Constellation Software Stock Crash is Not Because of AI!

Duration: 9:54 1348 transcript words EN summary

Video summary

The video analyzes the recent decline in Constellation Software's stock price, arguing that the drop is not driven by fears surrounding artificial intelligence but rather by fundamental issues within the company's aggressive acquisition strategy. While surface-level metrics such as total revenue growth of 17% and strong free cash flow to shareholders appear impressive, the speaker contends that these figures are misleading because they mask a significant slowdown in organic business growth. The core argument is that the company's expansion relies almost entirely on mergers and acquisitions rather than internal innovation or market expansion, with organic growth hovering around just 3%, which barely exceeds inflation rates. This reliance on M&A means the stock's performance is heavily dependent on the ability to successfully integrate new businesses, a strategy that has recently shown signs of fatigue as the pace of organic expansion decelerates. A critical concern raised in the analysis is the financial sustainability of this acquisition-heavy model, particularly regarding how the company funds its growth. The speaker points out that Constellation Software spends more on acquiring new businesses than it generates from operating cash flows, effectively burning through its own liquidity to fuel expansion. This approach suggests a lack of price discipline, as the company appears willing to purchase targets at any valuation simply because sellers are eager to exit, rather than waiting for optimal entry points akin to Warren Buffett's philosophy. The video highlights specific examples, such as the acquisition of Sabre Corporation, which carries substantial debt and shows low single-digit growth expectations, further illustrating that the company is taking on significant risk by buying assets that may not possess the durable economic moats required to justify their purchase prices. The transcript concludes by emphasizing the opacity and inherent risks associated with this business model, noting that key details about acquisition costs and the true value of purchased assets are often undisclosed. Because the company never records impairments on its acquisitions, it avoids revealing potential overpayments or declining asset values, creating a situation where future earnings could be significantly impacted if these hidden liabilities materialize. The speaker argues that without transparent disclosure of purchase prices and the actual performance trajectory of acquired entities, investors cannot accurately assess whether the company is truly compounding value or merely circling the drain. Consequently, despite the company's historical success and the genius of its founders, the current strategy is deemed too risky for a value investor, leading to a recommendation to wait until the stock price drops significantly before reconsidering an investment.

Read the full video transcript

Good day fellow investors. Constellation Software stock has rebounded a little bit, but is still significantly down from the previous highs. I have put it on my bets side of the quadrant, which I'm going to update tomorrow, but Constellation in this case deserves a specific video. And let's dig immediately in the numbers. If you look at revenue growth, great numbers, 17% growth. You're saying, "Sven, 17% growth, how can that business be down so much? Everything looks great, cash flows up 10%, free cash flows to shareholders 57%." All those numbers look really, really good. However, if you go to look at organic growth, just the businesses growing by themselves, then the story changes significantly. We have 3% growth compared to the same quarter For the 6 months ended 4%, which means there is more of a slowdown in the recent quarter. And when you have such an organic 3% growth, that immediately changes the whole aspect of the investment, because then the whole growth story is an M&A story. And then I look a little bit at the cash flows, great provided by operating activities. We have a billion point three four the last 6 months. However, if I compare those numbers with the cash used in acquisition of businesses, that is more. Thus, they are spending more than the operating cash flows for acquisitions. As they're acquiring all these businesses, how are those businesses operating with negative working capital? So, collection of maintenance payments and other revenues in advance of the performance to the related services. Then they say that the strategy is that these businesses continue to grow organically without any additional funding. But we have just seen that 3% growth, that can mean that half of the businesses are growing at 6%, which could be a standard inflation growth, and half are declining. So there is not really that organic growth that one could expect there. Yes, and people say those are vertical market software businesses moats, but 3% is not that moat-worthy. And they just keep acquiring. So some businesses are growing, some are not, but they are spending more than the free cash flow. Another issue I have here, when it comes to this aggressive M&A strategy, where you simply spend all the cash flow and more on buying other businesses, that means that also your acquisition strategy doesn't care about the purchase price. That's what I'm buying, I'm buying everything. All the sellers are happy to sell to you. So that's also an difficult thing to accept as a business perspective, from a value investing perspective. Warren Buffett is about buying at the right time. Constellation Software buys all the time. Sometimes it can be cheap, but it can't be the right price all the time. Then you say, but these are niche critical software with moats. Okay. AI situation, some say software will be impacted, some say not. But perhaps it might not be just an AI issue. They have acquired 12% of Sabre Corporation, another booking hotels travel software platform that looks very ugly, but okay, everything is stable there. There is a lot of debt with the company, 4.4 billion, which is much more than the market capitalization. So, enterprise value should be around 5 billion. If Constellation Software wants to take them over, could be, but this is not a business with the moat with growth because simply it's not growing at those levels. All the bookings, everything, low single-digit expectations. So, okay, but not that great. Then, if you go to make these bigger acquisitions, there is more competition. Then, we are back to the price story. And then I'm saying, this is not an AI scare. This is a size scare. This is a buying at whatever price situation scare. There is no moat because if you have a moat, you can simply grow in line with the economy and inflation, which is 5-6% not 3%. Even if AI disrupts just 10% of that, there goes your organic growth, which then becomes an M&A machine just circling the wheel, but without delivering tangible value to shareholders. So, I'm not saying this will go bankrupt. I don't see the comments. It's a great business. I'm just saying that the business model has an inherent risk that nobody wants to discuss because you're not allowed. This guy is a genius, the previous founder and CEO, all great. But, I'm looking at the business. Okay, it has compounded greatly. Sometimes people get overexcited, sometimes get panic. But, when I look at the numbers, net income is growing. Okay. But then, if I look at the organic growth, if I look at everything, then I say, net income doesn't include impairments. What if the buy price projects a certain gain on those, but that gain doesn't happen, then you have to impair. And they never impair anything because they are geniuses at buying. Questionable. We don't know what they are buying. We don't know the details. That's not disclosed. Okay, they have the asset write-downs and restructuring costs, just 40 million. That's nothing. Amortization and depreciation, okay, that grows as they buy. They amortize it, the intangible assets. Okay, but is that amortization right or wrong? Those are long-term estimations. And when it comes to long-term estimations, just small changes in wrong or right has big impact on future impairments and the true owners' earnings that are simply not disclosed here. If I look deeper, okay, cash from operations, great. But all the cash from operations is used for growth. Where? We don't know whether the buys here, all the money spent, the billions here, if organic growth is now 3% means that the business bought 2 years ago is already declining or the business bought 2 years ago is still growing at 10%, but that 4 years is declining at 20% because now the buys are bigger. And that's simply an inconsistency. I find it very hard to find a solution in my mind. Free cash flows look great, but those free cash flows need to be reinvested no matter the price. I'm missing here true value compounding. Okay, show me this engine is creating so much value and is creating more value in the future. That's missing. The value of what they are buying is declining over time, which means the price they are paying is extremely important, but that's not disclosed. It's all a growth story. The net income and amortization is based on their estimations, which is a very risky business model to invest in. M&A okay, is risky by itself, and when forced we need to spend all the free cash flow, no matter the price. My point is, okay, maybe it's great, but it's hard to know the truth, the value behind this business because it's not disclosed. When everything grows, great. When it stops growing, then all the skeletons might come out. Great story, great spiel. Perhaps he's right. I'm not saying this is a fraud or something. I'm just saying the risk of not being exactly what it presents itself as is too high. Therefore, as a value investor, I'm just putting it into the too hard pile. Further, from a valuation perspective, a business organically growing at 3%, not growth 17% that they are engineering through M&A. 3% growth, that's just inflation. Fair trade would be at 10 times free cash flows. If it is 3 billion CAD, that's 30 billion market cap, that's half of where it is. Another risk to think about. For me, it's a bad bet. Wake me up at 30-40 billion CAD, and then we'll see. When it comes to the bets, I'm canceling it out. If it goes up and down, okay. If it goes down 50% from here, we can discuss it again. Looking forward to the comments, it will be spicy there. I'm just saying the risk of the business model is bigger than the AI scare. Looking forward to your comments, I'll see you tomorrow in the bets update.