This is an excerpt from our first Speedwell Research piece, which goes over Constellation Software’s early history. It is just the beginning (<2 pages) of our 12k+ word deep dive (40+ pages). We hope you enjoy it! Please email us at email@example.com for any questions, concerns, or comments. See our full disclaimer on our website.
An intimately private man, not much is known about the early life of Mark Leonard. As far as the internet is concerned, he first appeared in life when he attended University of Guelph in Ontario sometime in the early 1970s. Without much financial support, he worked a motley crew of jobs to support himself through college, including as a grave digger, a municipal park ranger, a bouncer, a furniture mover, a windmill researcher, a warehouse employee and a mason helper. Despite long hours that were labor intensive, he would shield his spare time to self-study and read various literature. Having to work to put himself through college, it took him 7 years of juggling demanding jobs and part-time classes to get his bachelor’s degree. After undergrad, he continued with a grab bag of jobs in order to continue his studies with an MBA at The University of Western Ontario’s Ivey Business School. At graduation, he had a job lined up as a banker. Even though it provided higher pay and better job security, it was a continuation of the pattern of taking jobs out of necessity rather than following some sort of grand plan. That would soon change.
He figured out the summer before, when interning, that he wouldn’t want to be a banker for long—a superior had actually told him that—and he was advised to go through the bank’s client list and see whose business looked the most interesting. With an attraction to learning technical fields and helping build something enduring, he was drawn to venture capital. After blanketing every Canadian VC firm with his application, he was swiftly rejected by each. Not deterred, he spent the little money he and his wife had to fly to VC conferences to network and better angle himself for a job. Eventually it worked, and he joined Ventures West, a leading VC firm in Canada.
Over the next 11 years in VC, Mark Leonard would solidify what he wanted to build. He would fondly recall how fulfilling it was to build something properly as a masonry, which required mastery and would be there 100 years later. (To his surprise, this was in contrast to many of the start-ups he worked with that had a “build to sell” mentality). His masonry experience, coupled with some mentorship that that exposed him to the Buffett & Munger orthodoxy, inspired his plan to construct an enduring company. This nebulous desire, however, only started to calcify after a novel insight about the success of Venture Wests’ portfolio companies. He noticed that their most successful venture investments were vertical market software companies, which to Leonard seemed to have all of the business virtues Buffett would want with a competitive “moat”. The problem though, was that each vertical market software (VMS) company was relatively unimpactful to the overall portfolio results because of their small size. His idea was to create a holding company that would just focus just on acquiring VMS companies, which he imaginatively wanted to call Software Co.
Mark’s reputation as a sharp thinker with an indisputable work ethic made many of his Venture West colleagues enthusiastic to seed his idea, which, alongside an old business school buddy who happened to work at OMERS (Ontario Municipal Employees Retirement System) pension fund, allowed him to raise a full $25mn CAD. There was one piece of feedback though; the name Leonard picked was terrible. And so Software Co. became Constellation Software, a reference to seeing a unifying picture of otherwise unconnected pieces, and officially launched in 1995.
In the early years of Constellation Software, Mark Leonard would lead the acquisition process, focusing on wholly acquiring their first VMS companies. The attraction to VMS was born from the fact that each software offering tends to be mission critical to users and each market is small enough that competition is insulated from the big players who could not rationalize spending in these small TAMs. Additionally, the recurring nature of most revenues and minimal maintenance capex makes software inherently attractive (much more on this later).
Constellation closed their first acquisition in 1995 with Trapeze, a provider of fixed route scheduling software to North American public transit authorities. A year later, they acquired Harris Computer Systems, which focused on software solutions for the utilities industry. Leonard would have already been familiar with them as they were both actually Ventures West Portfolio companies. While details of their acquisitions are almost never disclosed, Mark Leonard did write a newsletter at the time called “Opportunity Above All”. They only published a few editions of the newsletter before axing it, ostensibly for competitive reasons, but there are some interesting insights in them. In the first edition, he remarked that a company growing revenues in the high-teens with low 20’s EBITDA margins was worth an average of 1.65x revenues before an “illiquidity discount” for private companies. He goes on to say that “We focus on buying companies that have a track record of double-digit growth and good profits. When we can find an industry leading firm with these characteristics and good management, we’ll pay up to 1.25 times revenues in cash. To the extent that these characteristics are missing we discount the price”.
Paying 1.25x revenues for a software company with positive cash flows may seem silly cheap, but keep in mind these are typically sub $5mn revenue companies that have growth prospects that are greatly constrained by their TAM and do not have natural buyers as private equity firms tend to only be focused on companies that are multiples of that size. (Having said that, valuations have considerably risen since this was written in 1998). Given that they are acquiring so many small companies, having multiple “capital allocators” who can find acquisition opportunities and deploy capital is critical, and actually at the heart of their success. (We will touch back on this in the next section).
A few years later, his friend who helped arrange the original OMERS investment left the pension fund, and a different analyst took responsibility to oversee the Constellation investment. Allegedly, the replacement and Mark didn’t get along as well, and the less congenial relationship spurred Constellation to add another large shareholder to counterbalance OMERS influence. This new investment came from TD Capital Canadian Private Equity Partners in the form of a $60mn private placement, which is what precipitated their IPO in 2006.
Unlike most IPOs, this public offering raised zero primary capital (funds that Constellation would receive) and was instead solely to provide early investors, namely TD Capital, a liquidity event. In fact, they never raised public equity capital and their shares outstanding has remained unchanged at ~21.2mn to this day. At IPO they had acquired 45 companies with $165mn in total revenue and a global footprint spanning 40 offices. Fast forward to today, Constellation generates in excess of $5bn annually with over 750 separate companies and their market cap has swollen from ~$275mn at IPO to ~$32bn; a ~120 bagger over a 16-year period which equates to an annual TSR of ~35%!
We will start our analysis with more details on their business.
This concludes the “Introduction” section of our report. In the next section, we dive deep into their actual business, followed by their Hold Co. Philosophy, Capital Allocation, and much more. See below for the full table of contents, and subscribe to get access to the full 12k+ word Constellation Software deep dive!
Table of Contents
- Founding History.
- Business History.
- VMS Moats.
- Other Business Virtues.
- Hold Co. Philosophy.
- Capital Allocation.
- Hurdle Rates and ROIC.
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