Good morning, ladies and gentlemen. Welcome to the Constellation Software Inc.'s Q2 Results Conference Call. I would now like to turn the meeting over to Mr. Mark Leonard, Mr. Jamal Baksh, and Bernie Anzarouth. Please go ahead.
Good morning. Thank you, Hugo. Welcome to the Q2 conference call. As you know, we go directly to questions, so Hugo is gonna give you instructions for how to tee up.
Certainly. Thank you, Mr. Leonard. We'll now take questions from the telephone lines. If you have a question and you're using your speakerphone, please lift your handset before making your selection. If you have a question, please press star one on your telephone keypad. If at any time you wish to cancel your question, please press the pound sign. Please press star one at this time if you have a question. There will be a brief pause while the participant register for questions, and we thank you for your patience. Our first question is from Thanos Moschopoulos from BMO Capital Markets. Please go ahead.
Hi, good morning. Mark, you said on the last call that you doubled the size of your M&A team relative to last year, and that clearly seems to be paying off with respect to how much capital you've deployed this year. I think that demonstrates, as you've previously said, that the constraint isn't the number of opportunities out there, but rather your ability to find those opportunities. That being the case, why not triple or quadruple the size of your team? Is the constraint now your ability to find and train qualified M&A people? Is it more a question about ensuring that you scale up the team in a thoughtful manner rather than risk over-investing? What are your thoughts on the topic? Thanks.
Since we got Bernie on the call today, why don't I let him sort of weigh in on the practicalities of scaling up?
Hi, it's Bernie Anzarouth. It's my first time on the call, please bear with me. Last time we reported about 60 or so full-time M&A people that are on staff. I think what you're going to find now that we're providing the opportunity for BU managers and for portfolio managers to go out and deploy more capital. What we've decided to do is to get them the resources that they need to go out and find more acquisition candidates. The fact is, indeed, we are looking to add more M&A resources, and I think we're probably about 10% more today than we were when we announced it in the last quarter or the quarter before.
I think where we'll end up being is at least 20%-25% higher by the end of the year, if not more. Yes, we are expanding our M&A force, and whether we get to double or triple, it's tough to scale that quickly, to find qualified people to actually do that. As well, when you're adding that many companies to our fold, we do need the bandwidth as well. We do have to have those trained up portfolio managers and BU managers to be able to take on those acquisitions and run them appropriately.
Is the hiring focused more in terms of the people trying to identify and source opportunities, the ones executing on closing the opportunities or both those areas?
It's both those areas. We do have a lot of business development managers that are going out and looking for the opportunities. And actually, some of them have to stay in touch with those that we've contacted in the past and weren't ready to transact. We need those folks to be out there as well as the people who can actually take it to a close, which is do the analysis, do the diligence, put the models together, and get it to close. We do need a combination of the two for sure.
Great. Thanks. On a different topic, the organic growth for professional services revenue was down year-over-year, which we haven't seen in recent quarters. I realize there might not be a simple answer for that, but is there anything specific you would call out?
I mean, the organic growth is only, what, 1% decline. Half of that % decline came from the transit group, and it's really timing. I mean, there are actually some pretty large projects on the way in the transit group, I'd actually expect it to pick up in the next year or so. Yeah, it's just timing of when we're recognizing revenue on some of these contracts.
Okay. Finally, there's obviously been some movement in the FX as of late. Just to confirm, if you look at current FX rates relative to FX rates in the past, quarter or so, should the recent FX movements be a very slight positive contributor to margins going forward? Am I doing the math correctly there?
To organic growth, possibly. Margins has always been a pretty immaterial amount. I mean, we also have a lot of Canadian expenses, so as the Canadian dollar strengthens, that's gonna go opposite to the margin impact. I wouldn't expect much to the margin percentage, but we're gonna have, if not, you know I'd expect less of an impact to organic growth. I mean, you're already seeing that, it might be a small positive next quarter. I'm not sure.
Great. Thanks. I'll pass the line.
Thank you very much. The next question is from Richard Tse from NBF. Please go ahead.
Yes. Thank you, Mark. I'm just wondering if you could provide us just a general broad update on the acquisition environment, say since, you know, last quarter. Any changes, any changes in trends, et cetera?
We try and monitor what's happening in vertical market software acquisitions generally, and I would say that maybe a slight upward trend, but nothing dramatic from what we've seen over the last few quarters.
Okay. You know, it seems like over the past, maybe year or two, you've been spending a bit more time outside of North America. Just wondering if you sort of frame the, you know, global opportunities relative to, you know, North America. Obviously, it seems like there could be some outsized opportunities there, I'm not really that familiar with those markets. If you could run through that would be terrific.
We've done a number of acquisitions, for instance, in Germany. That was a place that we went to later because English wasn't as frequently found there. We didn't have as many local staff to lean on to do acquisitions. It's a good example of a large market that we entered later. My sense there is that there are cultural differences that lots of entrepreneurs build their businesses and that they tend to stay within the family, perhaps more so than North America, where the idea of building a business and selling it is perhaps more the norm. I would say that in Germany, we're unlikely to have, on a per capita basis, as many opportunities as we do, for instance, in America. I think we're probably seeing something similar in Japan.
It's very early days. There's two big sort of developed markets with relatively high labor costs, which are the kinds that we prefer. We don't tend to go looking extensively in low wage rate countries, because we find that vertical market software isn't as important and prevalent in those places.
Right. I guess in those markets, would the deals be assessed more by, let's say, the corporate acquisition team as opposed to the BUs, or I don't imagine you have a lot of BUs in some of these countries?
I mean, Bernie, what's your sense of the BU's coverage of other geographies?
I mean, yeah, our operating groups, for example, our Dutch group recently made an acquisition in France, that was totally run and managed by the TSS group. I think it's whoever we have on the ground that's closest to the opportunity will be running with it, obviously with support from head office of that operating group.
Right. Okay, great. Thank you.
Thank you very much. The next question is from Mr. Paul Steep from Scotia Capital. Please go ahead.
Great, thanks. Mark or Bernie, could you maybe talk just a little bit about the evolution in the M&A process and the structure to better scale the organization? Like I noticed that Bernie, congratulations, has a new title maybe over the last six months. You know.
We're just joking about that.
I guess the bigger question is the understanding was all roads led to Bernie, you know, in the old model. How's that changed to help scale and also make sure that the process is still intact?
Yeah. We joke about me being the bottleneck in the whole process. The easy way to remove that was to give me a new title and not have my hand in the process anymore. That, that's not entirely true. We did increase the threshold by which the operating groups were able to make acquisitions on their own. Having said that, we decentralized the M&A function significantly recently. What we've done is we've allowed more people in the BUs to deploy more capital without necessarily getting headquarters approval. It'll allow us to make more acquisitions and deploy more capital.
We don't really know or we won't really know for about one or two if the capital that we're deploying today is going to generate reasonable rates of return. It's kind of early still to declare the experiment a success. We might have some setbacks. We might have a couple of investments that go sideways or even down. We have to give the BU managers and the portfolio managers who are deploying the capital some time to learn and mature. We won't really know if the experiment is a success for another four or five years. The one thing is that we will be deploying far more capital still under the guidance of the operating group managers and the team that has been there since, you know, day one.
All of that experience that we've built over the years is not lost on the new acquisitions and the new people coming in. They will be overseeing these people as well. I have full confidence in our ability to deploy more capital.
Is there a new process for you to I find it hard to believe you're entirely gonna go hands-off, and I know you said you just upped the threshold. Is there gonna be some form of like a spot audit? You know, I guess what's different about now having a CIO role? Is it now your goal is now to control overall capital rates, which before you and Jamal on the board and the team would have been doing?
I still get You're absolutely right, Paul. I still get to see everything. William, who used to work for Mark, is working for me now. we've got expanded capacity.
We do still look at everything, and we still have our hand in all of it, and we do give our candid feedback to all of the folks that are out there, generating leads and working on acquisition prospects. We do give them our unbiased opinions. Yes, that is true.
Okay. Then I guess maybe Mark, secondly, on the large deal environment, have there been any thoughts or changes in how you'd approach those in terms of helping differentiate CSU? We've talked about in the past that those situations have tended to be more challenging. Has there been any progress or thoughts around how you'd better maybe approach that market? Thanks.
We were talking about one of the brokers yesterday who seems to use us as the group they come to when they've got a busted process, one where they've gone out, advertised the company, published the information, shipped 100 copies of the investment memorandum or whatever they call it. People have gone into diligence and then discovered that a bunch of it was hooey, and the enthusiasm for the prospect has dropped away. In many of those instances, there's still something of substance there, and we're willing to do the work to understand what that substance is and are often comfortable doing more diligence and providing a price.
That fallback position of someone who's willing to transact in messy situations is a position I think we can carve out in the brains of the brokers who are trying to get transactions done that may not be glossy and perfect. In addition to that, obviously, when we have a strategic advantage because we're already in the particular vertical and there are obvious synergies, we may be a buyer of preference. And when there are not crisp numbers, when they're doing carve-outs of large corporate transactions, again, we're willing to build our models from the ground up to work from individual salaries and offices and maintenance contracts and sort of construct our own financial picture.
I'd say those are some instances where we can, perhaps, play where others would not.
Great. One just quick clarification as well. I notice you're out of the public equity market, it would seem, at the moment. Is that just a factor of opportunity set and valuation versus any other, you know, change that you might have had or change of heart you might have had?
Yeah, that's exactly the right conclusion, Paul. It's everything's expensive and things of size where we can put some dollars at play all seem to be trading high. I think one of the data points I saw was that the average vertical market software company with more than a CAD 50 million market cap is trading at 3.8 times revenues. Those tend to be fairly hefty valuations.
Okay. Thanks, guys.
Thank you very much. The next question is from Paul Treiber from RBC Capital Markets. Please go ahead.
Oh, thanks very much. I just wanna follow up on one of Paul's questions. Just in light of the more decentralization of the M&A function, how do you utilize, or what processes have you put in place to utilize the data and experience of the company in that structure? One thing that struck me was at the AGM, you mentioned that you have the insight to push back on M&A assumptions, given you know, in light of your history, if the assumptions are in like in the 99th percentile or the 50th percentile.
Yeah. We use base rates, as you mentioned, to compare any new prospect that we're looking at in terms of valuation and what the forecast, expected forecast would be for these prospects. We compare it to our 330 odd acquisitions that we've made so far. We don't track all of them specifically. You know, a few of the acquisitions have been tightly integrated to other operations, so it's very hard to see the results of that one, of the individuals that were tightly integrated. We still track, for the most part, all of the businesses that we've acquired, since the beginning of time. We do get to see how they've evolved over the years.
We look at key metrics, core profitability, growth, different aspects of the operations. We do get to compare these new prospects that are brought in, or at least the expected forecast to what we've seen in the past and whether or not the forecasts are a little overblown or if they fit into what we have done in the past. All of that experience that we've built over the years is being used in assessing new prospects for sure.
Okay.
Did I get all of your questions?
Yeah. I mean, it just, I imagine there have to be some new processes set up, though, if there is indeed more decentralization and the headquarters isn't as involved.
Yeah. If you think back, you know, 10, 15 years ago when everything was run or headed by headquarters, that same process is headed off by the operating groups. They have their M&A folks. They have the guys that have been with us since, you know, 1996, 1997, who have been working on all of these acquisitions since we started. All of that experience has just been brought one level down from headquarters to the operating groups. Those processes are still in place. There's a lighter touch from headquarters, if you want to put it that way. We do get all of the information. We do still get to see everything that's going on. That oversight is still there.
We regularly compile the information, Paul, and disseminate it to the group general managers and the M&A heads. Once a year, we have an M&A conference. We had a hundred and something people at it last fall. We'll do the same again this fall.
Okay. great. another question on M&A. just wondering your thoughts on the strategies pushed down capital allocation to the business unit managers. From what you've seen, and I know this is early days, but do you think capital allocation is a natural talent that someone has or doesn't have? Or do you think it's something that can be taught and they can gain over time?
We're staring at each other. I think if the folks are numerate enough to run a business and to understand the ins and outs of an operation, they can understand how a new operation could run. Now maybe they have the bias of believing that they could run anything if their own operation is running really quite smoothly. I think that over time, we're able to teach them, and they could learn. It's, it's not I mean, it's a, it's a bit of an art, and it's a bit of a science, but given the metrics that we give them, it's hard to not get it really quickly. Again, as Mark said, we have our M&A session every year. We talk to our M&A guys pretty regularly weekly.
The general managers get the feedback from me on a regular basis as well, and we get together every quarter. That feedback loop is always there, and I think the information is disseminated well enough that our guys can pick it up.
Remember, there's a lot of data points, too, from which they can learn. I don't know how many models William and Bernie see a week, but they're providing feedback on these models on a very regular basis to a large group of people. Every time you get feedback, you're honing your skill and learning against the hard stone of these experts.
We're not shy about giving the feedback.
Okay. One last one for me. You know, margins continue to improve, you know, as you get larger. I know you mentioned in the past that there's no economies of scale, or I guess, yeah, economies of scale in the business. You know, the data seems to suggest otherwise. Can you just bridge between those two comments?
The margin improvement, Q2 2016 versus 2017, I mean, there was, what, a 1% margin improvement. I mean, if you look at the key expense buckets, like staff costs, which is our key expense, I mean, that as a percent of revenue didn't change quarter-over-quarter. You've got some improvement in third-party license maintenance and PS, you've got some improvement in hardware. Again, timing of that and, you know, that's not our core business, but you've got some margin improvement there. Again, I wouldn't say that's because of economies of scale. It's just gotta be with, you know, margins on third-party products. There is some benefit, like if you look at our other expense line, where you've got things that aren't necessarily tied to revenue that were stable.
You've got a little bit of improvement there. It's minor little things and not part of our core business that is improving, right? If I saw staff costs, you know, as a percentage coming down, then I would say, "Fine, that's economies of scale." That's, that's staying pretty steady.
Right. I mean, my comment was more just along, if you look at over a number of years, you know, five, 10 years or so, the data would suggest that as you've scaled, the margins have improved significantly. I'm just wondering if there's an underlying driver of that.
I mean, yeah, over years, I would say the impact of acquisitions, like historically, has always been a negative impact on CSI at the beginning as we turn businesses around. As we become larger and acquisitions as a percentage of our total are less, then you're gonna have less of that negative. The other thing we had in the last couple of years is you had a TSS that was, you know, acquired in 2013 that was being improved, then you had CAD 200 million in the healthcare business that actually had margins way in excess of the CSI average, even though from a top line perspective, they were negative organic growth. You had a positive from acquisitions plus acquisitions improving.
I'd say that's all what was leading to the improvement as opposed to synergies or.
Economies of scale.
I think that was a really good explanation and worth reading the transcript over a couple of times.
Okay. Thank you. That was helpful. I'll pass the line.
Thank you very much. Once again, please press star one if you have a question. The next question is from Stephanie Price from CIBC. Please go ahead.
Good morning. Given the move to a more decentralized M&A model, can you talk about the oversight process post-acquisition and whether that's changed at all?
Sure, post-acquisition, the portfolio manager, BU manager is right in there, overseeing integration of the business. That's still being run by the operating group. What we have instituted is a post-acquisition review about 12 months after the acquisition to see if everything has gone according to plan. Now those parts used to be managed by headquarters. Now, for the most part, they are being run by the operating group general managers directly with CSI in attendance, so headquarters in attendance. That would be either myself or William. We are continuing to do that on a regular basis.
What we do is we try to take the lessons learned from those acquisitions and whatever happened during that transition period of the first year and try to disseminate that, those learnings to the rest of the M&A folks on a pretty regular basis.
Great. Thank you. Then in terms of organic growth, you press release two contract wins over the quarter. Can you talk a bit about where you're seeing organic growth and the outlook for it going forward?
I mean, the groups are forecasting a strong second half, but our ability to forecast organic growth has been terrible. I wouldn't place a lot of stead in that.
Okay, great. Thank you very much.
Thank you. The next question is from Ralph Garcea from Echelon Wealth Partners. Please go ahead.
Good morning. Just a couple of quick questions. Can you just remind us on the thresholds, what the old ones were versus the new ones for the BU M&A strategy? Does it differ geographically, I guess, between, you know, North America, Europe and I guess what the Japanese JV is doing?
Sorry, I didn't catch that last question, Ralph.
Do the thresholds differ geographically?
Okay. With the Japanese JV, we're just learning, and so we're intimately involved in anything that we're looking at there, no matter how big or small. With the other operating groups, we have the same thresholds for all of them.
What's the new one versus the old one again on size?
CAD 20 million is the threshold at which they have to come to CSI for approval and board approval as well.
CAD 10 million before.
CAD 10 million. Yeah.
Okay. I mean, how do you compensate these guys? Is there a success fee, or do you wait the 12 months, see if they deliver an EBITDA number? I mean, how are these guys incentivized?
The idea is to invest capital and get good rates of return. I'm hoping that the vast majority of them are compensated the way that we are, which is the return on our capital and for the growth of the business. We're not like an investment bank. We don't pay people to put money out the door or to transact.
Okay. I guess lastly, you've done 28 deals in the first half. You've got this increased bandwidth now. I mean, should we look at, you know, modeling sort of 50 to 60 deals through the second half? How does the pipeline look in You know, can you give a range, I guess, of deals for the second half?
I can't give a range. It's so difficult to tell. All I know is that everyone is extremely busy looking at a lot of potential acquisitions, and it's impossible to predict whether or not those acquisitions will close.
Just to give you some color on that impossibility of prediction, we have a sort of funnel of acquisition prospects, and we can add that up. We've figured out how to use that function in Excel. We do so periodically. I went back and looked at those totals that we've had over time and the amount of acquisitions that we actually closed during those periods. I found the correlation between our funnel and the actual acquisition closed was zero. Not just zero, it was so close to zero that I'm thinking of commercializing our sales funnel as a random number generator.
Okay, that's fair. Thank you.
Thank you very much. We have no further questions. I would now like to turn the meeting back to you, Mr. Leonard. Thank you.
Thank you, Hugo. Thank you all for attending the Q2 conference call. Look forward to chatting with you in a quarter's time. Bye-bye now.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you very much for your participation.