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Constellation Software reported 3Q26 earnings, and the stock fell -8% in response before partially recovering over the next few days. The ADR (CNSWF) is now +1.5% YTD after being down as much as 30% during the year.
Revenues grew +19% y/y, which is a slight acceleration from last quarter’s +17% y/y. Organic revenue grew +2% y/y, which is an improvement from 1% last Q. However, the aggregated organic revenue growth figures give us limited information.
It makes more sense to hone in on their Maintenance & Other recurring revenue, (which is the best barometer of the health of their core software business), which was +4% y/y. However, if you back out US healthcare (namely Altera), management noted that Maintenance & Other recurring revenue growth would have been +5%. Mark Miller described this as a normal quarter within the 5-7% range they have seen since 2016, albeit at the low end.
Altera declined -8% in 3Q, which has improved from last quarter’s decline of -19%. The shrinkage in Altera is attributed to the departure of several large clients, and they expect this business to stabilize by the end of 2027. In the quarter, U.S. healthcare was down -10%, which is much lower than -1% last quarter. They say that most of this decline is attributed to two new healthcare businesses they acquired and when they acquired them, they expected them to shrink. Mark Miller emphasized that this was in their models and both businesses are still on trajectory to meet their IRR expectations. If you exclude those two businesses, the healthcare group would have declined -3% overall instead of -10%.
The Altera example is a reminder that Constellation Software focuses on IRR over organic growth. If they pay a cheap enough price for a business and can harvest enough cash from it, it can be a good investment despite the contraction in revenues.
Putting pressure on total organic revenue growth was their license business which was down -17% y/y. This is their legacy business that is shrinking as more businesses move to a recurring model, but this was a tougher comp over last year’s +17% growth.
Overall, the 2% total organic growth is in the range of what we would expect for them. In our original report, we estimated 0-2% long-term growth, so they are still meeting the high end of that.
One lever that we have mentioned that would help them to accelerate organic growth is AI. On the call, Mark Miller noted that all of their businesses are sharing best practices when it comes to AI, but most of the spend in terms of AI hasn’t shown up in their financials. They will continue to experiment within their businesses and be a fast follower when something is working for a company. As AI allows them to create a lot more features and customization for a customer, we are optimistic that this could eventually lead to increased growth. Offsetting that though is that they may feel they have less pricing power on software improvements and instead feel that improving the product could be more defensive. While we still don’t think the average customer will want to rip out their mission critical software and take on developing features and maintaining it themselves, the threat of it might make them more conservative on price hikes. Every business unit though makes these decisions for themselves, and with over 1,600 businesses it is hard to generalize.
Turning to capital deployed, CSU deployed $609mn in 3Q26 and has already deployed $673mn QTD, which puts YTD capital deployment at ~$3bn. This continues to be a bright spot for them as of late because it shows that they are continuing to see opportunities to deploy capital. They noted that when they are looking to acquire businesses outside of their core VMS acquisitions, they add a wider set of assumptions to 4 financial models they run.
FCFA2S is the best indicator of owner earnings and FCFA2S (after backing out the IRGA liability) grew +2.8% y/y for the quarter. The reason FCFA2S lagged this quarter primarily has to do with changes in working capital, adding back which FCFA2S would have grown 21%. CFO Jamal Baksh commented on working capital below. LTM adjusted FCFA2S is ~$2.25bn, +10% y/y. Adding back working capital gets growth to 16% y/y, in line with our long-term expectations. A secondary factor is that acquisitions initially weigh on their cash flow margins. They noted their 1Q cohort of acquisitions ran a 16% margin and are now up to 27%. The 2Q cohort already went from 12% to 21%. So while the margin hit is short lived, the more companies they acquire, the more it impacts their results.
This doesn’t include their PEMS, or Permanent Engaged Minority Shareholdings, but PEMS weren’t meaningful this quarter as it only grew +$11mn q/q in investment in associates.
Overall, Constellation reported a good quarter as they continue to show strong capital deployment. At a current stock price of $2,350, Constellation has a market cap of $49.8bn. Since we add back the IRGA revaluation charge to FCFA2S, we also need to add the $1.3bn IRGA liability to the market cap. FCFA2S already includes Joday’s ~29% share of Topicus’s cash flow, and so it makes sense to include the $1.3bn liability in the valuation, since that is what Constellation needs to settle to actually own that earnings stream. This puts them at a ~23x LTM FCF multiple for a company that has grown cash flows at a 14% CAGR since 2000.
For more on Constellation Software, check out our research report here
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