Constellation Software (TSX:CSU, Financial) (5.8% of Sequoia’s capital at year-end, -16% USD total stock return in 2022)
Constellation’s shares declined this year, falling in USD terms a couple points less than the S&P 500 Index. Meanwhile, the business performed admirably. For full-year 2022, the company’s revenues and EPS are expected to be up approximately 28% and 14%, respectively. Organic growth, at approximately 2%, was typically modest. As is always the case with Constellation, growth was driven primarily by acquisitions, including the largest in the company’s history, the $700 million carve-out of the Allscripts hospital and physician practice software business. Versus 2019 levels, Constellation’s revenues and EPS are expected to have compounded at annual rates of 23% and 23%, respectively.
We are often wary of acquisition-driven growth strategies, but Constellation is an exceptional acquirer. For over twenty years, founder and CEO Mark Leonard has managed to maintain, in the face of ever-increasing scale, high rates of acquisition-led growth accompanied by high rates of return on acquisitions. Constellation’s track record puts it in rare company, alongside some of history’s greatest acquisition-led compounders.
The key question is whether Constellation can continue executing its strategy in a similarly successful fashion for long enough to render the current price attractive. We believe it can. Constellation is focused on vertical market software businesses, which are generally quite profitable and provide code that is essential to their customers. Constellation is working with very good raw material, and there are an awful lot of these vertical market software businesses out there. We do not believe Constellation is in any danger of running out of targets.
Further, Mark Leonard is a dedicated student of other high-performing conglomerates with similarities to Constellation. He is thoughtful about extending the company’s growth potential for as long as possible. For example, he has distributed M&A responsibility to scores of portfolio managers across the globe, developed a separate initiative to compete with private equity for large software deals, and explored new avenues for growth outside of software.
At the current share price, Constellation trades for approximately 29x expected EPS for 2023. We consider this is a reasonable price for a unique company with a proven ability to allocate significant amounts of capital at high rates of return. We believe the company will continue to do so, thereby compounding earnings at a mid-teens rate or better over the next several years.
From Ruane Cunniff (Trades, Portfolio)'s Sequoia Fund fourth-quarter 2022 letter.
