Good morning, ladies and gentlemen. Welcome to Constellation Software Inc. Q4 2014 Results Conference Call. I would now like to turn the meeting over to Mr. Mark Leonard.
Please go ahead, Mr. Leonard.
Good morning, everyone. As you know, we go directly to questions. So Melanie is going to give you instructions on how to get in line and pose your question.
Thank you. We will now take questions from the telephone lines. The first question is from Philip Wang of Barclays. Please go ahead.
Yes. Thanks. Good morning. Solid side of the numbers. First question on the margin expansion.
Can you provide us some color around the solid margin expansion this quarter? Was there any one time items that drove that in the quarter? Or do you kind of see this as pretty much new normal?
Any one time items, Jamal, that pop into your mind?
So it was the one time or there was a $4,000,000 adjustment to our benefits accrual in the U. S. In Q4. This is a little bit of a true up for the year. So from an annual basis, there's no real adjustment in Q4, there was.
So this is sort of an expense. It was overstated maybe in the first half and then adjusted in the second half.
So there was some of that adjustment in Q3 as well?
Yes. So it was a $3,000,000 in Q3 and then $4,000,000 in Q4. Other than that
So $4,000,000 in Q3 $4,000,000 in Q4 or just $4,000,000 spread between Q3 and Q4?
Sorry just dollars 2,000,000 in Q3 $4,000,000 in Q4, so $7,000,000 Got it. And some of that a little bit of that relates to where the full accrual from the last year, but it really does represent a lower run rate of benefits expenses for the company with some changes we made.
Got it. And any other items aside from that or?
I mean there was again this isn't a one time thing, but we've noticed there is like there's been some restructuring being done outside of TSS that we are now seeing the benefits of. Like one of the large acquisitions made in January in Europe, they now have a reduced headcount and they're seeing much higher margins. So that's not a one time thing. I guess we're now just seeing the benefits of that. And then in Q4, as we always say, there's always a push sort of complete projects and hit milestones.
And so there's always a little bit of an uptick in Q4 from a revenue perspective, which goes straight down to the
bottom line.
Got it.
There's a
lot of
things that goes on. And to me it's almost like magic in the R and D accounting and tax credits. And traditionally what we've done is offset some of the R and D expense directly against the associated tax credits and that tends to understate R and D and overstate EBITDA and then you get a tax effect below the line. And so we're going to try and break that out more clearly going forward. So you can see exactly how much the tax credits are and what the gross amount of R and D is.
And I think that will give you a better sense of what the true EBITAs are.
Got it. No, that's very helpful. Second question on TFS transaction. I was wondering if you could provide some color around this. I know it's part of the initial agreement, but you sold a third of TSS for $39,000,000 which is below what you paid for.
Can you maybe provide me with some context on the rationale behind that? Is it to reflect your control premium? Or is it more of an incentive to management?
Yes. I think we sold it for exactly what we did before. That was the transaction that we'd agreed to at the time that we did the acquisition. And I think you've just got to back out the refinancing that happened between the time that we purchased the company and the time that we sold the minority interest. So they got exactly the same deal that we did on our shares.
Okay. Got it.
Thanks very much.
Thank you. The following question is from Scott Penner of TD Securities. Please go ahead.
Thanks. Just Mark, first of all, on the organic growth side, maybe just leaving aside currency, whether this whether you thought this past year at around 4% was a pretty good indication of what the normal level of organic growth should be?
So Scott, I said it before, I would happily give up a point of EBIT for a point more of organic growth. All of our companies know that. And maybe after I've had a beer or 2, I even suggest that I'd give up 2 points of EBIT for a point more of organic growth. So it's clear to the managers that organic growth is very, very important to us that we think it's a sign of a healthy business and that they're gaining share in their markets and things of that nature. So I think implicit in what you're asking is, would we be happy with 4% organic going forward?
And frankly, no. We would like to see it be better than that.
Okay. On the capital structure side, the debenture issue obviously went quite well. Just given that short term funding costs don't look like they've gone up. If anything, they may have gone down for companies. So what are your feelings right now about future capital raises and maybe trading off the higher cost of longer term instruments for the shorter term capital shorter term credit?
Yes. I think that if you have short term assets then short term credit is a terrific way to finance them. I think if you're buying companies that you intend to keep forever, financing it with a short term debt is insanity.
Is that non the nontraditional instrument, is that a vehicle that you think given the success of the first tranche that you would look to use again if you needed additional capital?
I would definitely do so. And the issue is to exactly what extent would you use it and do you have good uses for the capital. And that's the challenge that all of our companies have is trying to find good acquisitions, companies that you would truly want to own forever.
Right. When you look at the capital position of the company right now, it looks like on the existing structure there's $300,000,000 plus of available credit and cash. Do you feel right now that just given the plan for the next year that you are that you need more capital that you're swimming in capital? How do you feel about the position right now?
So I'd much rather be overcapitalized praying for a downturn than vice versa. And yes, I would I've talked to the Board about having more capital at our disposal, we're in those discussions on an active basis.
Okay. I'll leave it at that. Thank you.
Thank you. The following question is from Thanos Moschopoulos of BMO Capital Markets. Please go ahead.
Hi, good morning. How should we think about margin seasonality heading into Q1? Should it still be the case given your current mix of businesses that we'd expect Q1 to have seasonally weakest margins of the year?
Jamal? Yes. I would say Q1 is always going to be the lowest margin of the year Will it go as low as last year? I don't think so. I think we're where you have a little bit of a higher run rate now.
But you definitely should see it. I mean, I would expect a dip in Q1 because of all the payroll taxes etcetera and also because of the push in Q4 PS that sort of then sort of trails off usually in Q1. But yes, so it definitely should be a little bit of a dip.
Okay. On CSS, surprised by how strong the margins are proven to be. I think you suggested at the time of the acquisition that there were some factors in that business that could lead to a structurally lower margin level. And yet, obviously, we're seeing some very strong margin performance there. Can you comment on how TSS is performing relative to your expectations when you bought that asset?
And whether we should expect margins to continue expanding from here given the program that you're now wrapping up as far as restructuring the business?
So it's not like we have some one size fits all program and that's driving margins. There are the way I look at it 15 business units at TSS with managers, some of whom have been doing the job for ages and some of whom are pretty green. And then there's a series of folks above that who coach and assist the people running the business units. Each of those business units has a different set of economics, a different set of competitors and a different strategic position And they're all sort of pursuing their own business plans and that ends up being the numbers that you see. But to talk about them in aggregate doesn't work.
What we hope is that we have something that we can share with them in terms of best practices and that they will find those useful and apply them. But it's not like we helicopter in with a bunch of high class vertical market software managers and change everything. It's just we talk to them about best practices. We share what we know and what we think. And they adopt what they think is appropriate for their markets.
Okay. That's helpful. Now regarding the TSS transaction, you took a liability related to the minority stakes. Will you be marking that liability to markets on a regular basis depending on their performance and depending on how that put value changes?
Yes. We'll flow out through the P and L every quarter. So we'll evaluate it each quarter and any change will flow through the P and L.
Okay. And to clarify, it seems like the formula is based on recurring revenue as a primary driver. Does the profitability of the business factor into it as well?
Yes. To the extent that book value increases, there's a direct correlation there as well.
Okay.
And when I say book value, I mean book value the way we measure it, which doesn't include amortization of intangibles and a couple of other things, but that would be the primary adjustment.
Okay. Thanks. I'll pass the line.
Thank you. The following question is from Paul Steep of Scotia Capital. Please go ahead.
Great. Thanks. So Mark, I guess in early 2013 you commented about the ability to double the size of the business in terms of profits and a number of metrics within 5 to 10 years with the current management and financial capacity. So congrats you got that feat in 2 years, not even 5 to 10. What's your take now about the ability to scale in terms of management and financial capacity and sort of do a similar doubling of the business
or whatever maybe higher goal
you want to set in the next 5 years? So Paul,
it's a crapshoot. It really comes down to the availability of good investment opportunities. If we just run the business as is and continue to pick up 15 to 30 small acquisitions a year. I think we'll deploy a chunk of our cash, but not the bulk of it. And if we work a little harder and a little smarter on organic growth, I think we'll have a terrific business of which we'll all be very proud 5 or 10 years hence.
That doesn't mean it will grow at anywhere near the rates it has historically. And as we invest in organic growth that investment will not generate instant profits. It's a 5 to 10 year run to get profits out of those investments. And so it will be a long slow grind. Occasionally, there may be opportunities.
Those opportunities may come in the form of a major recession in either a particular geography or worldwide or a particular industry. And so of course, we're looking at the industries you could imagine we would be looking at right now for the vertical market software players to see if there's any opportunity for us to buy. And unlike most people, we would be hoping that there would be a major correction in the stock markets because the multiples are as heavy as we've seen in a very long time. And one of our investors sent me a piece this morning that said he was going to a conference and a large chunk of the companies he was going to be looking at were trading at more than 25 times real net income. And as you know that translates into a sort of a 4% return plus whatever growth they don't have to invest gobs of capital to get.
And these are miserably low returns on capital. I really hope they don't persist for a long period of time. It makes me have to rethink investing and I didn't grow up in 4% return environment and I don't want to be in 1. And so I'm really hoping for a giant correction and that we will get to buy either entire companies or pieces of great vertical market software businesses, because I think we're well equipped and follow the public market to vertical market software companies. And if I have the access to capital and there is a downturn, we will buy as much as we can.
That was the lesson we learned from the last one. We did terrific during that 2008, 2009 period. We just didn't deploy enough capital. So my hope is that there will be specific events that lead to growth that exceeds the baseline level that I talked about and that we can indeed have 5 to 10 year window during which we can double top and bottom line. It requires though special circumstances.
It won't be out of the sort of daily grind of the historical rates. That would be a challenge.
Fair enough. The second one you actually started to touch on it a little bit. You call them initiatives. Is there any sense I know you've stopped measuring it in essentially collected way a number of years ago. But if we think back and we look at that organic maintenance revenue growth, you've talked about it historically growing mid to single high digits organically and a 5 to 10 year run rate for planting the seeds of those initiatives as they as they come due in terms of how you see those performing and maybe playing out and maybe look forward to the seeds you planted in the last 5 years since 10 to 15?
So there's a fun construct you can use to break up initiatives. There are initiatives where your customers want it and are willing to help pay for it upfront. There are initiatives where the customers want it and don't really want to pay for it upfront, but say that they'll pay for it once you've built it and made it work the way they want it to work. And then there are initiatives that you think your customers want and your customers aren't yet willing to say that they agree with you. Obviously, that first bucket are the easiest ones to invest in and we are having the most success with those And we can certainly see a bunch of them paying off.
The second set, we have a few. And the third are very rare and we generally see them in our low ticket software arena. We're learning about these things all the time. We try and share the results. We talk about the cost of rewrites and how you amortize that through an installed base and how you recapture that value.
It's just an inherently difficult thing to do. And we have a fair amount of overhead associated with it. So the reason we stopped tracking it centrally was because of that overhead and because the general managers only wanted to do it for certain initiatives that they thought were worthwhile tracking. But I can tell you that all the way up to me, we got 240 business unit P and Ls this quarter, give or take a couple. And there were a bunch in there with single person headcounts.
So why would you ever do a P and L for a single person headcount? Obviously, it's because the managers who sit above them believe that it's worth focusing some effort to track those particular initiatives, understand their economics, decide when to apply fuel the fire and when the traction is growing. And it's happening throughout the company. There is a grassroots level effort going on to do initiatives better and attract them and to learn from them. And I just think it's a wonderful thing.
And I just wish more companies, particularly our SaaS competitors, did this as rationally as I think we're doing it.
Fair enough. I'll hit one last one. On PSS, we haven't seen the membership agreement or I haven't seen it at least disclosed. Can you just confirm that the metrics in there in terms of compensation metrics for that team are effectively the same as what you've outlined in I think it was the AIF that's been consistent over all the years? Thanks.
So the senior management are paid on the same basis that we pay our general managers in our other business units. The one exception being that I believe we have an interest deduction and that we're just looking at equity whereas in our other groups, we treat the investment as entirely unlevered. In the case of TSS, we treat it as levered. And so they have a big incentive to manage their cost of capital and their banking arrangements around which they did a terrific job far better than I had done with Constellation previously, but Jamal is now going to trump that and do an even better job than both of us on our upcoming negotiations with our banks.
Perfect. Thanks guys.
Thank you. The following question is from Richard Tse of Cormark Securities. Please go ahead.
It's actually Andrew McGee in for Richard. I just had a quick question related to FX. And if you could talk about the opportunity in Europe given that Constellation reports in U. S. Dollars and just your thinking on the advantageous move in the FX on the euro?
And then maybe just a comment on top of that in relation to the market multiples that you're seeing in those companies and whether or not they've moved in your benefit, stayed flat or vice versa?
Yes. So I'll talk about FX generally and I'll get Jamal to talk about it specifically. I have
no idea what he's going
to say, so it'll be fun. Generally, I don't try and time FX markets. I have no idea which way they're going. And so I always find it amusing when people call out organic growth and profits excluding FX and translation adjustments and look at the native currency stuff, I understand why they do it. And when I look at the individual business units, I for sure do it.
But overall, I'm kind of assuming that FX goes up and down and that I can't predict it. And so when it goes against us, I should accept that and be responsible for it. And when it goes for us, I should accept that and be responsible for it. And so I'm obviously not pleased that we bought a big European asset at the end of 2013 and the euro has been hammered since. I'm not particularly pleased that we have a very large Swiss expense base and sell in euros nor that but fortunately, we have a big Canadian dollar expense base and sell an awful lot of stuff in U.
S. Dollars. So sometimes it works for you, sometimes it works against you and we don't deliberately try and take advantage of it either way. Do you want to talk specifically about what you think FX will do over the course of the next year?
Yes. I mean, again, I can't tell you what the rates are going to do. But assuming they say somewhere around the same rate as they are today, I would expect around that same 4% to 5% negative impact on our organic growth in 2015. However, you'll see we're fairly naturally hedged in most currencies. So the impact on EBIT will be I'd say less than a percentage point except for maybe the Swiss franc is something that we're a little concerned about that now it's no longer pegged to the euro.
And we have a lot of Swiss franc expenses and there are no Swiss franc revenues to hold not sufficient revenues to offset it. So we are exposed there. But as Mark said, I mean the CSI policy isn't a hedge and so we will deal with it. I'm not sure I think when you're talking about acquisition opportunities, I'm not sure if we look at the weakening euro dollar, I mean, that we'll be more aggressive necessarily in Europe?
No. Because you tend to buy businesses that have both revenues and earnings locally or even if they didn't, we look at it on a straight IRR basis, x amount of currency going out and y amounts of currency coming in and what's the IRR likely to be.
And just in relation to the multiples that you're seeing in that in those regions, are they moving up or down?
I would have thought Greece would have been moving down, but haven't noticed it as I poked around there.
Great. Thanks for taking my question.
Thank you. The following question is from Andres Kornetta of Euro Pacific Canada. Please go ahead.
Hi, good morning, gentlemen. Thank you for taking my question.
Just wanted to
focus on the organic growth for a bit. Maybe if you can tell us about the specific verticals that you can specify that might have exceeded your expectations over the last 12 months? And can you give us a bit of color in terms of what themes or industry verticals you like going forward?
So it's like children, you got to like them all. You don't get to pick and when you keep them forever like children, you hope for the best for all of them. There are businesses where we have fundamentally better strategic positions than others, those tend to be more fun. The single biggest determinant of profitability outside of maintenance revenues, which we believe correlate very closely to profitability. The next biggest impact is what I would call competitive rivalry.
And so at the margin in the competition for new names, are competitors behaving rationally. And if they are, then these are just wonderful businesses. If they're not, you have to decide how much you're willing to invest to play the new name game. And if you're facing a venture backed company that views every dollar of recurring revenue as being $7 on an exit to an unsuspecting public, then that tends to be an irrational competitor, not for themselves, if they've got a greater full to sell to, but ultimately in the marketplace, in the competition for new names, what are they worth? I don't think they're worth 7 times recurring revenues.
So I've lost the thread. What were you asking originally?
Yes. So just wanted to get your color on what sort of industry verticals you're looking into as you head into 2015? Probably and are you looking to build on the verticals that you recently expanded to like the communication or the healthcare?
So the ones obviously we would love to expand to those where you've got the rational competitors and you can do tuck in acquisitions, you can sell more stuff to your existing clients. However, if we can't get the rates of return as we look at the purchase prices, we certainly won't buy there. And so it's totally return driven. We generally end up going where other people do not go and that's where we find the best rates of return.
Clear. We saw that you ramped your deployment on acquisitions in the Q4, which is about 3 times as large as in 3Q. What does that tell us about the acquisition environment? Is it improving somewhat?
I think it tells you that it's a highly unpredictable environment that you can't forecast.
Clear. If I can focus on TSS for a minute, it seems like their 4th Q revenues have gone up a couple of percentage points Q on Q. What would have their growth been on a constant currency?
As I had them in, sorry. Give me one second. I'll tell you.
Yes. Jamal is going to poke away at that particular question. Do you have any other questions you wanted to pose while he does that?
Yes. Yes. Maybe just to add on to Thanos' questions. Can you offer some additional measures that could drive efficiency at the TSS given that the transformation program is now nearing completion? Is there anything else in the pipeline for you there?
So as I tried to say before, it isn't that there's any particular thing that drives the company. It's the sum of many, many actions across 15 business units with some able coaching from the head office group at TSS.
Got it. Thank you. Thank you for answering my questions.
Yes. On the TSS organic growth, it would have been excluding FX about a 2% to 3% organic growth for the quarter versus a 6% decline. For the full year though FX had an immaterial impact, so it really did shrink about 6% and that's because we defocused or with less emphasis on TS revenues purposefully.
Okay. Thanks.
Thank you. The following question is from Drew Stroginy, a Private Investor. Please go ahead.
Hey, guys. Thanks for taking my question. You touched a bit on this already, Mark. But in last year's letter, you highlighted how maintaining revenue growth in excess of 20% will likely add hugely to shareholder value. Now that you have the NTI in place, what do you think are the biggest challenges in maintaining that kind of growth rate over the next 5 to 10 years?
Is it just lack of good investment opportunities?
Yes. That would be it. Investment opportunities on which you can generate high rates of return.
Okay, great. Thank you.
Thank you. The following question is from Chris Sarlow of TD Wells. Please go ahead.
Hi, guys. Just a quick question about the stock price. Has there been any mention of maybe doing a stock split in the next little while just to get a little bit more liquidity and shorten up the kind of the bid ask spreads on a go forward basis?
No. There has been no discussion around that.
And any thoughts about any dividend increases coming over the next little while as well?
That would really relate to us getting embarrassed by the amount of cash lying around and that certainly isn't happening yet.
Okay. Thank you.
Thank you. The following question is from Paul Treiber of RBC Capital Markets. Please go ahead.
Thank you. I just wanted to revisit the margin expansion questions that were asked earlier. So margins for the full year look like they're up about 170 basis points. I think you had a similar level of profitability in 2011, but then it did fall back a couple of 100 basis points over the next couple of years. How do we think about the sustainability of margins in the low to mid-twenty percent range?
And I think Jamal said you're at a new higher run rate. So should we think about it as a higher run rate perhaps due to economies of scales or efficiencies? Or is it dependent on organic investments and where that goes going forward?
So I think that's a nice summary of the factors that influence margins. Firstly, I don't think economies of scale are a huge driver. They are a small driver of what we do. But as we saw TSS break themselves up into 15 or 16 business units, That would be my hope every time we get associated with a larger business. And I believe that autonomy and focus, customer intimacy are the things that drive these businesses.
You dig down into just about every vertical we serve, what you'll find over the last 10 or 20 years is that those verticals have become increasingly concentrated. The number of customers you can serve has decreased. Now their appetite for IT solutions systems of all kinds has also increased and the breadth of the systems, they no longer adjust used by the accounting group or the manufacturing group. They're now used by suppliers and customers. They're used by salespeople, etcetera.
And so the breadth of those solutions has increased. And you end up serving fewer more sophisticated clients. And then as they get very, very large, they have the choice of moving to highly customized systems built on top of an SAP or an Oracle. And so we lose some clients at the high end of those markets. So the battle we face is the little guys, the small clients go away, get subsumed, get acquired.
The mid tier guys who are very successful tend to move to highly customized systems and we live in the middle there somewhere. And the business becomes one where we have to offer a certain amount of customization. We have to anticipate the needs of the market and build solutions that are deeper and broader than our competitors. So that the SAPs and Oracles are not effective competitors because they have very expensive systems that they sell to only the largest and then they require real customization that often costs an order of magnitude more than the original license price. We have to live in a place where we sell a system and maybe we sell a dollar's worth of services for a dollar's worth of licenses and share that R and D costs across tens, maybe 100, maybe in some extreme cases, thousands of clients.
So economies of scale are important, but are not the absolute driver. We're always going to have a professional service staff associated with the bulk of our companies who are spending time camped out with the clients, understanding their needs and translating them back to our R and D groups. So you've got to think about our business as a hybrid of software in the shrink-wrap sense of the word and professional services. And you have to do both efficiently. Very, very hard to do, but the smaller the group, the more likely you are to do that, I believe, in a highly efficient manner.
Hence, business unit size for us tends to average less than 100 people. And the managers of those business units who are very close to their clients tend to be the authors of a lot of the initiatives and the business itself. When you get down to the 100 person business unit give or take, you end up with a set of economics that if you're driven off of maintenance are pretty predictable and we see very, very high correlations of EBITDA to maintenance in those fields. And it hasn't gone up by leaps and bounds. It doesn't look like a margin expansion story to me.
And there's terrific scope to take that into the knowledge that you have with the client and invest it in the future with relatively decent rates of return that in addition make the moat deeper and wider around that client base. And so I think that individual business unit manager has a big incentive to keep investing, irrespective of the pressures that a corporate might put on for increased margins in the short term. So it doesn't feel to me like this is a business where we're going to see a natural expansion of margins year after year after year after year driven by some sort of central authority or policy. It feels to me like this is a business that hopefully just gets to be a better and better and better business by getting deeper and deeper and deeper into clients and growing organically. And so that's the hope that I have is that I won't be tempted and whoever replaces me won't be tempted to drive for profitability at
the expense
of 1,000 initiatives at our 2 40 business units that we can't possibly understand from head office. I guess what I'm saying is, I'd much rather have that extra point of organic growth than that extra point of EBIT. And everyone knows that, I believe, in our organization.
The follow on question to that and you alluded to it earlier about the number of VC backed new entrants that are targeting vertical markets now. I think Mindbody is a good example in the fitness vertical. One is on the existing business, have you seen any change in churn or impacts from any of those new entrants in specific verticals? And then looking forward in terms of product or organic initiatives, could the VC entrance, could they cause almost like an arms race in terms of innovation in the space or needed innovation that may need to be financed?
Definitely. I think those are very scary human beings who have deep pockets and visions and write about those visions and hence are wildly committed to those visions. And yes, it's uncomfortable in many of the verticals where we see those new entrants.
And is that one of the reasons also why you're keeping the hurdle rates where they are as opposed to increasing them in light of the market environment?
You mean decreasing them in light of the market environment?
Sorry, yes, yes, decreasing.
It's because I believe over the long haul, there will be a reversion to the mean and that we won't find 4% 5% 6% rates of return on equity acceptable and that we will see a bunch of these guys jack up their hurdle rates over time because we're in it for very long periods of time and the investment cycles around our initiatives are decade long. You can't afford to react to the Bank of Canada rate last Thursday.
All right. Thank you. I'll pass the line.
Thank you. The following question is from Stephanie Price of CIBC. Please go ahead.
Good morning.
Good morning, Stephanie.
Mark, I just wanted to clarify with Paul's question there, you mentioned whoever replaces me. You don't have any plans to go anywhere in the near term, do you?
No. No.
Perfect. And if we assume acquisition activity sort of remains lower in the current environment, can you talk a bit about what sort of organic growth you think Constellation could get to? And what sort of R and D investment that will require?
So in the past, we have gotten to 10% ranges and we've actually exceeded that briefly. It's but because it's the sum of 2 40 business units now as opposed to a half dozen back at the beginning, there's more of a portfolio effect and there'll be more averaging out of those sorts of things. It would be total speculation, Stephanie.
Sure. And then in terms of sort of the R and D pipeline, I know in the past you have been not a huge fan of the SaaS model. Can you a bit about your thoughts on that and whether that is encompassing a larger part of the R and D pipeline right now?
Yes. So we own 15 businesses that are SaaS businesses. I wish they had the economics of other businesses, but they don't. It's a model that doesn't get the same level of commitment from the customer that conventional license maintenance model gets. It requires a lot of capital upfront by the SaaS company and hence it's just not anywhere near as much fun at the beginning.
Over the long haul, it should be attractive. And every time I get my sales force bill and look at the increase year over year, I smile to myself and say, at some stage, these guys are going to make money. And I can't believe how much I'm paying them. So I think it's a model that makes some sense and does provide leverage. I think it's an inherently difficult model to make work because you need a fairly broad base for the most part from what I can see.
Otherwise, you end up just doing a hosted system that major clients insist be resident on their premise and that they can modify to their own specific needs. And to me, that destroys a lot of the economic benefit of SaaS where one size fits all and it's hosted centrally by the vendor. So I think the market still got a lot of growing to do and folks have still got to understand the underlying economics of the business. We're amongst the players learning about it as fast as we can and in certain of our verticals, the low end verticals, ones with low ticket software, we have SaaS offerings. We also have them in other verticals that are inherently geographically dispersed and where the clients want something that's easily deployed and supported.
Okay. And in terms of competitively, are those the only areas you think you need to be competitive in the market? Or are there other areas that maybe you're looking at as well?
So just about every one of our businesses has a SaaS offering or some sort of add on usually aimed at the our customers' customers or our customers' suppliers. And that just sort of makes sense because there's usually a bunch of those. So if we have 1,000 customers in a particular vertical, they in turn probably have 100,000 customers and trying to put software on their premise doesn't make sense. And so a hosted solution is often what we come out with.
Okay. Thank you.
Thank you. The following question is from Bruce Harrop of Agenda. Please go ahead.
Hi. Thanks for taking my question. Just a question on the structure at TSS. They'll be able to to make their own acquisitions obviously through this co op. Will they finance that completely within the co op through the free cash flow of the co op?
So the business has done well in the 1st year, generated good cash is sitting on that cash because the banks don't let you dividend it out when you're in a leverage structure. Our strong hope is that they will be able to deploy that cash on subsequent acquisitions. They know their marketplace. They're close to their customers. They know what the customers use in terms of other products and would like to see within the fold.
And so they're working hard. They've got a couple of full time guys working on it and a lot of the senior management are spending time looking around for acquisitions as well. So yes, I hope that they will do them within that particular vehicle. If they come across something of size that exceeds the financial capacity of TSS per se, we have an arrangement whereby we can jointly, us and the other shareholders, look at other larger transactions on a basis that would allow them to invest, but maybe not a pro rata share if they don't have the resources. And I'm pretty comfortable with the structure that we cobbled together.
It did take us a year to get the fine print figured out. But I'm hoping that at the end of the day as individual circumstances pop up, we'll be able to work through them.
Is there a normal amount of leverage you'd expect to in there? Like right now, it looks like they have €130,000,000 of debt. Is that kind of the way you'd would you expect them to pay that down or keep that kind of leverage?
So the banks have suggested that paying it down each year is an integral part of their agreement. And so I would suspect that they will pay down some of it. There is a big bullet at the end. Okay. The appetite for debt relates to the returns you want to see.
If we are going to go chase large leverage transactions, we're going to have to get increasingly comfortable putting debt into those acquisitions. That's an additional stress that you place on the managers. The managers in this particular instance are also shareholders and are hopefully going to benefit from having that increased leverage. It's a model that we have had no choice but to pursue because of the competition for the large transactions where the competition, the private equity firms are using leverage. And so we're emulating them.
The difference is that we want to own these businesses forever. And we would like at the end of the 5 year period that a private equity firm would have and where they're looking for an exit, we instead will hope to pay down the debt and only use incremental debt if managers and we are comfortable with that prospect.
All right. And the put call arrangement you have on the 33% interest that you don't own, is it has the valuation methodology based on it sounds like book value per share, which isn't in your document, but also recurring revenue. Is it the same valuation if they put it to you or if you call it, it's the same valuation at that point in time?
I wish. So the deal is that if they put it to us, it's a lower valuation.
Okay.
If we call it, it's a higher valuation and we'll give you a little more color on that I suspect as time goes on.
All right. And then the kind of increase in value of this business will show up as a liability on your balance sheet. And you're going to flow that through the P and L as will that be a separate line item? Or where will that flow through?
It's going to be part of our financing cost line below EBITDA, but we'll bring Okay.
And will you call it out separately though, so we can see
what that is? Okay. There will
be a table in the notes in the financials which we'll break in.
All right. And just regarding that non the floating rate debenture you issued, I mean, I know this trading at 125 right now, so it's been successful. You said earlier in the call that you would consider doing more similar issues. Would they be very similar? In other words, indexed to trailing CPI plus a premium?
And also would they be marketed to existing shareholders or issue that's right to existing shareholders?
So I love the rights offering mechanism because if we get it wrong and apparently we did because this thing trades at a huge premium. If we get it wrong, the benefits have the potential to accrue to our shareholders. So they don't escape the net so to speak. So whatever we do that will be a preferred course. And I don't think I want to answer your other question.
Okay.
That's all. Thank you.
You're welcome.
Thank you. Following question is from Scott Penner of TD Securities. Please go ahead.
Thanks. Just a quick follow-up on that is that even Mark given your comments about the market multiples out there, how has that impacted the behavior of private equity? And are they in competition for some of the larger transactions? And are they starting to chase the same sort of verticals that you would be looking at this time?
Well, I think it's the other way around, Scott. I think we're starting to chase the verticals that they've been looking at for the last 10 years. And so we're latecomers to the large transaction market, never having previously been able to get comfortable with the rates of return that we could get on a straight equity investment in those transactions. So it was only once we started considering standalone leverage in the entities that we got comfortable with the idea. And we're still trying to convince ourselves that we want to do these things.
So I think another 6 months at TSS will give me much more comfort that the process works. And then if it proceeds as we're hoping, then I think we'll start to look again to do another launch leverage transaction if we can find one at the right prices with the right team. The team is an awfully important part of it. We basically have 6 people sitting around the table with Jamal, Bernie and I right now that we really like in respect. And every time you buy another big one, you're inviting someone else to the table.
And you'd hope they would be worthy of being there.
Right. Okay. I appreciate. Thanks.
Thank you. There are no further questions registered at this time. I'd like to turn the meeting back over to Mr. Leonard.
Thank you, Melanie. Thank you, everyone, for attending. There were a lot of new voices on the phone today and enjoyed the questions. Look forward to talking to you all in a few months' time. Thank you.
Thank you. The conference has now ended. Please disconnect your lines