The technology sector is an ever-evolving segment where disruptive tech can change market share. Staying sticky in this sector can be rewarding, and going outdated can be penalizing. Because of these dynamics, investors prefer tech stocks to grow their capital. In Canada, the tech sector is skewed towards software stocks. Among the software stocks, two names you hear often are BlackBerry (TSX:BB) and Constellation Software (TSX:CSU).
Source: Getty Images
Constellation Software
Constellation Software acquires small and mid-sized vertical-specific software (VSS) companies that cater to a niche market. For instance, it recently acquired WideOrbit, which helps media companies buy and sell advertising. What it looks for in its acquisition targets is cash flow and the stickiness of the software. As it is a niche market, there are few competitors, and companies have loyal customers.
Constellation focuses on small companies because they are not tough to acquire, and their shareholders are not as demanding. It largely makes cash acquisitions. The main objective behind an acquisition is to own the future recurring cash flows of the company. It then uses these cash flows to acquire more companies, compounding its cash flows. Investing is like buying a dividend stock for its future dividend payments.
Constellation then uses the cash flows from these acquisitions to acquire more companies. While there are a handful of large software firms, there is a huge pool of small VSS in the market. Constellation doesn’t buy these companies directly but through its six subsidiaries. And to unlock more value, Constellation even spun off one of its subsidiaries, Topicus.com, to be listed on the stock exchange. It not only benefits from the acquisitions Topicus makes but also from changes in its stock price.
What to expect from Constellation stock?
Like all businesses, Constellation also has strong and weak quarters, as its performance depends on how good an acquisition is. The first quarter was strong for Constellation on the revenue front as its acquisitions increased its revenue by 34% and free cash flow by 40%. When the tech market was weak, Constellation used the opportunity to acquire companies at a cheap valuation.
Think of Constellation as owning a diversified pool of dividend stocks that compound their returns. Hence, you see the stock price of Constellation Software surging gradually. It surged 138% in five years, growing at a compounded annual rate of 19%. You can buy this stock at a dip to enhance your returns, as a diversified pool of VSS companies reduce risk and enhances returns.
BlackBerry
Unlike Constellation, BlackBerry is a cloud software company with two business units – Internet of Things (IoT) and cybersecurity – each earning revenue differently. Cybersecurity earns money from licensing its system and getting recurring revenue for maintenance. The IoT segment earns money from royalties on the design and sale of units. For instance, many car companies like Ford use BlackBerry’s QNX software in their vehicles. BlackBerry collects an initial royalty for product design and a recurring royalty on the number of cars shipped.
While the cybersecurity business brings regular cash flow, the IoT business’ cash flow varies. Its huge exposure to automotive and governments exposes BlackBerry to industry-specific risk. BlackBerry shares have fallen significantly since November 2021 as the automotive market witnessed the worst semiconductor supply shortage. Moreover, governments delayed signing cybersecurity contracts amid business uncertainty. These headwinds are fading. BlackBerry expects to sign two major cybersecurity contracts soon.
And with the proliferation of generative artificial intelligence (AI) like ChatGPT and various security concerns surrounding it, the cybersecurity segment is likely to get hotter. As for IoT, the 5G rollout has set the stage for IoT proliferation. As 5G connects everything to the high-speed internet and cloud, it will create the need for a secure hyper-connected IoT system, an opportunity BlackBerry looks to tap into.
What to expect from BlackBerry stock?
You might want to stay active on BlackBerry stock, given its cyclicality. This stock is worth buying in the $4.5–$6 price range. And you can sell the stock when its price crosses $10, unless the company breaks out from cyclicality and enters into a secular growth trajectory with a revolutionary product with unmatched performance.
