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)

Capitalization

Excellent business with great

moats trading at 8.6% 2017 FCF
yield

Current Price (USD)

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

Current Price (CAD)

$469.68

CAD to USD FX

0.78
$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
Valuation

230.08 503.43
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
of a competitive market

CSU Organic Recurring Revenue

Growth
15%
14%
12%

10%

12%
9%
7%

5%

8%

7%

7%

4%

0%
2006

2008

2010

2012

2014

Constellation Organic Recurring

Revenue Growth from Price
Increases
10%

8%

8%
6%
4%

9%
6%

5%

6%

5%
5%

2%

5%

3%

0%
2006

2008

2010

2012

2014

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

40%
20%
0%

CSU ROIC

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

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

CSU directors and executives own ~11% of shares outstanding

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
Source: Historical transactional multiples are from Berkery Noyes

3.0x

CSU Historical Acquisition Multiples

vs. Market Multiples for Software M&A
Deals
Median EV/
Rev (Software
M&A deals)

2.5x
2.0x

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

1.5x
1.0x
0.5x
0.0x
2010

Excl. TSS
acquisition

2011

2012

2013

CSU Revenue
Multiple Paid

History of ability to integrate acquisitions

Labor

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

accounting, IT, HR)
Labor is biggest cost component

Financial
tracking

Each business unit has a long-term plan and financial

metrics it must meet
Immediate access to P&Ls of all 240+ business units

Small teams

Teams kept small, so nimble and not bogged down by

process
No micro-managing

Benefits for
targets

Permanent home Stability

Access to capital + resources / partnerships
Customer security that software will be around

Ability to continue to grow through acquisitions

Long runway

Scale-up
acquisitions

Scalable
organization

Leverage

Disciplined
buying

Street underestimating growth

potential
13,000+ potential targets in US,
Canada, and Europe
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
Evidenced by historical purchase
multiples

Source: Number of potential acquisitions based on CapIQ screen

Software companies in
US, Canada, Europe
Rev. (mm) # Companies
<$300

17,399

<$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

Key man risk

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

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
EV / EBITDA
P / Adj. E
FCF Yield
PEG
PRICE TARGET
FCF Yield
FY 2017 FCF / S
FCF Yield
Price Target (USD)
Price Target (CAD)
Total Upside
IRR

Blended Price Target

Price Target (USD)
Price Target (CAD)
Total Upside
IRR

2015E
16.8x
21.4x
4.9%
0.7

$31.43
6.0%
$524
$672
43.0%
23.8%

$546
$700
49.0%
26.9%

2016E
12.7x
16.3x
6.5%

EV / EBITDA
FY 2017 EBITDA
EV / EBITDA Mult.
Enterprise Value
(-) FY 2016 Debt
(+) FY 2016 Cash
Equity Value
Price Target (USD)
Price Target (CAD)
Total Upside
IRR

2017E
9.6x
12.3x
8.6%

825.7
15.0x
$12,385.1
294.6
132.5
$12,222.9
$577
$739
57.4%
31.1%

P/E
FY 2017 Adj. EPS
P/E
Price Target (USD)
Price Target (CAD)
Total Upside
IRR

$29.82
18.0x
$537
$688
46.5%
25.6%