impressive growth in a number of key financial metrics this year.
RBC’s Mr. Treiber, who calls Constellation an “unrelenting cash compounding machine,” expects the company can produce revenue growth of 31 per cent in 2023 compared with 2022.
He also expects free cash flow per share will increase 54 per cent this year –underscoring his case that the share price can rise to $3,000 within the next 12months, implying a gain of 16 per cent from the current price.
Constellation is on a roll again, extending a 17-year winning streak that is hard to ignore.
