The Capital Allocation Playbook (Part 9)

Constellation Software – 1

In software, one of the companies regularly mentioned in capital allocation conversations is Constellation Software. In its own words: “Constellation Software is a leading provider of software and services to a select group of public and private sector markets. We acquire, manage and build industry specific software businesses which provide specialized, mission-critical software solutions that address the particular needs of our customers. Our businesses continuously develop innovative solutions that enable our customers to achieve their objectives. With over 125,000 customers in over 100 countries and a proven track record of solid growth, we’re establishing a broad portfolio of software businesses to provide our customers and shareholders with exceptional returns.” The CEO is Mark Leonard, and the company is headquartered in Toronto, Canada.

Its stock performance through the years (from Google Finance):

From a recent commentary in Rational Thinking: “Under [Constellation Software’s CEO Mark Leonard’s] reign, the company has compounded at about 40% for almost two decades! … Constellation’s business model is to acquire small software companies under one umbrella while giving them autonomy without fiddling from HQ.”

25iq in 2018: “With an initial $25-million investment from OMERS and his old associates at Ventures West Capital in 1995, Mark Leonard has built Constellation into a world-leading consolidator of vertical market software (VMS) companies—firms that create products to help run businesses in specific industries. Over the years, Constellation has made scores of acquisitions and, through its six operating groups, now provides software to over 60 industries, from health care to law to public transit…. Typically, Constellation’s acquisitions are small—in the $2-million to $4-million range—but add them all up, slip in a dose of Constellation’s financial and operational discipline, and you have [a company with a market cap of $18 billion….In this age of zero privacy, Mark Leonard has managed to maintain a practically unthinkable level of anonymity for just about any individual—let alone an IT executive who runs one of Canada’s most dynamic, fastest-growing and most acquisitive software companies, and who has been compared favourably with Warren Buffett and Prem Watsa.”

Eagle Point Capital in 2021: “Mark Leonard and the small headquarters team are the foundation for capital allocation at Constellation, but most of the work is carried out in the subsidiaries. Leonard is clearly a very skilled capital allocator and investor. He thinks like Buffett and has a repeatable framework when thinking about acquisition candidates, purchase prices, risk, and forward rates of return. Constellation’s stated goal is to be a “great perpetual owners of VMS (vertical market software) businesses”. They look for what they deem both “exceptional” and “good” VMS businesses. Exceptional businesses feature an outstanding manager, consistent profitability, and above average growth. Leonard classifies good businesses as first or second-ranked players in their verticals that may still be working to establish a solid track record of growth and profitability. Constellation has carved out a sweet spot by acquiring lower organic growth (GDP-like growers) albeit very high-quality software companies. They’ve been able to maintain valuation discipline by staying away from high-growth software businesses where valuation multiples are far higher.”

Published by

Rajesh Jain

An Entrepreneur based in Mumbai, India.