I was going to write up Topicus but realized that it wouldn’t work without writing up Constellation Software first. So I changed the write-up to Constellation and will write up one on Topicus next. (Read it here).
I recently read Michael Lewis’ book, The New New Thing: A Silicon Valley Story and a thing that stuck with me was his reference to the phrase “business model” as “a term of art”. That’s what Constellation is: a piece of art on Mark Leonard’s canvas. His annual shareholder letters (which started as quarterly after Constellation listed in 2006, turned into an annual occurrence in 2009, and now arrive whenever Leonard has something to say) possess humility, competency, and a nail-to-the-head type of writing that makes understanding the business the easiest thing in the world. Many investors are better off reading his letters back to 2006 to arrive at a fair assessment of the business rather than reading my, or any other’s, explanation of it. Find them here.
An example of his humility was on display in the 2015-2016 letters in which he set out to study other “high-performance conglomerates” (HPCs) such as Constellation, even as his company by many measures was the most successful of the rare bundle of HPCs. Over the past decade up until 2015 when Mark did the study, Constellation had compounded revenue/sh and CFO/sh by 24% and 30%, respectively. The share price had gone from CAD24/sh to CAD510/sh, a 36% CAGR over the 10- year period.
The study found patterns in the HPC lifecycle of three main phases: 1) the HPC starts out earning extraordinary returns through operations in asset-light businesses, 2) then embarks on attractively-priced acquisitions to which it applies its refined operating practices learned from phase one to increase ROI, and 3) it then drifts towards paying higher multiples for larger acquisitions as size became a constraint and declining ROIs across the conglomerate turns inevitable.
Constellation hasn’t shown reversion to the mean in a meaningful way yet but likely found itself transitioned to the third phase recently for reasons I’ll discuss.
Throughout its history, Constellation has earned the HPC badge largely from intelligent capital allocation in VMS businesses rather than through operational excellence. Not that Constellation’s VMS operations haven’t been excellent — obviously, that goes without saying — but that’s largely been a result of earning a high return on existing capital rather than reinvesting new. By existing capital, I mean essentially no capital.