In the world of technology, many things are hailed as “game-changers.” Consider cryptocurrency, artificial intelligence (AI), and smartphones. Some do change the world as they are supposed to, but most don’t.
As far as investing in technology goes, there aren’t many companies that can be considered “game-changing” in any way. The venture capital model, which consists of investing in companies when they’re small and hopefully selling in the next funding round, or an IPO, is pretty well established.
Yet there is one Canadian company that could be considered a true game-changer in the world of technology investment. An operating company, it eschews the “invest until the next funding round” philosophy in favour of long-term investment. It has done very well with its unconventional approach. Since going public in 2006, it has risen 14,000% — a return that most VC funds could only dream about.
In this article, I will explore this “game-changing” Canadian tech company and what it has in store for the future.
Constellation Software
Constellation Software (TSX:CSU) is a Canadian technology holding company that buys smaller tech companies and, typically, holds on to them for a long time. There have been exceptions, in which CSU has spun off subsidiaries to the public or other companies, but they’ve been rare. For the most part, CSU has stuck to its “buy-and-hold” philosophy.
What kinds of companies does CSU buy and hold? There’s a wide variety of them, but they typically share these characteristics:
- They’re small (most deals are for $5 to $10 million)
- They sell enterprise software that locks in recurring revenue over long periods of time
- Their clientele is either businesses or government (rather than consumers)
- They have revenue
CSU’s acquisition strategy is more conservative than average for venture capital. The company never invests in mere “ideas”; it wants to see a real operating business with actual revenue before it buys. It’s an unusual strategy, but it has paid off well, as shown by CSU’s revenue, earnings, and stock performance.
High growth
CSU has experienced consistently high growth over the years. Over the last five years, it has grown its revenue, earnings, and free cash flow at the following compounded annual rates:
- Revenue: 22%
- Earnings: 14%
- Free cash flow: 25
Truly phenomenal growth. And, unlike many fast-growing tech companies, CSU’s growth has not come at the expense of profit.
Consistent profits
If you’re like me, when you hear about a high-growth tech stock, you often become skeptical, wondering if it’s even profitable. Because truthfully, many tech companies achieve high growth only by borrowing piles of debt and selling stock, diluting investors’ ownership. However, in CSU’s case, this isn’t what’s going on. In the trailing 12-month period, it boasted the following profitability metrics:
- Gross margin: 35%
- EBIT margin: 13%
- Net income margin: 7%
- Free cash flow margin: 28%
- Return on equity: 35%
Those are pretty fat margins across the board. And as long as CSU remains prudent in its acquisition strategy, it will likely remain that way.
