TSX: CSU CN Long Investment Thesis Current Price: $469.68 CAD Jan 2017 Price Target: $700 CAD (27% IRR) May 4, 2015 Lily Miao 2015 MBA Candidate, The Wharton School
Highlights Capitalization • Target price: $700 CAD in 2017 Current Price (CAD) $469.68 (27% IRR) CAD to USD FX 0.78 Current Price (USD) $366.35 • Excellent business with great Diluted S/O 21.2 moats trading at 8.6% 2017 FCF Equity Value $7,764 yield (+) Debt 276.0 (-) Cash 131.8 • Monopoly-like company with the EV (USD) $7,908 benefits of a competitive market Key Metrics • Stellar CEO + mgmt team Net Debt / EBITDA 0.4x Trading Volume (CAD) $38 • History of smart capital allocation Dividend Yield 1.1% and ability to integrate 52wk Range 230.08 – 503.43 acquisitions Valuation 2015E 2016E 2017E EV / EBITDA 16.8x 12.7x 9.6x • Street underestimates ability to Street 18.3x 15.4x 14.1x continue to grow through P / Adj. E 21.4x 16.3x 12.3x Street 29.2x 24.5x 22.6x acquisitions PEG 0.7
Excellent business with great moats • Vertical market software targets markets with only hundreds to thousands of customers • Software is too specialized and markets are too small to move the needle for larger software companies • Focus on mission critical software (e.g. accounting, production) • 85-90% is on premise, which has higher customer stickiness Constellation has high barriers to entry
Monopoly-like company with the benefits of a competitive market CSU Organic Recurring Revenue • Portfolio of monopolies Growth 15% 14% 12% • CSU seeks to acquire market 12% 10% 9% leader and then make tuck-in 8% 7% acquisitions to create a monopoly 7% 7% 5% 4% • Seeks fragmented verticals that 0% lack access to capital 2006 2008 2010 2012 2014 • CSU business units within the Constellation Organic Recurring Revenue Growth from Price same vertical are kept in friendly Increases competition 10% 8% 9% 8% • Benefits from pricing power of a 6% 6% 5% 6% monopoly and superior product 5% 4% 5% 5% of a competitive market 2% 3% 0% 2006 2008 2010 2012 2014
Stellar “Outsider” CEO / Founder + Management Team 40% • Called a modern-day “Outsider” CEO by William Thorndike, author of The 20% Outsiders CSU ROIC • 11 years in VC prior to founding CSU 0% • CSU stock has 47% annualized return since IPO and ROIC of 37% Executives Years at CSU • Decentralized organization with deep CFO 12 talent pool who have been at the COO 15 company for a long time. Based on my VP of M&A 20 (since inception) checks, CEO does not micromanage Head of Op. Groups Volaris 15 • Unique compensation structure – Harris 16 executives must use bonus to buy CSU Vela 12 (was CFO of CSU) TSS Acquired in 2013 shares on the open market, which are Jonas 19 held in escrow for 4 years Perseus 10 CSU directors and executives own ~11% of shares outstanding
History of smart capital allocation • FCF has largely been deployed into acquisitions and CSU Historical Acquisition Multiples to pay dividends vs. Market Multiples for Software M&A Deals • Acquisition strategy: Create 3.0x monopolies, hold forever, Median EV/ prefer distressed assets at Rev (Software 2.5x M&A deals) distressed prices 2.0x • Very disciplined buying with IRR hurdle in 20-30% range Median EV/ 1.5x Rev (Software • Historically, paid 0.5-0.9x M&A deals: $10-20mm) revenues vs. 2-2.5x median 1.0x multiples in software M&A CSU Revenue 0.5x • Benefits from cyclicality, which Multiple Paid Excl. TSS acquisition creates buying opportunities, 0.0x while diverse portfolio buffers 2010 2011 2012 2013 CSU from idiosyncratic shocks Source: Historical transactional multiples are from Berkery Noyes
History of ability to integrate acquisitions • First, lay off non-mission critical employees (e.g. Labor accounting, IT, HR) • Labor is biggest cost component • Each business unit has a long-term plan and financial Financial metrics it must meet tracking • Immediate access to P&L’s of all 240+ business units • Teams kept small, so nimble and not bogged down by Small teams process • No micro-managing • Permanent home à Stability Benefits for targets • Access to capital + resources / partnerships • Customer security that software will be around
Ability to continue to grow through acquisitions • Street underestimating growth Software companies in Long runway potential US, Canada, Europe • 13,000+ potential targets in US, Canada, and Europe Rev. (mm) # Companies <$300 17,399 • First large-scale acquisition in Scale-up 2013 acquisitions <$200 17,144 • Successful integration is sign CSU can scale-up acquisitions <$100 16,536 • Decentralized org is very scalable Scalable <$50 15,507 • Thin head office with 6 operating organization groups <$25 13,410 • Raised LT debt for first time in Leverage 2014, sign CSU is willing to lever <$10 7,986 up • Debt is trading at only a 2% yield Total CSU Acquisitions • Evidenced by historical purchase 131 Disciplined from multiples buying 2010-2014 (5yr) Source: Number of potential acquisitions based on CapIQ screen
Risks and Mitigants • CEO is the founder and has set company philosophy Key man risk • Deep talent pool that has been at CSU for a long time • CEO involved in big acquisitions. Heads of op. groups involved in acquisitions with <$20mm in revenue. Avg. revenue / acquisition has been $7-20mm over the past several years • Reined in by (1) requirement to invest bonus into CSU Empire building shares and (2) tying bonuses to ROIC • CSU reports in USD, trades in CAD, debt is in CAD FX • Most expenses and revenues incurred in same currency • SaaS is less sticky than on premise hosting Competition • 10-15% of recurring revenue is SaaS from SaaS • Disruption is limited to low-ticket software, which comprises only 20-30% of recurring revenue
Base Case Valuation VALUATION 2015E 2016E 2017E EV / EBITDA 16.8x 12.7x 9.6x P / Adj. E 21.4x 16.3x 12.3x FCF Yield 4.9% 6.5% 8.6% PEG 0.7 PRICE TARGET FCF Yield EV / EBITDA P / E FY 2017 FCF / S $31.43 FY 2017 EBITDA 825.7 FY 2017 Adj. EPS $29.82 FCF Yield 6.0% EV / EBITDA Mult. 15.0x P / E 18.0x Price Target (USD) $524 Enterprise Value $12,385.1 Price Target (USD) $537 Price Target (CAD) $672 (-) FY 2016 Debt 294.6 Price Target (CAD) $688 Total Upside 43.0% (+) FY 2016 Cash 132.5 Total Upside 46.5% IRR 23.8% Equity Value $12,222.9 IRR 25.6% Price Target (USD) $577 Price Target (CAD) $739 Total Upside 57.4% Blended Price Target IRR 31.1% Price Target (USD) $546 Price Target (CAD) $700 Total Upside 49.0% IRR 26.9%
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