We are going to periodically share updates on companies we have covered in the past here. These will sometimes show up as Twitter threads first, but we want readers to be able to easily access the archive of earnings recaps. The start here tab allows for easy navigation. We may occasionally refine or expand our analysis based on feedback.
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CSU 2022 Earnings Recap
Constellation Software recently reported 4Q22 results. We review their FY2022 performance, touch on key financial metrics and adjustments, and conclude with a valuation framework.
Revenue grew +30% y/y to $6.6bn. However, this figure is distorted by acquisitions. Organic growth was -1% in 2022, after a strong 2021 (+7%, covid comp). The all important maintenance revenue line, which is the best barometer of the health of their businesses, was +1% y/y.
Expenses grew +36% y/y, but there are many charges that are recorded as an “expense”, which do not represent a real economic cost. Principal among which is amortization of intangible assets (+30% y/y to $676mn).
However, as their organic maintenance revenue still organically grows, the economic value of these intangibles increase (or at least stay stagnant), rather than decrease.
We think adjusted cash flow metrics are better. Shown below is CSU’s “FCFA2S” calculation.
CSU’s “FCFA2S” calculation.
The IRGA/TSS liability is worth taking a second look at. If you read our report, you’ll know this is related to the Joday Group’s right to sell Topicus shares to CSU at a price which changes based on their performance. The change in purchase price is the change in IRGA/TSS liability.
While we argued in our original report that we didn’t think it made sense to both burden FCF with this charge and then back out the earnings associated with the ownership of the stake, they have since increased their recognized equity interest and reduced the NCI.
Still, an investor might want to back it out to better reflect underlying FCF. (Note: acquisitions aren’t included). This adjustment increased FCF to $965mn from $853mn in 2022. FCFA2S has compounded at 14% since 2017 (a figure that is ~400bps higher w/o the IRGA liability).
Zooming out, CSU’s success will be dictated by their ability to deploy ever growing amounts of cash into acquisitions.
Below we see acquisitions as a % of FCF exceeded 100% the past two years. They spent $1.6bn on acquisitions in 2022, their most ever.
Larger acquisitions, like the Allscripts transaction ($727mn) and incurring a moderate amount of debt could keep this figure elevated, a great outcome for CSU shareholders. At almost a $40bn valuation today, CSU trades at a ~3% earnings yield (adding back IRGA)...
That means investors are counting on CSU to compound their retained earnings at a very high rate to achieve a satisfactory return.
Which they historically have done. However, as they get larger it will get harder to maintain their ROIC. We see evidence of it tapering.
An investor should think: When I am paying a >30x multiple, what do I expect the company to compound retained earnings at in order to reach an acceptable yield to cost?
Compounding a 3% earnings yield at 20% means an investors yield on purchase is 19% in 10 years. However, that assumes a steady increase in CSU’s ability to deploy capital into acquisitions.
To achieve that 20% ROIC, they will need to deploy >$20bn into acquisitions in the next decade (our estimates). At their 2022 run-rate, this seems plausible.
Investors should be aware of their assumptions though. If ROIC falls and/or ability to deploy 100% of FCF falters, then the terminal value may be impaired…
How would you value CSU if they can only deploy 50% or 25% of their cash flow (which we estimate around ~$4-5bn in a decade)?
Deploying half of their T+10 FCF at a 20% ROIC is ~10% growth (vs. +30% y/y in 2022).
What multiple would be appropriate in that case?
Rather than a multiple, which has hidden assumptions, we prefer to use a reverse DCF. This will allow investors to make explicit their assumptions and see the corresponding expected returns.
Become a Member today to get our full report as well as access to our Excels with our reverse DCF.
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