TSX: CSU CN Long Investment Thesis Current Price: $469.68 CAD Jan - - PowerPoint PPT Presentation

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

• Target price: $700 CAD in 2017

(27% IRR)

• Excellent business with great

moats trading at 8.6% 2017 FCF yield

• Monopoly-like company with the

benefits of a competitive market

• Stellar CEO + mgmt team
• History of smart capital allocation

and ability to integrate acquisitions

• Street underestimates ability to

continue to grow through acquisitions

Capitalization Current Price (CAD) $469.68 CAD to USD FX 0.78 Current Price (USD) $366.35 Diluted S/O 21.2 Equity Value $7,764 (+) Debt 276.0 (-) Cash 131.8 EV (USD) $7,908 Key Metrics Net Debt / EBITDA 0.4x Trading Volume (CAD) $38 Dividend Yield 1.1% 52wk Range 230.08 – 503.43 Valuation 2015E 2016E 2017E EV / EBITDA Street 16.8x 18.3x 12.7x 15.4x 9.6x 14.1x P / Adj. E Street 21.4x 29.2x 16.3x 24.5x 12.3x 22.6x 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

• Portfolio of monopolies
• CSU seeks to acquire market

leader and then make tuck-in acquisitions to create a monopoly

• Seeks fragmented verticals that

lack access to capital

• CSU business units within the

same vertical are kept in friendly competition

• Benefits from pricing power of a

monopoly and superior product

• f a competitive market

14% 12% 12% 4% 7% 9% 7% 8% 7% 0% 5% 10% 15% 2006 2008 2010 2012 2014

CSU Organic Recurring Revenue Growth

5% 8% 9% 3% 6% 6% 5% 5% 5% 0% 2% 4% 6% 8% 10% 2006 2008 2010 2012 2014

Constellation Organic Recurring Revenue Growth from Price Increases

Stellar “Outsider” CEO / Founder + Management Team

• Called a modern-day “Outsider” CEO by

William Thorndike, author of The Outsiders

• 11 years in VC prior to founding CSU
• CSU stock has 47% annualized return

since IPO and ROIC of 37%

• Decentralized organization with deep

talent pool who have been at the company for a long time. Based on my checks, CEO does not micromanage

• Unique compensation structure –

executives must use bonus to buy CSU shares on the open market, which are held in escrow for 4 years

0% 20% 40%

CSU ROIC

CSU directors and executives own ~11% of shares outstanding

Executives Years at CSU CFO 12 COO 15 VP of M&A 20 (since inception) Head of Op. Groups Volaris 15 Harris 16 Vela 12 (was CFO of CSU) TSS Acquired in 2013 Jonas 19 Perseus 10

History of smart capital allocation

• FCF has largely been

deployed into acquisitions and to pay dividends

• Acquisition strategy: Create

monopolies, hold forever, prefer distressed assets at distressed prices

• Very disciplined buying with

IRR hurdle in 20-30% range

• Historically, paid 0.5-0.9x

revenues vs. 2-2.5x median multiples in software M&A

• Benefits from cyclicality, which

creates buying opportunities, while diverse portfolio buffers CSU from idiosyncratic shocks

0.0x 0.5x 1.0x 1.5x 2.0x 2.5x 3.0x 2010 2011 2012 2013

CSU Historical Acquisition Multiples

• vs. Market Multiples for Software M&A

Deals

Median EV/ Rev (Software M&A deals) Median EV/ Rev (Software M&A deals: $10-20mm) CSU Revenue Multiple Paid

• Excl. TSS

acquisition Source: Historical transactional multiples are from Berkery Noyes

History of ability to integrate acquisitions

• First, lay off non-mission critical employees (e.g.

accounting, IT, HR)

• Labor is biggest cost component

Labor Financial tracking Small teams Benefits for targets

• Each business unit has a long-term plan and financial

metrics it must meet

• Immediate access to P&L’s of all 240+ business units
• Teams kept small, so nimble and not bogged down by

process

• No micro-managing
• Permanent home à Stability
• Access to capital + resources / partnerships
• Customer security that software will be around

Ability to continue to grow through acquisitions

• Street underestimating growth

potential

• 13,000+ potential targets in US,

Canada, and Europe Long runway Scale-up acquisitions Scalable

• rganization

Leverage

• First large-scale acquisition in

2013

• Successful integration is sign

CSU can scale-up acquisitions

• Decentralized org is very scalable
• Thin head office with 6 operating

groups

• Raised LT debt for first time in

2014, sign CSU is willing to lever up

• Debt is trading at only a 2% yield

Disciplined buying

• Evidenced by historical purchase

multiples

Source: Number of potential acquisitions based on CapIQ screen

Software companies in US, Canada, Europe

<$300 17,399

• Rev. (mm) # Companies

<$200 17,144 <$100 16,536 <$50 15,507 <$25 13,410 <$10 7,986 Total CSU Acquisitions from 2010-2014 (5yr) 131

Risks and Mitigants

• CEO is the founder and has set company philosophy
• 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

Key man risk Empire building FX Competition from SaaS

• Reined in by (1) requirement to invest bonus into CSU

shares and (2) tying bonuses to ROIC

• CSU reports in USD, trades in CAD, debt is in CAD
• Most expenses and revenues incurred in same currency
• SaaS is less sticky than on premise hosting
• 10-15% of recurring revenue is 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%