Good morning, ladies and gentlemen. Welcome to Constellation Software Inc. Q2 Results Conference Call. I would like to turn the meeting over to Mr. Mark Leonard.
Please go ahead, sir.
Thank you, John. Thank you for joining the conference call. As you all know, we go directly to questions and John will tee those up.
Thank you. We'll now take questions. Our first question is from Paul Steep from Scotia Capital. Please go ahead.
Good morning. Mark, maybe you can talk just about the M and A environment and in particular maybe both the sourcing of deals as well as the potential down the road to maybe shift the geographic mix, how you're feeling about moving into other new geographies?
Okay. On the sourcing side, we have been examining some databases to get a handle on our market share from a sourcing perspective. There are no easy answers out there that we can lay our hands on, but we have gotten a sense that we haven't yet covered the market. So we've roughly 25,000 names in our database and we've been adding something on the order of 5,000 a year to that database. We think there's probably another 10,000 or 15,000 that we could add based on some of the database work we've been doing over the last little while.
Obviously, if we're doing that at $5,000 a year, we would get through that fairly quickly. I think, however, once we've added those, we'll discover there are more to add. So I think it is a fairly large market for vertical market software companies that potentially could be acquired. The trick then, of course, is to stay in touch with them in case they are available and for sale. And that's a nontrivial effort.
It's going to require lots of manpower. We already have lots of full time people working on it, and I anticipate we will add lots more over the course of the next few years based on what we've been doing to date. So I'd say we're placing more effort on sourcing than ever before. We've also started a bit of an initiative to figure out how we cover the high end, the larger transactions in the marketplace. These obviously are easier to spot and much more highly contested and we'll have a much lower hit rate with them.
But we'd like to make sure that we do see the larger transactions and get a chance to bid.
And then just geographically, you have done very little historically in Latin America or Asia. I don't know if there's any view as to the thoughts of expanding towards new markets on that front?
So my sense is the vertical market software in low wage countries suffers from 2 things. 1 is that software tends to be a substitute for labor. And the other is that if labor is cheap, you can generate custom software fairly cheaply. And so I think those markets tend to be somewhat less burden in terms of opportunities for things to buy. But we continue to look in all kinds of places.
I think we have our 1st Brazilian office with the CAE acquisition. And obviously, once you've got local feet on the street, you start to leverage off of that and try and use those people to introduce you to other software companies they're familiar with in their local geographies. We do continue to add lots of names in lots of different places, but it's a gradual learning experience. It's not that we're averse to going anywhere, but each one is a new set of learning curves to climb. Okay.
And I guess the last one for me is no update per the letter you talked about thinking about some compensation structure changes. Has there been any sort of advances in your thinking over the last 90 days or so?
Yes. We talked about it at the Board yesterday. I'm trying to make sure that everyone shares the same basic feelings about the facts and then start to build a solution from there. And I think we're making progress.
Okay. And then just to clarify as well, the materiality threshold, where does that stand these days in terms of you folks press releasing acquisitions at the parent corp level? Thanks. The
$10,000,000 purchase price.
Perfect.
Thanks guys. Thank you. The following question is from Andrei Knaude from Euro Pacific. Please go ahead.
Good morning gentlemen. Thank you for taking my questions. Professional services revenues were a bit light in the quarter. I was wondering on the private side, they were down Q on Q and historically they are up sequentially. Can you tell us a little bit about what drove that and sort of what that speaks about the activity going into the second half?
I hadn't noticed that actually. I tend to look at the businesses on an individual basis. And so there's a couple of 100 of them out there. And in aggregate, I don't know that you get a whole lot of information out of looking at the professional services number and trend. I do tend to think professional services as a rule are a fairly good leading indicator of the activity levels in a business.
If they start to go down, it's usually because you're chewing through your backlog and you're scratching for business And that's never a good sign. It could, however, depend upon whether you're deliberately reducing professional services business that has low profitability. We tend to see a couple of different kinds of PS business in our verticals. The stuff that is working on our own proprietary product and that tends to be pretty decent margin and business that no one else really can compete with. And then we also provide a bunch of professional services that are commodities and that isn't very good business.
Sometimes we do it because we want to offer a full bundle of services to the client and not have other people in there fooling around with the systems and disturbing them. But it's much harder to make decent money on that. But I think there's no obvious reason that I can see why PS has trended down. The general feeling amongst the managers as we talked with them is that the second half is looking pretty decent. So I don't think in this instance the trend downwards in professional services is a scary thing.
I mean, there were some it's like magic, for example, there's a couple of business units where they have very lumpy, very large projects. And so there was some that were tailing off that we had last year that have now tailed off. Now that again doesn't show a huge negative trend, I would think, because you would probably staff up for those large projects and then staff down whether or not there's not normal course. And there was a few in public as well, though, like that. But again, I don't think it shows a huge priority, but there are of course on the tail off.
Got it. Mark, you mentioned the business you acquired from CAE. Just wanted to see if there's anything different you're applying to your valuation framework as you look at industries or verticals that are arguably in a cyclical decline or a cyclical softness let's call it. Is there something different that you might look whereas those businesses might offer you attractive valuations now, but may take longer to turn around?
Yes. I mean attractive valuations are always attractive. And we tend to buy off cycle and we go where other people don't go because we intend to hold the businesses forever. So we think through the cycles. We don't think about this quarter or this year.
And in this particular instance, we're delighted to get into the mining space. I remember it must be over 15 years ago, Bernie, our M and A guy, went to the mining conference in Toronto, came back with a bunch of names of software companies in the mining space. And we have been studying it ever since. And we're now in one of the biggest downturns the sector has seen. And so we're buying stuff.
It just kind of makes sense to me.
And maybe one for you, Jamal. R and D tax credits, they were higher in the back half of twenty fourteen. How should we think about them as we head into the second half of twenty fifteen?
So 2014, if you sort of read through some of the disclosure, I don't remember the exact amount. There were a lot of catch up entries made before we started filing in the U. S, we started filing some stuff in Australia. So that's not a trend. Whatever is being booked now is probably the trend that you should expect.
Got it. That's all the questions I had. Thank you. Okay.
Thank you. The following question is from Paul Treiber from RBC Capital Markets. Please go ahead.
Thanks very much. Good morning. Just in regards to the capital deployment and acquisitions this quarter, the amount looks like it was above what we were estimating. Can you just help us better understand in this probably an easy way to put the question is, was it take out multiple and acquisitions quarter closer to what you paid for TSS? Or is it closer to what you paid for in the past for smaller deals prior to TSS?
So the IRR on TSS that we were seeking was lower than the and I'm talking here on the equity portion of TSS, was lower than the IRR that we operated on this quarter. What we did decide at the Board meeting, however, is that going forward, we will use a lower hurdle rate for larger transactions and we're going to use a higher hurdle rate for tiny transactions than we have in the past. So we're going to have a 3 tier hurdle going forward.
What's your I mean, you've been dabbling, for lack of a better word, in larger transactions for the last couple of years. What's your sense on the ones that you didn't win on the bid ask spread and your lower hurdle rate for the larger ones? How would you see that closing the gap? Or how close would you get?
I think it's very situation specific and varies a lot. If you've got a troubled sector and the company isn't making money, we love those because there tend to be fewer bidders and the bidders can't use as much leverage against those acquisitions if they're PE funds. And if you got a situation that's highly optimized running 50 percent EBIT, there's probably nothing we can do to make that business better. And in fact, probably believe that it is unsustainable at that level. And if they go out and the competitors leverage it 7x, we're not going to be competitive on those.
Lastly, just in regards to leverage, I think you mentioned before you'd prefer to be overcapitalized. I mean, what's the magnitude of overcapitalization we should think about? And then I think, Jamal, or you may have mentioned at the AGM that you're working on renegotiating your credit facility. How is that proceeding?
So over capitalization is in the eye of the beholder. It's something that I suspect we will iterate towards over time if we aren't managing to deploy as much as we're generating and we continue to raise the ventures. And it will be shareholders providing feedback, directors providing feedback and arguments about what the potential upside on having that excess capital around is. So I don't know what the answer to that is going to be, Paul. I think we're going to figure that out over time.
And on the credit facility, I've been the hold up on that, just haven't applied my mind to it. Jamal has been working on it with the bankers, has a sketch of what it looks like. And I just need to focus and get it done.
Okay. Thank you for taking my questions.
Yeah. Thank you. Following question is from Thanos Moschopoulos from BMO Capital Markets. Please go ahead. Hi, good morning.
Mark, as you start to look at larger transactions, how important is the notion of diversification across your business? So in other words, would there be a scenario in which you'd be comfortable having more than, say, 10% or 15% of your revenue coming from a single individual vertical, if that made sense from an IRR perspective? Or is that something that you'd be unlikely to do just from a risk mitigation perspective?
No, I think we would be comfortable with more than 10% of our revenues from a single vertical, mainly because recurring revenues tend to be recurring. And so even in the downturn, we saw that these businesses held up well. Homebuilding was the one that got hit the hardest inside of our portfolio. And even it I think remain profitable on an annual basis throughout the piece, it might have had a couple of quarters of losses. So yes, I don't think it's because of the nature of the underlying businesses with the high recurring revenues, I don't think it's scary to have concentration in a particular industry.
I just don't see any industries out there that are likely to be 10% in the short term.
Okay. That's helpful. Constant currency organic revenue growth seem to be a little slower this quarter. Given your commentary about the optimism for the second half from your managers, should we just assume that might have been related to maybe some restructuring, defocusing on lower margin work or maybe the larger projects that came off as Jamil talked about?
Yes. I don't know what the causes were, but the I asked the meta question of how optimistic are you about being optimistic in the second half and they told me that they felt that they were reasonable about the optimism in the second half and that they probably would do slightly better. So we'll see.
Okay. And finally, can you comment on the pipeline you're seeing of M and A opportunities? Or is that just are those deals so few and lumpy that it's really hard to comment on that?
So we saw 3 of 19 transactions in the first half that we would have considered Elephant. So we're in 3 of the processes. And we only had 8 of those 19 in our coverage universe in sales force in our database. So it would have been both nice to have had full coverage, so to have had all 19 of them on the radar and to have been in a lot more of those processes. So we're working on that.
Okay. Appreciate the color. Thanks, Mark. Thank you. The following question is from Kim Cook, shareholder.
Please go ahead.
Hi, Mark. I'm a very happy retail investor. And my question for you is with the stock price about to touch $600 Congratulations. Could you talk about your philosophy as it relates to that stock price and the possibility of a stock split?
So the underlying thought on keeping the share price high is that we don't want people trading in and out. What we want are long term oriented investors. It's a nontrivial company to understand, but to study it and read a lot of material and wrap your head around a whole lot of peculiar technology and terminology for the vertical market software space. If you do that, I think it can be rewarding both in terms of your investment in Constellation and potentially in investments outside of Constellation and other vertical market software companies. We track about 400 of those public companies and many of them have done extremely well.
It's an inherently good business model. And we love having educated shareholders in the stock. We don't want to see them sell. The share price is a bit of a barrier to retail people popping in and out and I'm comfortable with that.
Thank you very much, Mark, and congratulations on the outstanding accomplishments.
Thank you.
Thank you. The following question is from Brian Slit from G. Press. Please go ahead.
Hi. I'm also an individual investor and I would echo the comments in terms of what
a great job you're
doing. I wondered in terms of I know that the question of organic growth was kind of touched upon previously. I just wanted to know from your perspective, given the fact of so many other positives in terms of net income, etcetera. Is organic growth something that you are even concerned about? Or is your feeling that as long as the company continues to make, let's say, very favorable amounts of money and cash flow, etcetera, that it's something that doesn't particularly concern you?
So we're in a very I'll give you the long answer. We're in a very low yield environment. Multiples are very, very high for nearly all companies that you can see out there right now. And when it comes down to it, that's a function of growth and profitability. Organic growth in our business is a particularly attractive thing because we don't tie up a whole lot of assets when we grow organically.
In fact, arguably, we have negative capital employed. And if you grow, you end up with more negative capital employed. So you don't actually have to put cash into factories and fixed assets and working capital. So organic growth can be a tremendous lever in our business and in an organic growth situation where you're generating sort of 5% organic growth and the discount rates or multiples out there suggesting sort of 5% percent to 8% rates of return are adequate, that organic growth lever is enormously valuable. So I'm a little disappointed with our organic growth and would like to see it higher.
It's not something you can mandate. You can't say go grow organically next quarter. What you can do is say we're looking to make high rates of return on the money that we invest in R and D and sales and marketing. We want to do it intelligently. Let's use processes around that so that we don't piss away money on it.
But let's try and do it as much as we can. What we have is a wonderful collection of clients who spend a relatively small amount of their revenue dollars on IT. And so if we can deliver value to those folks, they're probably willing to pay for it. And since our systems frequently run their businesses and help them ideally run their businesses better, we're in a great position to deliver big value to the underlying clients. So who looks for that value opportunity?
Obviously, it's the people who are interacting with those clients on a regular basis. It's our support people. It's our R and D people and it's our sales people. And we're trying to encourage innovation and the creation of add on products throughout the portfolio. So I guess bottom line, a bit disappointed in the organic growth.
I think it has tremendous leverage. We'd like to see more of it.
Thank you very much. That's a very detailed answer. And I'd also just like to say just before I leave that I'm a relatively new shareholder and have tried to do all the research that I could do. And one of the things I've seen is that you personally seem to have a tremendous amount of integrity. And I appreciate that as a shareholder certainly and it's certainly one of the reasons that I'm a shareholder.
Thank you very much.
You're welcome.
Thank you. The following question is from Stephanie Price from CIBC. Please go ahead.
Good morning.
Hello, Stephanie.
I just want to circle back on the large deals. You mentioned that you've seen 3 of 2019 transactions. Can you talk a bit about what you need to do to get more of those large deals into the database and into the pipeline?
So into the database isn't hard. It's not hard to identify the large vertical market software businesses out there. We've done a bit of work and we're going to do a bunch more. But I think we'll drive up coverage over the course of the next few months. And I'm hoping we'll take it from sort of 50% of available market to a lot closer to 100%.
So I think that's a few quarter exercise, and it's just a bunch of Internet and database work. To then actually establish relationships with those companies is a massive task and it's a senior management task. It's not the sort of thing where you can take kids out of school and put them on to talking to major multinationals and developing relationships. So we have to pass out our efforts to build those relationships very carefully and it's something that all of our senior managers to do. Obviously, they're going to do it in their own spaces much more easily than they are in new verticals, but we're also going to try and do it in new verticals.
We've got to prioritize amongst those companies once we've identified them those that are likely to transact. And obviously, there are some ways of getting at that. Clearly, underperformance in the case of public ones is going to be one of the things you look for, but every private equity firm in the world is also looking for that. So it's a hard one to distinguish yourself on. So we're trying to think through how you get not proprietary deal flow because these are going to be well sharp deals, but deal flow where you have an information asymmetry and that's what we're focusing on.
Great. And in terms of your new IRR hurdle for sort of the larger deals, given the 3 that you bid on that you didn't win, can you talk about the new IRR hurdle and the sale price of those? And how competitive you would have been with the new IRR hurdle?
I don't know what the prices were on all of them, but I'm sure it would not have made a dramatic difference to the outcome on most of them, but it will make an incremental difference on some of them.
Fair enough. And then just finally on SaaS and on the cloud, I think in the past you've kind of talked about 30% of maintenance revenue was cloud based. Has that changed all over the last couple of quarters or relatively stable?
I haven't looked at it since the last time I published on it. But next year when I'm doing the maintenance review, I will take another cut at it and give you a sense of what the trend has been.
Great. Thank you.
Thank you. The following question is from Richard Tse from Cormark Securities. Please go ahead.
Yes. Thank you. Just a quick question going back to the organic side. Can you maybe sort of walk us through some examples of some of your more successful organic investments and perhaps the area that you're looking at now in terms of opportunities for the future on that side? Thanks.
The problem is that there's literally dozens, almost hundreds of little initiatives that have created growth in revenues. And its portals for your customers' customers is a very common one that we end up creating for many of our verticals. And those tend to have high take up Reporting sort of BI in the grand sense, but in the much more specific sense of particular verticals, you create stuff that isn't as flexible as a Cognos type application, but isn't as tough on the user as a Cognos type application, has a bunch more prepackaged reports that are industry specific. Nearly all of our businesses offer BI add on. And the list sort of goes on.
Every three letter acronym space that you can think of that has horizontal companies chasing it will end up with an analog in the vertical market space that we can probably offer to our clients as a much more industry specific add on product.
Okay. So in the case of let's say your reporting RBI, if one of your divisions were to roll out an organic initiative to build that out, would one of the sort of other divisions be able to use that same platform? Just trying to kind of get an understanding whether you get some leverage?
Generally not. But I'll give you one example where it did work. As you know, the smart meter market took off back during the recession with a lot of government funding down in the States. All these meters popped up inside of all of our utility companies and instead of collecting data on a once a month or once a quarter basis with a guy wandering around with a clipboard, they were getting streaming data or off the meters in minutes on status usage, things of that nature. What do you do with this vast torrent of data?
And we created or actually acquired and meter data management and that grew by leaps and bounds. And that particular product line is offered through all of our multiple business units. However, most of the BI products for a particular industry end up being industry specific BI products that are tied tightly to our database and hence are not useful across other verticals. And we spend very little time looking for synergies because we believe that what you give up in terms of autonomy and flexibility when you start seeking those synergies is not worthwhile. I'd much rather have someone running a 50 person business doing what he thinks his clients need as opposed to some guru of BI sitting at head office telling everyone what they got to build.
Right. Okay, thanks. And just one last question, sort of following up on Stephanie's question. If you look at your existing base, do you think they're becoming more receptive to these cloud subscription models? Or is it part of that base is receptive others are not some of the changes that may
have happened year over year on that side? Thanks.
I think there's increasing acceptance of cloud based or SaaS solutions. Yes, no doubt about it. It's just a question of how fast it happens.
Okay, great. Thanks. Thank you. The following question is from Drew Strogyny, a shareholder. Please go ahead.
Hey, I wanted to ask about the Constellation brand impact when it comes to acquisitions. And I'm referring to the fact that Constellation holds for life and it's probably viewed as a good home for the business. Do you think about that as a competitive advantage? And how is the advantage different for tiny acquisitions versus large acquisitions like CSS?
So I think as you suggest for the vendors of these businesses Constellation, we hope is perceived as a happy home for their business, the business that they've spent decades building. And because we're not a highly leveraged company, because we hold forever, because we don't take the business and wrap it together with another business and fire off the staff, I think owners like that. And so I think it does have some appeal. I don't know if it's a brand per se, but we're trying to make sure that the vendors are aware of what we do and how we do it. But yes, it's not something that if you asked a dozen brokers, they would be able to say this is the Constellation way.
So but whenever we get to a vendor and we get to a lot of them, we do tell them how we operate and there are a lot of people who have sold to us who we can use as references.
And do you think it has a bigger impact on smaller acquisitions or larger acquisitions or it's no different or not worth thinking about?
I think it's definitely worth thinking about. It has a big impact on family owned businesses, has a lesser impact I suspect on corporate owned businesses, particularly underperforming corporate owned
businesses. Got it. Thank you.
Thank you. We have no further questions. Mr. Leonard, please go ahead sir.
Thanks very much. Look forward to speaking with you all again on the Q3 conference call. Bye bye now.
Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you for your participation.