CSI - sithankanna/companies GitHub Wiki

What is Constellation's Moat

Unlike other analyses, let's state all the risks upfront.

Risk/Warning Signs:

  1. Organic Revenue growth (very low) at ~ 2%
  2. Companies are becoming more expensive to buy (pushing down ROIC)
    • More people competing to buy (copycats)
    • CSI are very aware of copycats (and hence even stopped publishing shareholder letters)
    • Easier for new entrants to raise capital (capital is cheap)
  3. Their "star" Portfolio Managers (aka "Compounders") and experienced BU Managers ("Craftsmen") leave to set up a rival shop.
  4. Decentralised method fails at a certain scale i.e. number of independent companies (we don't know what the limit is )

Overview

The structure of this memo is as follows. We will first try to identify the business model of Constellation Software and try to exhaustively list all the sources of competitive advantage any company could have and then test if CSI has that competitive advantage. Let's anchor our discussion to the business model of Constellation.

Business Model

Raise Capital > Acquire Companies > Hold & Operate Companies > Reinvest Cash In Step 1

Sources of Competitive Advantage

1. Raise Capital

Sources of Competitive Advantage

>> Company has lower WACC compared to market

Constellation has the following funding sources

  • Cash from Operations
  • Existing CSI Stock is overvalued
  • CSI can raise debt cheaper compared to the market

Hypothesis 1: CSI has a lower WACC compared to its peers [To Do: Estimate CSI's WACC to test H1]

2. Acquire Companies

We can break this step down into their M&A Deal Flow funnel (think of it like a sales funnel)

CSI Database of Companies > CSI Filter > (% Outbound + % Inbound) Requests > Due Diligence > Offer > Acquire

Now let's assess the competitive advantage of CSI across each of this dimensions.

2a. Acquire Companies | CSI Database of Companies

Informational Advantage

Sources of Competitive Advantage

>> Better Database of companies 
   1. More companies  (# Verticals x # Companies/Vertical)
   2. More information per company

Known facts CSI Database of Companies (TAM);: ~40k (and growing according to Apr 2018 Letters)

I don't see how CSI can have better information about the market compared to other PE/Strategic acquirers. For example, Capterra (a VMS review website) claims to have 50k+ VMS companies on their database. If you join it with Owler (crowdsourced company info website) and Pitchbook, then you could have a database as large as what CSI claims it has. The only caveat is that building a "clean" database is harder than you think.

[ToDo: Add quote from Auren Hauffman, on DaaS businesses]

2a. Acquire Companies | CSI Filter

Analytical & Behavioural Advantage

Sources of Competitive Advantage

>> Better filter to find assess ROIC 
>> More disciplined process to decide on attractiveness

Given their experience in buying, holding and running VMS companies, CSI could claim that they are better at

  1. assessing the value of potential investments and
  2. are more disciplined at only buying companies that match their criteria

Let's assume that 1) is true i.e. CSI is better at understanding the "peculiarities of VMS" [2] companies due to their experience. They seem to have long standing employees and directors, so it [Reference needed]

However, who knows if 2) will hold true for the next 10+ years. To understand this, we need to understand if the values of the founding members are embedded in the culture. What is the succession plan?

2a. Acquire Companies | (% Outbound + % Inbound) Requests

Sources of Competitive Advantage

>> Bigger deal team 
>> More efficient deal team (people can reach out to more companies)
>> More companies approach them (increasing % inbound enquiries)

Unlike public market asset managers, CSI can't buy companies with a click of a button. They need people on the ground reaching out to VMS companies and building up the deal pipeline. So, they can create a moat by creating a bigger & more "efficient" deal team. This could also be engineered by increasing % inbound enquiries, thereby reducing the need to actively reach out to companies.

2a. Acquire Companies | Due Diligence

Sources of Competitive Advantage

>> Better quality information 
>> Lower Cost (time and money)

Here CSI could have a competitive advantages with their own network of VMS Business Unit managers they can tap into to get on market or even company specific information. This is a source of advantage they can continue to build.

To track this they could tract their cost and time of a DD.

Offer Sources of Competitive Advantage

>> Ability to offer a lower acquiring price, driven by
   >> Better value proposition
   >> Better "convincers"

Here, the metric to track is the offer/acceptance ratio. What % of companies accept CSIs offer. CSI could have a higher accept ratio is because:

  1. They have a better value proposition (besides the price). To compete against PE and strategic buyers they could use their autonomy and buy-and-hold-forever selling points. On the other hand, they could use their brand reputation against copycats. Besides that, the value prop of being a part of a bigger family of like-minded people (being a CEO of VMS company seems like a lonely job) is a something I wouldn't underestimate. Side note: Each holding company under CSI seems to organise yearly conferences for portfolio companies.

  2. They have more convincing deal-makers. Don't know if this is true. From my read of the company, it doesn't seem like they go for the [Glen Gary Glen Ross types]. Did I hear coffee is for closers?

Advise to Mgmt:

  1. Explore structured way to harness information from your BUs

    • Knowledge from BU managers
      • Hire someone from GLG to manage run this "InfoCo"
      • Use see how this info can serve your Portfolio Managers
    • Data from BUs
      • Find someone to explore how to use data to aid DDs

  2. Build up the Brand value of CSI to be able to increase offer/acceptance ratio Maybe think about the playing up the exclusivity of joining the CSI club. (On the flipside, you might attract the wrong people/businesses) The venn diagram of people who want to be part of exclusive clubs might not intersect with the level-headed Craftspeople and Compounders that fit the Constellation culture.

References

  1. Capterra
  2. Owler