Ladies and gentlemen, good morning, and welcome to Constellation Software Incorporated's Q3 results. All lines are currently on mute to prevent any background noise. I would now like to introduce the speaker for today's call, Mr. Mark Leonard. Please go ahead.
Thank you, Dan. Good morning, everyone. I'm joined by Jamal and Bernie. As you know, we go directly to questions. Dan is gonna give you instructions, then we'll take your questions.
At this time, if you would like to ask a question, please press the star followed by the number one on your telephone keypad. Your first question comes from the line of Blair Abernethy from Industrial Alliance. Please go ahead.
Good morning, gentlemen.
Morning, Blair.
Mark, just wondering if you can give us a sense of how the scaling up of your M&A capacity has been going this year. How are you feeling in terms of, you know, do you have adequate capacity for continued growth for 2018 at this point?
Blair, we've got Bernie on the line, so we might as well go directly to him for responses relating to M&A.
Hi, Blair.
Hi.
Last quarter, I think we said that we were going to be increasing the number of headcount for M&A. We, in fact, did ramp up quite a bit, pretty much on target to where we wanted it to be. Since then, our activity has increased dramatically. It's a nice thing to see. I don't think that we're going to be increasing dramatically from here in terms of headcount. It's going to increase, decrease slightly here and there. I think we're pretty well set for 2018, right at the top.
It's sort of launching an experiment, Blair. We wanna see what happens when we've added all these new people and some new processes. Once we've got feedback, then, you know, you use that feedback to give you ideas on what to do next. I think it's a waiting period for us.
Okay, great. Second question, just quickly on Japan, any update on how that partnership is progressing?
They're actually visiting with us right now. We're doing our M&A session, our offsite. Things are going reasonably well. We're filling the funnel and got our fingers crossed that one of the many companies that they're talking to will at some stage wanna sell.
Okay, great. Then just last one for me, Mark. As you look at the overall company, the scale of the business now, are there other areas of CSU operations that you think you could get more benefit out of from economies of scale or any opportunities you would see for offshoring some of your expenses to maintain or improve your margins?
We are the anti-economy of scale company. We believe in small teams, outperforming large teams. Given the choice of taking a 200 -person business and busting it up into two smaller ones, we would much prefer to do that and believe that the benefits are there, as opposed to ramming businesses together, firing a bunch of people, and moving a bunch of work offshore. I don't think you'll see any of the benefits that you were talking about.
Okay, great. Thanks very much, guys.
Yeah.
Your next question comes from the line of Paul Steep with Scotia Capital. Please go ahead.
Great. Morning. Mark, or I guess any of the guys, can you talk a little bit, you know, presumably, you're now in your 2018 planning cycle. Could you talk about what you've heard back from the businesses at this point in terms of how they're thinking about organic growth, as well as maybe any larger organic investment initiatives, or is it all purely a focus still on M&A?
Over to you, numbers guy.
I mean, I think we say the same thing every time this year, that the numbers we get from the groups around organic growth are positive. If you ask me what the numbers will be next quarter, I bet you they'd be down from what they are today. You know, this is a positive outlook. We also have the benefit of FX next year. When I'm looking at what they're forecasting organic growth for 2018, it's not FX adjusted, and then it's quite a favorable adjustment, especially in the euro year over year. You know, if you're asking the question, are we only focused on M&A, not organic growth, I would say that's not the case.
I would say, you know, Harris has, you know, specific objectives and goals of organic growth, and Volaris does. I'm not sure about the other groups, but we are not just an M&A-focused organization.
There are dedicated full-time people who coordinate initiatives at a number of the operating groups, Paul. For some people, it's their full-time endeavor, and somewhat they live and breathe. You know, that kind of focus tends to hopefully get you results.
Great. Bernie, I know you like to keep stats. Maybe you could help us out with this one. In the last six months, could you sort of classify how those acquisitions looked in terms of, excuse me, how many of those were either top one or two in their verticals in terms of landing a new beachhead, a new market, versus market consolidation plays?
Oof, I don't have those at the top of my head. In fact, I think about 50%. 50% of the acquisitions that we have been making have been tightly integrated to our existing operations, and the other 50% are standalone operations, we can tell you that. Whether or not they're beachheads into new verticals, we have gone into some new areas. I'm not gonna start going through the list, but there are some new areas in telecoms, some engineering areas as well, that we can go ahead and try to look around to see if there's some add-on acquisitions to tuck into or at least associate themselves with existing companies that we have now. It's really hard. It's not a crisp number that I can give you.
Fair enough. Just one last quick one for me. On a SaaS basis, in terms of businesses that are either a subscription-driven business, what's that percentage looking like these days? Thanks, guys.
I don't think we've measured that in ages, Paul. It doesn't really sort of influence our thinking on whether a business is interesting or not.
Okay. Thank you.
Again, to ask a question, please press star followed by one on your telephone keypad. Your next question comes from the line of Paul Treiber with RBC Capital Markets. Please go ahead.
Oh, thanks very much, and good morning. I believe that you're hosting your internal M&A conference today with some of your teams. Just hoping if you can share any of the key themes that you might discuss at the conference.
I think we've talked about it before. We're trying to push down M&A further inside the organization. It's an education conference as much as anything else. We're talking about whatever new revelations or discoveries we've had over the course of the last year that we believe should be broadly communicated amongst the people who are working on acquisitions. It's best practices, you know, recounting what worked and what didn't over the course of the last little while. Bernie, anything else?
No, I think you hit it precisely.
Do you think, will any of the teams bring up the current valuation environment and how that factors into their thinking?
Yeah, I mean, they always say that it's hard to buy stuff at attractive prices. I don't think they've ever not said that. Maybe during the Great Recession, they might not have said it for a year. I think that instead, they had a different line. It was something like, "No one's selling right now because it's a terrible market." That was the one. Yeah, I remember.
Okay. Shifting to the results, the MD&A discloses that there's a relatively large increase in the contingent consideration. I think it's up to CAD 4.2 million. You attribute it to an increase in revenue forecast at acquisitions. What changed to drive the increase? Going forward, would you make any changes to your forecasting processes to adjust for that?
Yeah, I mean, it was something within the earn-out agreement with a specific acquisition, and if they hit certain targets , we'd have to pay them X amount of the revenue above a certain target. They overachieved. You know, what we expected on the day of acquisition then was obviously less. They overachieved. Like, in terms of forecasting, you know, if we had known it, then maybe we, you know-
Well, we would have-
Yeah.
Had it if we'd known.
Right, exactly so.
It was a surprise.
Right.
It was a nice surprise.
Yeah. It's a nice surprise. We paid out the amount. As a result of us paying out their amount, it also means, though, that we have a higher recurring revenue stream, we'll recover that amount over time. Yeah, these things happen, right? It just, they overachieved.
Okay, it sounds like a positive one-off, nothing systemic, there's no systemic trend there.
Although, you know, it's interesting, Paul. When we look at the stats for the M&A, and we look at our forecasting ability, on an individual basis, it's not particularly good. On a portfolio basis, it's not bad at all. The intriguing thing, though, is we use a multi-scenario approach to forecasting, and I'm struck by how frequently, even outside of our outlier forecasts, we end up with actual performance, both at the low and the high end of the outliers. So you do get a real spread on these things. This happened to be a spread on the upside.
That's interesting. In regard to M&A this quarter, I mean, it looks like the frequency , or the number of deals , has increased quite a bit. But it seems like the average size has decreased. Why do you think that is? Could that reflect a lower purchase multiple versus what you've done historically?
I don't see that the average price has decreased, not from the numbers that I see. I think we're pretty much at the same level. That's okay, and I don't think we discussed multiples on the call.
Okay. Thanks very much. I'll pass the line.
Your next question comes from the line of Stephanie Price with CIBC. Please go ahead.
Good morning.
Morning, Steph.
Mark, you mentioned adding new M&A processes when you were talking about ramping up the M&A headcount. Can you elaborate a bit about what those processes are and what kind of early wins you're seeing?
You know, that's kinda proprietary. We're trying to do M&A on a scale which I can't think of more than two or three companies that have done it. So what we learn, we don't really wanna share and would like to keep internal.
Fair enough. Maybe moving on to, you know, the fact that you're moving down the M&A onto the business units. Can you talk a bit about what percentage of M&A historically has been sourced from the business units and the percentage from the M&A team, and kind of how you see that rolling out over the next couple of years?
Bernie, I don't think we've ever looked at those stats, have we?
No. No.
A general observation would be that the people running the businesses have relationships. They have relationships with competitors and with adjacent products that they meet through their customers. Those will always be things that get fostered and nurtured better by the business unit managers than anyone else inside our organization. Obviously, we'll use the skills and capabilities of the M&A group, but that's always been where it's been at. The use of BD people smiling and dialing. We did some of it in the early days. We used to do direct mail. We used to do some telephone. You know, it's more common now than it has ever been in the past.
Okay. Thank you.
We still do get some sourcing from investment banks.
Oh, yeah.
And through headquarters, we disseminate them to the operating groups.
Yeah. Investment bankers are very important to us. They're involved in a very high proportion of the transactions, even when they're independent owner-operator type businesses. They serve a useful role. When there's a banker involved, we know it's really for sale as opposed to maybe for sale, and you can save yourself a lot of time. They tend to give comfort to the vendors so that they know what's normal and what's not normal. Because most vendors don't sell multiple times. They just sell once in their lives. The bankers serve an important role, but they are expensive.
If you're selling your single largest asset and you're willing to build a relationship with the buyer and get comfortable over time, you know, then we often see that there aren't bankers involved in those sorts of transactions.
Okay, great. Thank you very much.
Yeah.
Your next question comes from the line of Steven Li with Raymond James. Please go ahead.
Thank you. Mark, as your stock price moves higher, is that a risk to your ability to attract and retain M&A talent, to the extent your new members now have to acquire stock at higher prices? How do you think about that? Thank you.
You know, I'm gonna be with 100 and something of them later today. I'll ask them. You know, it's I don't like the multiples that I see in the market generally right now. I think there are many highly overvalued companies out there. When the market gets as high as it is right now, I think it's a very tough place to be investing your capital. You know, when we ask employees to do that as part of their bonus program, it doesn't make me feel good.
All right. Thank you.
Again, if you'd like to ask a question, that's star followed by the number one on your telephone keypad. Your next question comes from the line of Richard Tse with National Bank Financial. Please go ahead.
Thank you. Hey, Mark. Just kind of curious, you know, what you're thinking today, if you look forward to what's the reasonable sustainable growth rate for this business here if we look at the next five years?
You know, it's a tough one to call, Richard. It really depends on how well the acquisition engine works. You know, talk to me in about four years, and I'll be able to tell you.
Fair enough. This one's for Jamal, though. You know, you look at IFRS 15, I think more people are talking about this now. If you kind of look forward here next year, what do you think the kind of the broad impact is gonna be on your numbers here? I'm sure you guys are running that analysis right now.
Yes. We don't have crisp enough numbers to put into the MD&A yet or the financials. What's coming out right now, the P&L impact is not gonna be material in my mind. It's got a few things that are going one way, a few things offsetting it the other way. The impact on the balance sheet might be a little bit larger in terms of what the deferred revenue number might be. The annual impact on the P&L, I'm not expecting a material change.
Okay. Then a last one-
Yeah, just a comment on IFRS. The changes can have profound impacts on software companies. I think investors and people in general need to be very, very careful about this. We did a bit of an exercise to say if we were buying a company and that company had worked hard to use the change in IFRS to make their numbers look good, how good could they make them look? We think that they could probably move the needle by 7%-10% on the kind of companies that we buy. There's lots of sloppiness and room for games playing in this rule change.
Just a last one for either Mark, Bernie, or Jamal. Can you give us a flavor for the environment today for transactions? Is it sort of tougher than it was last year? Same, easier?
I still get feedback from the M&A guys that it's a tough environment. Again, I think it's the same message I gave last time I was on the call. It's the portfolio companies of private equity firms that are also trying to do their own kind of roll-ups in whatever industry they're in. A bunch of copycats is popping up as well, trying to do something similar to what we've done in the past. Still plenty of competition out there. It makes it hard for our guys, but we still managed to get some very good, solid acquisitions done over the course of, well, over the last year or so.
Okay, great. Well, have a good conference.
Thank you.
Thank you.
Your next question comes from the line of Thanos Moschopoulos with BMO Capital Markets. Please go ahead.
Hi, good morning. Mark, you mentioned that you don't really focus on whether a M&A target is a SaaS business or a licensed business. I'm just curious on that. I know that the economics of a SaaS business can sometimes be less favorable, but if you buy a licensed business, wouldn't that increase the risk that you'll have to invest in a major platform rewrite at some point in the future?
I don't see why. I would've thought that SaaS was just as likely to require a major rewrite at some point.
Okay. Fair enough. Then maybe in terms of your experiment scaling up the M&A team, has that been confined primarily to North America , or have you been doing that internationally as well with Robin and the team?
No, it's been happening across the board. We do have operations in Europe and Australia , and as we push capital deployment down through the ranks, the people at the BU level want M&A staff with them so they can go out and do their thing. It has been international for sure.
Finally, any update you can provide in terms of the pipeline of larger opportunities? Clearly, you haven't had any luck on that front. Has there been a pipeline? Has there been activity there?
You know, you try and look at everything you can, because sometimes there'll be a special situation that gives you an opportunity. And we're getting pretty good coverage of large opportunities in our CRM system, but we're only being invited to look at a tiny number.
All right. Thank you.
The-
Oops, sorry.
Oh, sorry. The levels of leverage that we're seeing applied to LBOs of these companies right now are just astonishing. The non-traditional lenders are getting into it and are driving multiples up to 7x or 8x EBIT, and often it's a forecasted EBIT for these businesses.
Great. Thanks, Mark. I'll pass the line.
Yeah.
There are no further questions in the phone queue at this time.
Thank you, Dan. Appreciate it. Thank you, everyone, for joining the meeting this morning, and look forward to talking to you next quarter. Bye-bye now.
Thank you to everyone for attending today. This will conclude today's call, and you may now disconnect.