Company. Constellation Software: The Business of Buying Software Businesses

(upbeat music) Welcome to another episode of the Synopsis, a Speedwell Research Podcast. Today, we have an installment in our company DeepTime series where we will be discussing fan favorite constellation software. Of course, for anybody who wants the underlying report or any of the many written reports that Drew and Speedwell team have put together, these are available at speedwellresearch.com for subscribers. Of course, you can also have access to the Excel models, the reverse DCFs as a subscriber plus, which is always helpful, allow you to put your own assumptions in and see what you think. So anyway, well, let's get right into a constellation software. At most people have heard of it in the quality investing sphere, the Mark Leonard's beard is legendary. What about constellation software interests you? And then maybe just a little bit about what the company does for those who may not have known. - Yeah, so constellation software at a very high level, what they are in the business of is basically investing in various vertical market software companies. And so they are a conglomerate of hundreds of different vertical software market companies. We'll get more into what that means later on. The things you should know for now are since IPOing, the stock has done pretty tremendously, 35% plus Kager, they now have eight billion in revenues. There's a bit of an asterisk on that number, we'll get into in a little bit why that is, over 1.1 billion in free cash flow. And they're acquiring over a hundred of these small vertical market software companies every year. They now have an estimated close to a thousand of them, all aggregated together within their company. And I'll also say one last thing, which is they now have a 60 billion market cap. And so it is a pretty sizable company, given that a lot of these small companies they're buying, they could be buying for as little as five million a piece originally. - Yeah, and I mean, one of the original reasons to consolation software, I think it's such a famous company amongst the kind of the investor communities, Mark Leonard's investor letters are exceedingly insightful. He wrote them for many years. I think the board eventually told him to stop writing them because he was kind of giving too much away or trying to hold the copycat started coming in. So he stopped writing it in 2017 and then he had one more letter in 2021, I believe. But other than that, that's all we got. And you know, it'll be really great to get into, we're gonna get first into vertical market software, what does that mean with your notes around that? And then separate that out from consolation software because I think a lot of people will tout the benefits of vertical market software. But again, that's different from the business consolation software, isn't right? They are in the business of acquiring those companies. So it's good to get that bifurcation. - Five minutes in and you're already stealing my lines. Listen, I have to have some lines every once in a while. You know, I'm not gonna come up with them on my own. But I'd love to get into the history. There's not a lot here because Mark Leonard is famously hard to know anything about. I mean, he's a very private, he's done maybe one interview that he had stricken from the internet. I think you can find it in the depths of Twitter if you're really looking. But what were you able to scrounge up on the history of consolation in Mark Leonard? - Yeah, as you noted, really not a lot. The first piece of information we have is when he starts at the University of Ghulif in Ontario, not sure if I'm pronouncing that right, but that was in the early 70s. And so we don't know a lot before that. Again, this is in Canada. And it seems like he had not a lot of financial support early on, not sure what the family life was and all of that, but he worked a lot of jobs to support himself through college, including grave digger, municipal park ranger, a bouncer, a furniture mover, a windmill researcher, a warehouse employee, and as a masonry. And so all of these jobs, he's kind of just taking, so we could continue a long college. You could see that he's not really scared of hard work. And he is open to doing many different things. He gets his MBA eventually at University of Western Ontario's Ivy Business School. And he had a job lined up as a banker. And he had a job lined up to intern as a banker. And when he was working there, he has this conversation with someone who's there who basically says, this is not your thing. You're not interested in this. You don't want to be a banker. Go look at our client list of everyone who's here. And think about what kind of job that you actually do want to go out and get. And so he decides that he wants to become a venture capitalist. And he doesn't have any connections or anything. So he saves a little bit of money he has to fly out to VC conferences, to try to network. And it takes a while. But eventually, he's able to get into the VC area. He starts at a firm called Venture West. And one of the more interesting things that he noted, while he was there, was that a lot of the companies he was working with, even though they were very passionate about their businesses and the problems they're trying to solve a lot of the VC companies were still building something just to sell it. And then the day, and he in turn kind of like this idea of more of building something for the long term. And so he had one other really important insight when he was there, which was he was looking at the returns of all of their investments, all their venture investments they did. And he noticed that the software companies that they had, while they may not have had the most tremendous 100x returns, they were the most consistent in execution and actually being profitable. And so he thought, well, why don't I just create a company that invest in nothing but these vertical market software companies? We could talk more specifically later on why these are good businesses. But his idea was to just focus on this one little niche and raise money and just go after that. And around the same time, he's also becoming influenced by Warren Buffett, Charlie Munger, kind of the whole Berkshire halfway mode of investing in a business, being decentralized and letting them kind of manage it on their own. And so that's kind of the impetus from where he starts to go out, raise money and then make his first acquisition. Yeah, and that's kind of a, you know, as much inside I think as we're going to get to his early life, you know, unfortunately, just not a lot going on there. But you know, we have a little bit more data as times progresses. We know that he's able to kind of get an in into the Ontario's teachers fund and maybe take us through that stage of the company's life. Yeah, so it was the Ontario Municipal Employees Retirement Fund. And he had a friend there who helped him raise $25 million. And at the time, he was considering calling this new endeavor software co. They did get one piece of feedback. Everyone liked the idea of focusing on vertical market software enough, everything, but he did get one piece of feedback, which was that name is terrible. Do not call it software co. And so instead he called it constellation software, an ode to the idea that even though all of these companies would be independent, there still is some unifying picture overall. And so now we're in about 1995 when they close their first acquisition with trapeze, which was a provider of fixed route scheduling software to North American public transit authorities. So you're talking about bus scheduling software. So you can imagine this isn't the most kind of popular thing that VCs are going after. But once you are embedded in their business operations, this is a very important function. They'll call it mission critical. We'll talk about more exactly what that means later on. But you could just get some sense that this is something that is very important in the business and not something that they would want to take out without a replacement. And this is kind of indicative of the companies that he's going after. It's not very big bus scheduling software. There's not too many people to really sell that to, but the people that use it, they really do rely on it. It's obviously very important to making sure the buses show up on time, which is their core business. And so that's kind of this idea of it being mission critical. It's not something you can pull out of the business without at least replacing it with something. And there's usually no prerogative to ever replace it so long as it continues to work well. And we'll talk more about that in a bit. But that just gives you some sense of the kind of things they're doing. And you'll notice that name later on, when they split up into these different divisions within constellation software, they'll have six of them. And this is all coming from its initial acquisition in 1995. At the time, Mark Leonard is writing a newsletter called Opportunity Above All. And he's really trying to focus on, it sounds funny saying it now, but buying these companies for one and a quarter times revenue. And so these are not very expensive acquisitions. In his mind, he's paying a very low price that almost no matter what, they're going to be able to extract some sort of margin from it. Usually you're looking at at least like a 20% free cash flow margin for this sometimes much higher, because you don't really have to reinvest too much into it. But it does depend on the company. And so he's starting to roll up these different companies. He's buying typically at the time the companies are buying around like 5 million in valuation. And so the real place and the reason why constellation software exists in the first place is because there's no natural buyer for these sorts of companies. And this is important to know. So if you think about who they could sell to, they can't really sell to a private equity company because private equity companies, they're not looking for a $5 million opportunity. It's too small. Secondarily, a private equity company is looking to usually flip these. And so if this is, he'll use the word baby, like your business is your baby. And you've been working on this for a decade, maybe two decades, do you really want to just sell to a private equity guy who's going to jack up the prices, piss off all your customers, and maybe fire life long employees? Probably not. OK, so you don't want to sell to private equity. And there's not too many other people that are interested in the sort of business. You're obviously too small to go public. So who are you able to sell to? And so this was their niche where they were able to really hone in on these opportunities where people cared about who they sold it to. The businesses were really small. They weren't growing a lot, right? If you're thinking about the bus scheduling, market tam, or something like that for municipal authorities, once you get them, that's it. It's not growing a lot. And there's not a lot you could really do on that. And so it's a good business in terms of the cash flows that generate. But there's not a lot of reinvestment opportunity. And so you have to put those cash flows elsewhere. And so that's another reason why it's not so interesting for other people. But his insight is, I want to collect these businesses. And the cash flows, I'll be reinvesting into more of these sorts of high quality businesses. And so this goes on for the better part of a decade. It's not a lot of info on what's going on. But they continue to just acquire many of these small companies. And the idea, too, is that when he does acquire these companies, he wants the companies they acquire to also help field ideas for different potential acquisitions. If there's something in their sector industry they know about, they'll go out and acquire that as well. And so they're starting to gain a little bit of awareness in the software industry as a go-to buyer for all of these things. And now we're getting up to about 2006 when their IPO was in the thing that precipitated the IPO was not the need to raise capital. They did not raise any primary capital whatsoever in the IPO, which means money, of course, that goes to constellation software. Instead, what happened was his contact at Omers, the Ontario Municipal Employees Retirement Fund, actually left, and he didn't get along so well with the new people. And this kind of actually goes back to what we were saying in one of the recent memos I wrote from private to public markets, the detriment of investor expectations and the idea in that memo was that the investors you have can influence your business. And so Mark Leonard was aware of this. He wasn't getting along very well with this person. And so he wanted to go public to kind of thin out the investor base. So it wasn't one investor who had such control over the company and then it also helped give them an exit. So they could sell down their stake. And so before they went public, they first did a private placement with TD Capital, a Canadian private equity firm for 60 million. But then they also eventually would want to exit as well. And then shortly after they did that private placement with them, they went ahead and went public in 2006 with 21.2 million shares outstanding. And that is an interesting number because even today, they still have exactly the same number of shares outstanding, 21.2 million, despite all of their acquisitions. And so they're not using equity for any of their acquisitions. And so at IPO, they had about 45 companies under their belt, 165 million in revenue, a global footprint with 40 offices. And that is where we will leave it for right now. And I mean, two things to note there. One, we'll get into the compensation structure. But yeah, they're not handing out stock options, willing early to their employees. They have a compensation system that forces individuals to take a portion of their bonus and buy the stock on the open market. So it's a little more skin in the game. But we'll talk about that alignment. Second thing, which is really interesting and Buffett will talk about this at Berkshire, which is Berkshire is not going to pay the highest price. And everyone's selling to Berkshire knows that Buffett's not going to overpay for something. But talks about it as a good home, as someone where we're not going to be overbearing. We're going to let if you want to stay on a CEO, they'll let you stay on a CEO. Those types of kind of more qualitative aspects that an individual might look for as they're looking to exit their company. And one interesting thing that in the perspective and droopled out some really interesting diagrams, but you start to see that the machine that constellation is building in the business, the acquisition pipeline, the streamline management, getting operational improvements, then kind of working on tuck-in acquisitions or investment opportunities at the vertical market software company level. And so you're starting to see this machine that's being assembled in the company itself, how that will have their own competitive advantages. But before we get into the structure of constellation, kind of the revenue segments, things like that, I really just want to spend 10 minutes in talking about the hallmarks in the characteristics of why vertical market software is a good place to be. So maybe take us through some examples and the characteristics of those businesses. So very high level. You basically, when you're thinking about a vertical market software company, we identify five key features of why they're so good at businesses. And there's a few other like cash flow dynamics that are quite positive too. But generally speaking, the first thing for most, they're mission critical. And so what that means is that the business is basically relying on it in order to function properly. You can imagine most businesses without some sort of key piece of software, they're just not going to work as well. Doesn't almost doesn't even matter what piece of software that is, whether it's something in human resources, accounting, scheduling, there's all sorts of different software that a business has. And so when you think of vertical market software, and this is in contrast to horizontal, the thing that's different with vertical is its software that is made for a very particular and usually idiosyncratic use case. And so one example we have in the report is chicken coop software. And so what sort of software are you going to run if you have a chicken coop, right? And so this is very specific things that's going to count the number of chickens, how many eggs they're laying, and all sorts of things that I did not do a deep dive into. But that's why it's vertical is because it's focusing all on these specific use cases. In contrast, you could think of horizontal market software. And that's the sort of thing that, you know, like a Salesforce kind of specializes in, or even Microsoft Word. It's a very general software that is applicable to many different use cases. And so maybe the same HR software works across all sorts of different industries. The same sort of customer review system may work across all sorts of industries or accounting like QuickBooks. So that's horizontal. And the problem with horizontal, not necessarily problem, but one of the big differences with horizontal versus vertical is vertical, especially the markets, the companies, the constellation software acquires goes after, they have very small tams. There's not a big business of people that are buying chicken coop software. And so that sounds like a negative until you realize that means that it's relatively easy to dominate that market. And once you have market dominance, there's a very little incentive for someone else to come in there and try to displace you. Everyone who in all these VCs who are really funding software companies, they're gonna try to go after the big tams. They're gonna say I have a better accounting software. I have a better HR system and we could sell it to everyone. They're not gonna be pitched on, you know, the next best way to count eggs in a chicken coop. And so because of that, it means that once a business is able to establish itself and its competencies and get customers, the customers then become reliant because it's mission-critical to their service. But at the same time, it kind of scares off any potential competitors because they now, not only have to build a similar offering, they have to now go out and get enough customers to rationalize their spend in R&D to create that offering in the first place, but it's very unlikely that the customers that are on the competitors offering are gonna leave. And so it's just a very hard position to compete against in the sense the fact that it is a small tam becomes a competitive virtue because there's not gonna be a lot of funds flowing in to try to attack that. And so that's one aspect. The other is in similar reasons following through that. There's very few substitutes very often. You're not picking between, you know, five different options of, you know, some bowling alley software that's gonna run the software or how many pins get knocked down and all of that. And so these are not companies where there are many different options to pick from. And so the option that they're one relying on, they're gonna be tend to want to stick with that 'cause there's not a lot of reason to switch, but it also means there's just not a lot of alternatives anyway. - You know, I can just imagine the latest, you know, computer science class coming out of Stanford and they go on down to San Hill Road and Sequoia's lined up. All right, what ideas do you kids got? And they go, word disrupting chicken coops software. That's what we're doing. I mean, that's just, and that's the beauty of it, right? And again, that your memo, that's how it's so well, which is all these VCs, they need parabolic bets, right? Like, why would you be pumping into money when you have an entrenched thing? And then even if you win, it's just like, the spoils aren't even that great. So it's just, and kind of look, I mean, I'll play devil that could it here. If I was a chicken coop manager, I would really hate the fact that I probably only had one or two softwares to choose from because again, you know, that's kind of for incentive. What was there incentive to update it? What's, you know, I can't really negotiate price, but having said that, I'm sure it's still better than dropping things to pen and paper, which is what historically was done. So, yeah, it's a good place to be for. - Yeah, and the other aspect of that though, is that the software is a very small portion of their total cost. It's not typically that, and especially for the value that it's adding, it's not like it's a material, P&L item very often. And so because it is a relatively small portion of the total cost, you do get a little bit more pricing power in that. But the other thing I really want to hit on it, we're touching on this, but I think it's too often, you'll think of like an early mover advantage, is not really being a defensible competitive position, and that's because it's not. But I think if you more broadly think of it as you are serving a customer well, then that itself is a sort of competitive virtue, because if you are serving someone well, they're not going to leave for no reason. They're not going to deal with any sort of friction and switching cost, unless the next thing that you provide is much better. And that of course is why, you know, Peter Tail and other VCs talk about making a solution that is 10X better, but it's really not so possible that in a lot of these markets, you could really do that, nor is there an incentive because the tam is small. And so for these reasons, you're starting to understand why there's such defensible businesses, and then there's also just like the straight switching cost, which is once you train all of your employees on a particular software, you may have integrations in with all of your other software and all your data that you're collecting, and in a lot of cases actually constellation, or the company's constellation owns, will work with companies and clients to help customize the software for their needs. And so you may also have already paid and developed some sort of customization, which is going to work well with everything else in your business. And it's like why rip that out? I have to retrain all of my staff. All of my computers may not work. I have no idea if I'm going to cause an issue with one software program not being able to talk to another. I could potentially lose clients. I could lose revenue if everything falls down. It is such a material risk switching that you're not going to do it unless you see a clear benefit, which usually is not there. - Yeah, and I mean, I can wax and weigh in about the advantages of vertical market software. These individual businesses they own, they have such strong competitive advantages, such durable modes that the underlying businesses that constellation are exceedingly attractive. But we'll come and find out is that most of the valuation, of course, is not out of these businesses continuing, but that they're ever able to invest ever increasingly large amounts of cash flow into more of these companies, which is the question that we'll have to answer. - Real quick, I want to talk about a couple of the business model virtues of vertical market software. So we're talking about the competitive positions, but there's certain aspects of the business, the financial model that makes it even more attractive. And so very high level, you have a positive cash flow dynamic because you have them paying upfront for it. Usually, it's an annual license. There is some specifics we'll get into later on licensing versus maintenance revenue, as well as SaaS versus kind of the more traditional on-prem model, but that aside, you do have positive cash flow dynamics where the cash comes in first, you're servicing it later. It's not very capital intensive. There's very little in the way of maintenance, capex and software whatsoever. And so that's obviously great. And then on top of that, in a lot of cases, you're having recurring revenue. So you do have revenue visibility, and it's just always on. Basically, a lot of times you're not losing a customer unless they go out of business. And so for those reasons, it is very attractive. If you're looking at how much deferred revenue they have, deferred revenue is almost a third of all, apex. And so that is helping fund the entire business. And so that's another thing. And look, I got to give you at least one Mark Leonard quote, we'll sprinkle some in. This is from the 2019 AGM annual general meeting is what that stands for, and the quote is, the moat around our businesses, as you would expect. It's the stickiness of the software. It's the relatively limited number of competitors in each of the verticals. It's an intimate knowledge of their needs and being able to deliver to those highly targeted verticals very customized solutions, which is the opposite of the sort of thing you hear in a lot of software companies where it's the economies of scale and being a low-cost provider. And so right there, he just, he hits on the thing we were talking about earlier, the difference between vertical and horizontal. They want to go very big and try to sell to everyone and then being able to win basically on price and how many people they're selling to versus vertical. That's not really the game they're playing. They just want a very specific solution that's going to serve that small end market. And Drew can wax in vain about the beauty of vertical market software for at least another three hours because it is just a beautiful business. I mean, the durability, the lock in, the economics. I mean, it's clear that these businesses at Constellation currently owns are exceedingly attractive. And not only that, now the portfolio that they had, they're diversified across geography, they're diversified across many hundreds of different verticals. And the question will quickly come to is it's not that, wow, the durability of their existing businesses, it's that, you know, at the valuation they're at, they're gonna have to continually invest increasingly larger amounts of cash flow at these high rates of return. And that will be the question investor ultimately has to answer is whether they can continue to do that. But we kind of talked a lot about the underlying businesses that they own, but as an equity holder in Constellation software, you're buying the machine that's investing in them as well, right? You have to have some ability to think that they can continue on their current path. So I want to dive a little bit into two separate things within Constellation, which is one, their corporate structure. And then two, kind of their revenue line items because it's interesting, we'll do a little software history about where are they in the SaaS revolution, things like that. But first, let's get into their corporate structure. How do they split up these thousands of businesses, they don't have thousands at hundreds? - So there's six segments. And I guess seven now with with Lumen. And so you have Valerous, Harris, Topicist, Vela, Jonas, Perius Group, as well as now Lumen Group. And so the way it kind of works is that they make these acquisitions. And so all these were originally companies they owned. And then the companies they bought, they would delegate capital allocation decisions down to dumb, who in turn they would then acquire other companies that would be delegated capital allocation decisions down further and further and further. And so right now they have these different operating groups, the responsible, generally speaking, they have some sort of vertical specialties, although there's a good amount of overlap. And so in the report, we get into more of the specifics between every single group and what they specialize in. We'll just gloss over that here because it's not necessary to get a general understanding. But the idea there is that we want people who are more on the ground and who are interacting with all these software companies to take responsibility for allocating the capital. And we will set a hurdle rate that they must hit, but we cannot from this office in Canada allocate all of this money out on our own, you know, in $5 million deals, it's just too hard. And so this is actually one of the big differences between, if people like to compare them to Berkshire Hathaway, but this is a big difference is in Berkshire Hathaway, Warren Buffett is telling all of his companies, whatever capex you need to invest in your business or whatever you need to do, do it, but whatever excess cash flow you have, send it back to Omaha. Mark Leonard in return is basically trying to keep pushing down all the capital and the capital allocation decisions throughout the organization. Now there are some exceptions to this. Large acquisitions with over a $20 million threshold at some point, maybe they raise this, they do need to get approved by the corporate office, and he also will sometimes help lead certain acquisition efforts, especially kind of the larger deals they do, like with Topicist and Lumen, but they at the same time are really trying to spread out the capital allocation decisions because if you're doing 100 acquisitions a year and just so people know how large and how many vertical market software companies there are, there's estimated to be at least over 50,000. And in a given year, constellation has not heard of at least 70% of the deals that are done. Doesn't even know that that company existed. And so a lot of what they're doing is just trying to database all these companies that exist and build relationships with them. And so that requires a lot of people and a lot more kind of decentralized and boots on the ground effort, rather than Mark Leonard and his M&A team sitting out in Omaha trying to get everything done. And you're starting to answer some of those questions, which are, well, how long can this keep going on? And then you're saying, well, they don't even hear about all these deals and they haven't even with the large amount of team that they have and they're trying to specialize in discovering every vertical market software company that exists and get them in their pipeline. They still haven't heard of 70% of the deals they get done. So that's kind of a nice fact for somebody saying, well, how long can this continue? Well, there's kind of a big, so do you speak to them of vertical market software companies that exist? You know, and what we're also touching on here is kind of the culture that exists within constellation. I mean, when you read the annual general meetings, when you read Mark Leonard's transcripts, you really get to sense of the learning machine that the organization is. I mean, he's constantly talking about doing pre-mortems and post-mortems and learning from other vertical market software aggregators like Tyler Technologies and how that kind of permeates throughout the organization. And it's kind of this Russian Doll situation. You just keep pulling out more Russian dolls and there's more. I almost look at these business units as many constellation softwares. And then I'm sure within each of these large many units, there's even many other units. And it also makes achieving these hurdle rates much easier because clearly, like if I'm investing a million dollars, it's going to be much easier to achieve a high IRR in a million dollars than it is 10 billion dollars. Everyone knows that as capital gets larger, there's less opportunities during those access returns. And so maybe touch real quick, and we're maybe going to talk this later, but whatever, talk a little bit about the keep your capital initiative that they did and how that's like one way that they're seeking to constantly be achieved even these high returns. - Yeah, so that was an experiment they did with I believe those two operating groups. And so the idea there was instead of just focusing on the highest rate of return, we're going to basically incentivize you to keep more capital and invest it even if it is at slightly lower rates of return because what's happening is everyone who's just looking for, it was a 20% hurdle rate. I believe it was that Mark Leonard said once in 2011, but he's never said exactly what the hurdle rate was. And so the idea there is basically, the hurdle rates were setting if we sent them really high, we'll just do fewer deals, but we'll be hitting them. And maybe it's better we just deploy more capital, maybe at a slightly lower rate. And then also if I'm forcing you to keep your capital, maybe you are taking just a little bit more risk, hopefully not too much, but a little bit more than otherwise just sending it back up to us and knowing that you at least hit your threshold with higher confidence. And so the idea there was we're going to incentivize them and basically force them to invest more and see what happens with the returns. The other aspect, important aspect to keep your capital wasn't really about the acquisitions though, it was also about these internal initiatives. The idea there being that we can invest internally in some of these companies and have a return, except that return may be somewhat delayed, right? But it'll show up in terms of revenue growth. And so he talks about being willing to trade off a point of margin for more than that in growth and appreciating that trade off. And so part of the thing that you need to keep in mind when you were thinking about a software company is that the way you invest is different. In a traditional company, you're investing through the cash flow statement in terms of CAPEX. But on a software company, CAPEX doesn't really exist. The way you invest is through SNM and R&D. And that of course is going to reduce your margin in that period, but it's growth expenses. It's not maintenance expenses. Having said that, it's going to still hit your ROIC in a more punitive way than it would if you were to just have a capital outlay for that period. And so because of that, part of the CAPEX initiative was to see what happens when we do lean into more of these internal growth initiatives. The outcome was that they were investing more, albeit at a slightly reduced hurdle rate. But that also then got into a broader discussion. Investors were having with Constellation Software, which was basically your hurdle rates are too high. And so in 2019, they actually did a dividend, $20 per share dividend, returned $420 million. And investors weren't too happy with this decision because in their mind, the Constellation was just optimizing to keep this very high hurdle rate. But then investors, like you're trying to invest at a 20% plus hurdle rate, or sometimes even higher. And we cannot invest our capital at 18%, or 15%, even, or maybe even 13. Just keep this money and invest it on our behalf. Don't give it back to us, while then we're investing at a much lower rate. We would rather you lower your hurdle rates, and accept more. Mark Leonard, though, would push back and saying, are concerned with lowering the hurdle rates. And he'll say hurdle rates are magnetic, is that when we do lower the hurdle rates, all investment opportunities drift down to there. And so I think what he's implying there is basically, if we tell everyone to go drop the hurdle rates, five points, they'll just continue to bid up companies until it hits that. And so the kind of middle ground that they picked was, they will keep the hurdle rates the same on the smaller acquisitions, but they will lower it on larger acquisitions. And it is funny, because I mean, I think this was the 2021 general meeting, which is the only time you really hear from Mark Leonard or any more, but everyone was saying, well, look, we're in a zero rate environment, and a lot of them were complaining, you know, the guys at Constellation, oh, well, all these software companies are getting bid up to stratospheric heights. And investors were saying, well, you need to lower your hurdle rates because we're in a different rate environment and all these things. And of course, yeah, Mark Leonard said, well, look, yeah, it's hard to reverse that trend, right? So it's better to keep him high and just, you know, wait out this period. And I'm sure he was grateful that they waited it out. I'm sure some opportunities came up in the last. Yeah. So the thing that they did change, though, with their hurdle rates is, like I said, they lowered it for the larger acquisitions, but they did a second thing too, which was they would also take on more debt. And now this is a ring fence debt that has no recourse to the company. And Mark Leonard talks in a bunch of the earlier earnings calls when he did talk about debt, how he would want a structure note. And he has all sorts of specific things he's looking for to basically give him a lot of optionality, either defer it if needed and long time horizon and all that. And so they actually just did a note recently with all sorts of these features within it. And the idea there, though, is that if you are adding debt to some of these acquisitions, it's lower cost of capital effectively because the debt is coming in a lower interest rate. And so that's also getting you to then a higher return on equity, even if the total return of the company purchase wasn't as high as prior. And so that does kind of back you into the same place, right? And so this is more of capital allocation. You know, my conversation Center goes linearly as I would like them to, but you know, we just, we have to corral drew as best as we can. And so I want to get into the revenue segments because I think that that'll show one interesting thing that I would be thinking about as a listener and someone looking at this company, which is software as a service. That whole idea is, hey, they're monthly subscriptions. It's easy to switch around. How is that impacting this vertical market software company or businesses? And one way to really, I think dive into that is to look at their revenue segments and then kind of discuss how selling software has evolved and how constellation is and all their portfolio companies are dealing with this evolution. So take us through the revenue segments and you know, why they were initially laid out like that. - Yeah, so there are four revenue segments and there's one that matters more than all the others, but we'll give you them all. So there's four revenue segments. There's licensing, professional services, hardware and maintenance. And so before we get into the actual segments, let's set the stage on the actual overview of on-prem versus off-prem software. And so, prem is short for premise. What used to happen with these software companies is you would literally have servers in your headquarters, in your office and someone would come with a physical disk. They would install the software into your server and then it would be distributed throughout the internal network. And if you needed to update something, you'd need a new physical disk and it come in. And then you'd also need people to upkeep the servers and upkeep the software, you know, stuff happens, servers go out and all of that. So that is on-prem. What has changed and what has been happening recently, of course, with the cloud is now that software is moving off from being housed on premise to being off-prem, which basically means it's in the cloud and being served over the internet. And so you do not have an IT guy that is working on all of these servers in the basement to make sure the software is running for your company. It's all done through the cloud served on the internet. This is important to understand when we talk about these revenue segments because the first one, licensing revenue, it doesn't really exist with software as a service. And so what this basically is, is that when you are dealing with a physical disk, you can't really control it, right? So anyone could put in a physical disk, it's easier to pirate it. And the concern there is that people will just buy software either from a third party, or they'll use it outside of the terms of the way it's intended to be used. And so they create a license, which is basically a legal agreement on how they expect you to use the software to basically force you to continue to either engage with them, not mess with the software without their permission, and use it according to whatever the terms they want to outlay. The point there being though, that they are trying to legally restrict what they couldn't technically restrict. And so when you do move to software as a service, you are able to just turn the software off immediately if they violate some sort of term or try to do something. It's not really even an issue anymore. And so the licensing revenue really only exists with this old on-prem model. And so that's one segment. But still, it's a very high margin segment because it is just licensing of software that's by and large already created. And you're looking at that being roughly 5% of the revenue or low single digit percent. And so that's the licensing portion. The next portion we're gonna talk about that's also relatively trivial is the hardware segment. Again, this only exists because of this legacy on-prem business. If they're helping someone set up the servers for the software and all of that, they're also happy to sell them a pre-made server, help them configure some hardware in order to enable the software business. This is a very low margin business. I don't even know that they usually do take much of a margin on it. They don't talk much about it, but it's only a couple percent of revenue. Okay, that leaves us with the two last segments. These are the ones that matter really. So there's professional services. This is gonna be any sort of customizations with the software and implementing and integrating the software as well as training and consulting with the customers. And so this is important because this is basically helping integrate the software even more in the customer's business. And so this is about 20% of revenues and that's another good portion of revenue. It's not gonna be the highest margin revenue, but it is important because it's helping increase the competitive positioning and reducing the churn rate of the software. Well, also providing features that they could potentially raise their price for providing. And so that's the professional services and then the most important segment and the one that is the best barometer for the health of the constellation software is the maintenance revenue. And it's called maintenance and other recurring revenue. Within this is all of the fees charged for customer support on the software products post delivery. And so in the case of it being on-prem, it's once you have licensing, once you pay your licensing fee, then you also have maintenance revenue associated with the upkeep of that software. But more recently, you have all the SaaS revenue that is now becoming housed in this. And so this is subscription revenue from software, all sorts of products that are hosted elsewhere and they're just selling them via the internet. And so this is their main segment. That's about 70 to 75% of revenues now. All right, so again, that was a good break, Kendall, but it's always interesting to see the evolution of where the software kind of industry's been and where it is now. And I don't think anything elucidated that better than their revenue segments because it even took me, I go, why isn't it just a one line? Why isn't it just, hey, software licensing fees or things like that? But clearly, when you have kind of the older model, it makes sense about all of these ancillary services that they try to add. I'll kind of sprinkle in here. What has the shift or the pressure been to move to more software as a service? And do you see that as a risk to some of them, meaning the switching costs will be a little lower? - Yeah, yeah. This was a big topic. They talked about this at some of the AGMs. And there is something to that. But you also have to remember that the difference between horizontal and vertical is, vertical is very specific for a certain market, right? And the idea of SaaS and kind of some of the benefits of it make much more sense if you're gonna create a horizontal product, one that you're trying to sell to a lot of people versus bus software that you're trying to sell to the Ontario local municipality bussing, you know? And so that business, if they already have all the on-prem server set up and all that and no one is going out there and creating a very specific internet SaaS solution just for them, it's less likely to really be a disruption risk and SaaS is more likely to be a disruption risk for these kind of more general markets. Having said that, to the extent there are customers that prefer the sort of SaaS model, the software service over the internet, they'll switch. It's not such a disruptive business model change for them because again, these are software products that are pretty small and niche. And so if they do want to switch to a SaaS model, they've talked about how they've done that in the past for certain software providers. For a lot of these businesses, that's not necessarily the highest prerogative. And the point I really want to hit on is that this whole idea of software being served over the internet is much more disruptive in the horizontal kind of market. If you could think about Intuit and QuickBooks, the difference between QuickBooks being served through a disk versus online, if they didn't switch to an online model, you can imagine that there'd be a much, much smaller business. And if they required on-prem services to upkeep the software, then of course that's a no-go. And so that's why it's kind of more disruptive for the sort of SaaS stuff. The one thing that did change, though, is that a lot of SaaS is billed on a monthly instead of annual basis without this sort of licensing revenue up front. And so the cash flow dynamics did change because of that for the worse. But then in 2015, 2016 Salesforce started billing annually. And so then that also kind of reversed a little bit. And so generally speaking, this was thought to be a very disruptive thing. And the impact has been relatively muted. - Yeah, and to answer my own question a little bit, you have a great quote that I just kind of read real quick from Barry Simmons, the CFO, which is, it just applies to all software. Like whether it's vertical, whether it's horizontal, he goes, if you've ever switched some critical type of software, it's not on a fun experience. Rookanows are much better. I'd much more recommend that. And it's true no matter what. Like whether it's vertical, like for example, someone who uses bill.com or Brex over ramp, like you have all your vendors already loaded in bill.com. For Brex, you have all of your employees with all of their cards already in Brex. Like you're not going to want to switch to ramp even though it's software as a service, you can cancel at any time and ramp has easy onboarding. It's just a headache and there are enough headaches going on in any business that you just don't want. If a software is good enough, it just is good enough. And it's going to take I think a very adverse event or you don't want to leave. So yeah, the software is a service, go ahead. - Yeah, and it's basically like you think about what the real difference is, it's three things. There's a different economic model because you don't have the licensing and maintenance instead it's just one fee. Okay, that's not a huge difference. It's a different billing cycle because the monthly versus, okay, that's not a huge difference in the cash flow dynamic. And three, it's a different distribution means. And that is really the big difference here is the distribution changing from people actually going into there to being served by the internet. But again, this is not as material of a difference when you're looking at markets that a lot of competitors aren't looking to come into the first place. And so a lot of competition that the internet opened up, it opened up in vectors that people were not able to compete in any way. And the fact is the chicken coop tam doesn't really change because now you could sell it over the internet. That doesn't really make it a much more attractive proposition to enter that business. Yeah, and it's a great point in your idea. It's been harped on for so long. It hasn't manifested in any noticeable negative fashion for consolation. So you're right, I don't know. I don't think it's interesting. I will say one other thing though. And that's more an insulinary concern to it, which is again, the way investors can kind of disrupt or I should say influence businesses, which is the with the rise of SaaS came a lot of VC money into these SaaS startups. And that could be disruptive because a lot of these companies would be valued at valuation destructive revenue multiples. And so let's say that you could spend five dollars to earn a dollar in revenue. Well, okay, that math is probably never really going to work out, but it does work out if that one dollar in revenue gets a 10 times revenue multiple. And so then you're happy to spend five dollars because then you're turning it into $10. And so what was happening with a lot of VC's and a lot of money coming into it and being valued on revenue multiple is they were really just chasing a lot of growth. And that did have the potential to be disruptive. But again, just given the markets the small size of them, they were somewhat insulated from all those impacts. So that though is one area where the rise of the SaaS kind of impacted some of these companies. And again, it's not really because of the business characteristics so much as just the flood of money that was being invested un-economically. And you know, that is actually a great segue into my next topic. And I love when it flows in the way I wanted it to. So perfect, which is, you know, we've, again, we talked a little about a constellation, corporate structure, revenue segments, the evolution of the software sales model. And now I really want to talk about constellation as a business and their competitive advantage is separate from vertical market software. Mark Leonard has a great quote, which is, vertical market software has all of these great competitive advantages to compete with constellation software. All you need is a check in a phone book, right? That's what he famously says. So there's not a lot of how you say deep moats surrounding constellation, hold co, we buy cheap vertical market software companies, and clearly, you know, the secrets out. Like everyone knows about constellation. There's $60 billion market cap. People know this is a good business. So how is constellation going to continue to defend their position and continue to invest at such high rates of return as all this competition moves in? Like, what advantages do they have as the incumbent leaders, so to speak? Ain't that the question? So, so not to dismiss the crux of what you're getting at, which is at then in the day, a lot of businesses are going to sell to the highest bidder. And that's just the way it is. And so to the extent that there's not a lot of money chasing some of these smaller deals, especially early on, even that really isn't as true as some of these constellation copycats have popped up, understanding the model, reading the Mark Leonard letters. And so there is more money chasing a lot of these deals. And so their real advantage is basically just their size reputation. And the fact that people know they're going to hold up to the word when they say, when we acquire a company, we're not going to just lay off everyone. Jack up all the prices on the customers that, you know, you've been treating very well for the past decade or whatever have you. And so that's kind of mostly what it is right now. It's reputation. The second thing is just knowing about these companies, as I mentioned, there's 50,000 plus of these companies. So just knowing about them to even get in the bidding process is part of it. And so right now they have the biggest organization of people that are going out there looking for these VMS companies to try to cut deals. And so that's another aspect of it. The decentralization and the culture of it really does help as well because that helps align incentives where they can do this at a larger scale. As you mentioned earlier, employees do have to invest their own money, their own bonuses into the company, they're buying the stock for cash. And because of that, they're also going to care more about the sort of deals and success that Constellation has. But if you're looking at a bidding process, why does someone pick Constellation over someone else? They ultimately have to care that Constellation is going to not dismantle the company. That has to matter to them because Constellation is not always going to be the highest bidder. And so it is going to be a problem. Having said that, some of these copycats that have popped up and tried to copy their model have messed up the management of it either being too aggressive with the pricing. So they piss off customers or firing too many people, not really making the proper customizations for the software that are necessary to allow them to charge a higher price without his end. So there's a few things that they've been able to do. But it's not the modes of the VMS companies are not the same as the modes of the business. And so ultimately, it is a bet that you believe Constellation software is going to continue to be able to make more and more of these acquisitions. And as they scale up in size and do some of these larger acquisitions, they may actually have a little bit more unique of an advantage because there's not too many people who are able to cut a $500 million check and say that we're going to be a permanent home for these businesses. And so to the extent that that is true, that's also a little bit of a differentiator. But yeah, it's not the most satisfying answer. And I know that. Yeah, it's not like, you know, it's always nice when you go, well, look at Amazon's logistics network, go recreate that, right? But I think what Constellation has, it's a lot of these intangible aspects. I mean, the amount of pattern recognition, the amount of data that someone who's done 400 of these, you know, vertical market software acquisitions as one leaders at these subgroups, the amount of pattern recognition that these individuals must have, how many reps that they've gotten. And then secondly, just cultivating those relationships. It is not easy, you know, a lot of these individuals are small business owners. This is the largest transaction that they'll ever have. They're going to want to sell to someone who they trust, who they know. And so that sales process is going to start several years probably before that they even actually decide to sell. So creating that kind of very entrenched network of, hey, going out there, when you think of us, this is it, taking them out to lunch. I mean, they always talk about the continuous process of being the first thought for these people when they want to sell, even if it's not today and it's five years from now, right? Yeah, that's a good point. And I'm glad you brought that up. And then, you know, the other thing is they'll talk about the best practices. There's all sorts of learnings they share after running hundreds of these different companies that help them run them more efficiently. They'll talk about, also you mentioned this very briefly, but it is important, the database that they have. It's not just the database of all the companies that exist, where they can go after them and continue to engage them, but it's also just knowing what price to pay for stuff, knowing what to expect in terms of churn, if you raise the price to this, knowing exactly where to kind of push to the limits or leave it there. And so they obviously have been at this and to a larger extent and more in depth than anyone else with hundreds of these deals done. And so to the extent that that draws more talent and more competent people, all of that, of course, matters too. Right. And, you know, I want to get to some of the big questions, but real quick, I want to ask you a mini question because it always bothered me when I looked at Mark Leonard's shareholder letters, and I just want to put this on the record, which is he has this metric, which is, his return on invested capital, plus the organic net revenue. And he looks at that as kind of like the, you know, they publish it every quarter, every annual report, and he really hypes this number up. How is he not double counting? Because return on invested capital, okay, where the year is going to be operating income divided by invested capital, but that will include the organic revenue growth already in that operating income figure. So is he double counting? And maybe that wasn't clear. Maybe you have to kind of do the math out for people, but what's going on with that? - Yeah, I'm glad you asked that. And so that was kind of my first impression, but if you think back to the conversation we were having on how a software company invest, they're investing mostly through the P&L, right? And so to that extent, what's happening is that it's reducing their earnings, so that's going to reduce their return on invested capital, and the idea is you're willing to accept that reduction in earnings because of the growth that you're getting. And so you'll kind of talk about his decision to want to trade off some margin for growth. And so that is a very rough barometer of saying we are investing more in this company in order to get more growth. And so that's kind of how I understand it. The number itself, if you just think of the numbers 47 or something like that, it doesn't mean a lot, but it means something if you're looking at like the trajectory of it. 'Cause then you're basically saying, if I am trading off profit, I do want to at least show more growth. - That's a great point. I mean, I guess what he's essentially trying to do in Oswa, kind of accounts for this in software companies, but I readjusting R&D spend as a capital expense and then amortizing it and then getting an adjusted return on invested capital. I think maybe Mark Leonard didn't want to get that arcane and just said, hey, this is kind of a good proxy for these are the benefits that we're getting through investing through the P&L. - That's good. - That was a good answer. - Yeah, yeah. I mean, and people talk about the rule of 40. And so it's kind of similar to that where you're just adding a growth rate, revenue growth rate, and margin. He's doing the return on invested capital, so it is a little different instead of the margin. - And so, all right, that was just a little sidebar. I had to get that off my chest because it bothered me and I think you had a good answer. And of course, and investors are always gonna have to question, how effective is consolation going to be at deploying ever increasingly large amounts of cash flow into deals? And what's been interesting are these topicus and lumen and/or lumen transactions. One thing that's guaranteed on the show is true and I are going to mispronounce words, but these two recent spin-offs are interesting case studies. And I'd love for you to kind of take the listeners behind the rationale. Of course, the accounting, and it's funny, you mentioned the revenue numbers and how that's can get a little confusing. And you had a pretty in-depth consolation update where you went through the nuances of the accounting which are not intuitive. And I'd have to say I have to relearn them every time I go and look at them because they definitely do not stay top of mine. But yeah, why don't we just start high level? Why does consolation do these spin-offs? - Yeah, so there's really two main reasons why consolation is doing these spin-outs. And we go into more detail in our full speed while report on topicus and in the update that for members only on lumen. But very generally, the idea is they wanted to deploy capital in a way that probably wouldn't have happened otherwise. And so in the case of topicus, originally, there was an operating group called TSS total specific solutions that had a family office that was the controlling interest there. They acquired a majority interest of that. And later on, then they merged it with something called topicus, which was another European vertical market software entity. They did this sort of spin-out merger together. And so the idea behind that is not only was the family probably not willing to sell the whole thing, but also it allows the owner operators to still have a stake in the business so they're better incentivized. And as we talked about earlier with consolation software, all the employees do buy stock using their own cash, their own income, it's not like they're given stock in. So part of that idea is they really want to properly align them and incentivize them. And so I think these spin-offs are also, in part, an experiment to see whether or not they're going to be better aligned, better incentivized. If they're buying stock in an operating unit that the employees have more control over the actual outcomes versus a conglomerate, which can get a little unwieldy at times. And so that's just kind of high level to get into a little more detailed constellation bought TSS in 2013. And as part of that original purchase agreement with the owners of, it's the Stripe Worder family office, I believe it is, they retained a 1/3 stake. And then later on, this is now in 2021, 2022, they go ahead and acquire Topicist. They merge them together. Topicist started in 1998. And it is also similar to consolation, a conglomerate of all of these different VMS companies, but it is European-focused. And so one of the differences between constellation and Topicist is that in Europe, there's a lot more regulation, and a lot of regulation happens in line with each country's borders. And so you see that these vertical markets are, in some cases, even smaller. And so the analogy sometimes used is that, imagine if every state had its own sort of regulations and required its own software offering. And so instead of it being a vertical market software offering for the whole US, it would just be for a state for even a smaller market. And so that is part of the reason why it's thought that these businesses are even better, just because the terms are now even smaller, less likely that competition is going to come in. Also, the regulation raises the barriers to entry, as well as the likelihood that someone's going to want to switch a solution. On top of that, another reason why they bought Topicist or why they did this sort of merger spin out with Topicist is they wanted to learn lessons on how Topicist has been able to grow more, because they've had a higher organic growth rate than constellation. And so part of the impetus was the belief that if we were to acquire them, we could learn possibly on how to reinvigorate constellation software's organic growth. Now, if you look at what their maintenance growth has been historically, and again, maintenance growth, this is the 70, 75% of revenues, which is kind of their key metric on the actual health of the core business. That's going to be all the recurring revenues, the SaaS revenues, that sort of thing. And that has been kind of in between zero to two percent organic growth for many years, and not a lot of growth there, very minimal. But more recently, since 2023, we're actually starting to see 5%, 5%, 6%, a year of a year growth for the last three quarters, which is encouraging that they have actually taken some lessons from Topicist, and that has allowed them to raise their organic growth rate. Now, is part of the transaction with Topicist? Constellation retained a one-third stake in Topicist, as well as has a right to acquire another roughly third stake, 30% stake, from the Jody group, which owns 30%. And now, this creates a lot of distortions in Topicist's financial. So if you are looking at Topicist, you have to be aware of this. There's the basic share count, which is materially lower than the diluted share count. And the reason for this is because the Jody group doesn't own ordinary shares. They own these sort of units that can convert. And the other byproduct of this accounting treatment is that there's a very large NCI now that backs out free cash flow available to the shareholders, which is a metric we'll touch on in a second, that Mark Leonard sort of created, to look at consolation software. And so this is an important point, because if you are looking at either the basic shares, then you're not getting a correct understanding what the real market cap is. And if you're not backing out the NCI, and you are looking at the diluted number, then you're not giving them full credit for all the free cash flow there. It's a confusing adjustment. We talked more about it in the report. I recommend you read that if you're interested in that. Yeah, and it's to be fair. I mean, they even had a selected investor questions received press release about the nuances of accounting behind this. So don't feel bad if you're confused, because a lot of individuals were confused. And I just want to jump in with two quick questions there. One, which is when Mark Leonard and Constellation are focusing on this maintenance growth revenue number increasing, where is that growth coming from? Is it they're upselling new add-ons, is it new users? Is it price increase? What is driving a lot of that growth? Yeah, no, that is a great question. And it is part of the reason why the maintenance growth revenue line is so important, because it is the best parameter of the health of the business. And the reason why that is is because we don't actually know what, at least not anymore, we don't actually know how much is coming from price increases versus churn, versus building out new products and cross-selling those to existing customers. So they used to publish this table until 2015, where it would talk about how the organic growth is calculated. And there was four different pieces of that. There was new maintenance growth. There was price increases. Then there was loss customers and loss modules. And the idea there was you could actually see whether or not it was just the case they're raising jacking up prices on the customers, or if they are actually getting some new customers coming in as well. And of course, one of the criticisms-- and we haven't gotten into this yet-- but this is one of the criticisms that you'll get with consolation software is that they're buying all these dying businesses. Their customers are churning off. They're jacking up the prices on them as much as possible, which is going to just further lead to customers churning or looking for other solutions. And so you're kind of running it like a very aggressive private equity company that's just trying to ring out the last dollar of cash flow. And they're not replenishing the business with new customers for future growth and longevity of the cash flow. However, if you do look at the numbers before they discontinue them, you do see that new customers coming in does roughly offset churn. It doesn't totally, but it does roughly. And then plus price increases is where you're getting all of that growth from. And so it is true to an extent that most of these tams at the vertical market software is our focus start. They're not very big growing tams. And it is generally the case that customers are not being added at a very fast clip in some are churning, going out of business and all that. And so there is the fact that some of that is being covered up by price increases. But it's not entirely that there still is some new growth, some new products. They are still adding stuff. All that professional service revenue is done basically getting paid to create and customize new products for customers. And so to answer your question as to where that growth is coming from, it is coming from, I would say, mostly price increases to a smaller extent units, new customers, new products, and then offset by a good amount of churn, which last they published it, your churn was you were looking at about 7% a year. - And you know, one interesting insight as we're talking about organic revenue growth and Mark Leonard talked about this, which is, when he's looking to build out new modules or new kind of features within the software, he always has this rule, which is, don't build it unless they're going to pay for it, right? And I think that's a big thing about like saving R&D dollars, because I think a lot of software companies will go and they'll just really nearly build things out. And by the time you're done as the end user using this, there's 500 features that you haven't even thought about using, he's been all these resources deploying them and there's no incremental return on those. And so that's just one interesting thing I thought of as we were talking about organic growth. I don't know if he would comment on that. But I mean, it's true that he does focus on only spending money where people believe they will be willing to spend money in return. And so he had that whole discussion about saying, you know, if someone really wants something, we kind of bucket it in three areas. Are they willing to pay up front for it? If they're willing to pay up front for it for us to do it, and we'll do it immediately. If they're giving us sort of like the soft commitment, then it's not that interesting. And if they're waiting for us to go and build it to decide, then we're probably not gonna do that. - And you know, just kind of speaks to the whole capital discipline, nature of constellation, which isn't, you know, isn't build it and they will come. It's very much, do they want it, we'll build it. But anyway, we digress. I mean, so we're getting back into the intricacies of the Topgis transaction. So constellation software, we left off the own of third, the Jode group owns a third, which is this, which was the selling family of Topgis, right? They retain, so technically they've retained two thirds or who actually is a Jode group. We still has that right there. - Yeah, so constellation group outright has about 30%. Jody group has about 30%. Then there's another player that has about 8%. I'm not gonna try and pronounce that name. And then the rest of it was spun off and distributed to the constellation shareholders. And the Jody group is who there's this weird like putt call right between constellation and numb. The valuation changes every year according to free cash flow. Other metrics as to what they have the right to sell or buy it at. And because of the change in valuation, that actually flows through the PNL and they make an adjustment for it, assuming as if they actually spent that money to buy it. The problem with that is though, it's gonna reduce your free cash flow amount. And then if you're putting a multiple on it, it's assuming you're basically spending that money every year because you're putting a multiple on an expense. And so you're basically capitalizing it. So that's erroneous. And so what we do in our report is we do back that out because if you are paying for that, you're only gonna be paying for it once. And so not really a true like ongoing capital expenditure if that makes sense. So has there been any indication of when constellation is going to act on this call or is it just kind of in limbo when they feel like it? I mean, because you know, that's a good way to deploy some capital. Yeah, you're testing my memory here. I have the correct date in the report. I believe they have until the 2045. So it's long term, she thinks long term. So anyway, as we were talking back to the Topi Group, so they have a third, they have the right to purchase another third from the Jode Group. And the other third is kind of more or less outstanding with constellation shareholders and in Republic float. And as a follower of constellation, do you kind of follow individually Topicus as well? And Lumin, do you think that that's kind of pertinent for someone interested in constellation software? Or is it similar enough to where you don't necessarily need to be following each of these companies individually? Well, it's an interesting question because to a large extent when you're investing in constellation software, you have no idea what these businesses do. Like the actual specific businesses, you have ideas about their characteristics and you could look some of them up and kind of check out exactly what the software offering is, but you know, there's hundreds of them. And so you don't know. So it is very much that you are trusting Mark Leonard, his team and their capital allocation decisions. And so if you own constellation software to the extent that they also own Topicus and Lumin, it makes sense that you wouldn't necessarily need to vet their decisions for them. And if you felt that you needed to vet their decisions for them, then maybe you shouldn't be invested in them in the first place. And so you could have an argument either way about that. Every time we have done an update including in the regional report, we did just go through them because if you're giving us financial disclosures, we're going to check them out and see what we could learn from that. And so we do still touch on all of them. They are pretty similar businesses as far as everything we've read and can tell with the exception that Topicus is a little bit higher growth. And we'll talk about Lumin in a little bit and why that one's a little different too. - Yeah, I think I just wanted to throw that out there because sometimes I was thinking of Brookfield Asset Management, which Brookfield Asset Management has like 10 different public spin-offs that they have. And then I remember one time looking at them and I was like, oh man, I'm going to have to figure out what each of these do and are the material to the business. And so sometimes it's challenging to wrap your head around all these interconnected pieces. But so far, they only have two, which is good so that they are manageable. So Topicus, I think we touch on pretty well. I mean, they have vertical, very focused in Europe, very proficient at maintenance growth, pretty good modes in terms of not only do you have the vertical market software advantages, but now you have the regulatory component, which also is kind of going to shield competition as well locally, which is pretty attractive. And then this was kind of a test for them. - I'll just give you some numbers 'cause I don't think we touched on any numbers, but Topicus, you're looking at about a $10 billion market cap for free cash flow. It depends how you analyze it. Our estimate is roughly around 200 million right now. And then in terms of revenues that you're looking at about 1.1 billion LTM. - Okay, yeah. And so yeah, definitely a sizeable business and growing pretty aggressively. It's a sizeable business. And yeah, definitely something to look into. But it was kind of the test run for this new form of acquisition they were doing. You're right, it allowed them to kind of get their foot in the door with Topicus, probably not something that they were going to have been able to do if they didn't pursue this structure. And now we just recently saw them kind of follow up a very almost identical structure, I would say with Lumin group. So you can see that this is something that we might see a lot more of. So for all those individuals who were hoping that there wouldn't be too many spin-offs to analyze, I think that it might be trending in the direction of-- - I think it's the opposite. I think the constellation followings love the spin-offs 'cause they usually sell off 'cause of some sort of institutional imperative that they can't hold something for some reason. And I think people like that. - And of course, yeah, Joe Greenblatt's book, he was all about spin-offs and looking at things that were kind of forsaken by maybe the institutional investors. Maybe the constellation people will love the continued spin-offs. But anyway, let's talk about Lumin group. So that would just happen. Similar structure to Topicus, is there anything kind of incremental to say about that or maybe give us a quick overview? - Yeah, just real quick. So the Valerus operating group spun out a collection of the MS businesses called Lumin. Lumin then went and acquired wide orbit in a $490 million transaction. And this is another scenario where you have to be careful with the kind of structure of the deal because if you are not, you will think the market cap is much smaller than it really is because all of constellation share holdings are in the form of preferred shares. And so you have to make that adjustment that they convert into common shares in order to get a proper understanding what the market or what the enterprise value is. And so that was a mistake I've seen some people make. Roughly speaking, if CSU exercises everything, they have about a 61% ownership stake, existing holders of constellation software got 25 and the rollover group of wide orbit got the other 14. And so that's just kind of high level. One thing that is difference about Lumin versus the others is that they are industry specific. And so they focus on global communications and media industry. In the update, we talk more specific about some of the businesses and all of that. But you could also just go pull up their 20 off and learn more about that. It is perfectly on the line of somewhat informative and ambiguous in terms of exactly what they do. And so we won't get too much into that, but it is important noted is an industry specific vertical. So you'd expect them to go after more companies within that vertical. - Yeah, you know, every year, you definitely have to wait with baited breath for the annual general meeting because you get a lot of good information out of there. And you kind of have to, you know, so with the disclosures and the limited stuff you kind of can get from them. But, yeah, I mean, the topics and Lumin transactions and also, I'll briefly mention all scripts. It was kind of one of the other large acquisitions. They did this whole topic we wanted to talk about was the deployment of cash flow. Because again, in any business, right? You are making some type of inferred calculation that this business is going to be able to invest excess cash flow at some high rate of return. Usually that's kind of obfuscated by, oh, well, they have to build a factory or they have to build a plant. Well, this one's really clear and it's funny when Drew and I were doing the university CF, we were just like, well, they just have to deploy this amount of dollars at this, you know, return on Vesicapital and like, they'll be fine. And we're kind of like, well, that's every business, right? But it's just funny that this is like, their business is investing. So you're investing in them investing. But talk a little bit about how have they been deploying free cash flow, how big of a concern should this be? And what are some positive developments that you've seen where they've been able to take this larger excess cash flow they've been doing and demonstrate that they can step up to the play and do some bigger deals at some attractive IRRs? - Yeah, I think what we've seen with free cash flow and right before we get into it, Mark Leonard likes to use this metric he calls free cash flow available to the shareholders. You can go pull up any of the reports, you'll see the adjustments he makes. We use his numbers with the one exception that we do think that IRGA liabilities should be backed out because again, that's like a one-time payment then they'll own that cash flow. It's not really an ongoing thing. So if you're putting a multiple on that, it doesn't make a lot of sense to me at least. And so with the exception that one adjustment, everything else I'm fine with in terms of the free cash flow available to shareholders number uses. And so if you're looking at actual numbers, so let it be known Drew Trusts, Mark Leonard's adjusted figures. This is not a community EBITDA like we work. This is a cash flow number. - I will say there's surprisingly few people that run a business where you're actually like, this is a metric that makes sense. (laughing) So this could even be like operators who really trust and think are great and they're still putting out some funky numbers. But anyway, if you're going back to 2017, you're looking at them doing about 225 million in free cash flow. And then if you're looking at acquisitions for that year, it's only about 50% of cash flow was being deployed to acquisitions. And so then you pass forward to 2019. And there's about 580 million in free cash flow and about 100% of that's being deployed into acquisitions. And it's at this time, we also have to make an important point, which is that constellation did a $20 special dividend. And when they did this $20 special dividend, the idea was basically we have too much cash on our balance sheet. We're not going to buy back stock. Mark Leonard has some trepidation with buying back stock, thinking that he is kind of ripping off a shareholder's because he's going to always have more information than them. Although there's some disagreement that could change in the future, although at current valuations, it doesn't seem like they're itching too much to buy back stock. But anyway, his decision is basically hold the cash, distribute it, or hopefully wait for a larger acquisition, except they're generating so much cash. He decides to do a $20 special dividend. And we talked about this earlier, kind of how the capital allocation policies shifted a little bit. That kind of receded some of the shifts and focuses on these larger acquisitions with a little bit more debt, with possibly a lower hurdle rate. And so that's around 2020 COVID kind of hits. And so acquisition activity wasn't as high. They generated about half a billion in cash, only deployed half of it though. 2021 is where things started to get interesting and turned. And for 2021, 2022 and LTM, we see that they've actually deployed over 100% of free cash flow on acquisitions. And so this might seem a little weird, except if you're thinking about them going out and acquiring a company, and if they're also using some debt on top of that, then that's why this number can sustainably stay ahead of their actual dollar amount. 'Cause we're not looking at the equity, we're looking at the total value of the acquisition. And so either way though, as long as this number continues to be quite high, they're deploying all of their capital into these acquisitions. And if the hurdle rates continue to be sufficient, and we sensitize around different rates in our report on the reverse DCF, we sensitize around different ROICs and different capital deployment scenarios. What if they only deploy 50% and that drops to 20? What if they deploy 100% and it slowly drops? And so we can actually see exactly what the implied return is if you own the entire business over time and were in under various scenarios, what that would look like. And so that's in the reverse DCF in the report and then also in the update, we updated it. But big picture, it does look like they've been able to deploy capital better than at least I would have had as a base rate expectation. And on top of that, it is encouraging to see them kind of step into some of these larger acquisitions. They had the all scripts or all terror acquisition for 730 million. They had optimal blue, which was a mortgage origination software for 700 million, that another larger one called in power, another loan origination system. Those last two are kind of interesting because black night was merging with ice and they basically thought antitrust concerns. And so two of the key assets they ended up divesting to constellation, which I'm not sure why they went through with that one anyway. But nevertheless, good deal for constellation shareholders. You'd love to see a four-seller there without a lot of buyers. And so the fact that those have happened, you gotta wonder whether or not they're gonna continue to have these sort of opportunities going forward. And if they do, then perhaps the reverse DCF that we have may even be a little conservative because we sensitize around zero and 2% organic growth. But as I mentioned, past at least three quarters, they've been closer to 5%. And so if that continues to, that is another source of value. And so an investor needs to make a judgment on these three key pieces of information, what they expect the acquisition deployment to be, the hurdle rates going forward, as well as the organic growth. And so if you could get comfortable with reasonable assumptions there, then you could see how that looks in terms of your return. - Yeah. - I mean, the one thing that you'd have to be concerned about is what are your return on invested capital assumptions? I mean, you know, you can look historically when they're putting these four, five million dollar deals, are you gonna assume there are OICs coming down, especially on these deals? Or are you gonna assume that, hey, because they're using leverage, the return on equity is still somewhat similar. But that is definitely a concern for investors. And it would be hard to measure whether those are gonna work out in the present day. Obviously, you have to look back forward several years and say, "Hey, are these gonna come down a little bit?" But you really have to trust in the apparatus and the deal making and in the discipline that they're not going to be putting capital to work at unacceptable rates of return. And it's not even unacceptable. That's the problem. It's exceedingly high record term. - It'd be very acceptable to anybody else, but the consolation into what, and again, you can look at diversity, see how far it's priced in, but you need them to be killing it essentially on every deal they do. And so, what are your thoughts on that concern? - Yeah, it's a valid concern. Mark Leonard would say, we still don't even know about 70% of the VMS companies that are sold in a given year. So we still have more room to just get a more granular database, have more relationships, bid on more companies. On top of that, there's 40 to 70 VMS companies sold in a given year. We've only purchased fewer than three of them, at least as of a couple years ago. And so, they are kind of suggesting there's more opportunity here for another inning. And on top of that, there's no assurances. They only stay just in vertical market software. Mark Leonard kind of surprised everyone at the AGM, and I believe it was 2022, when he talked about in the prior year in '21, when oil prices were so cheap, they were looking at buying some oil assets that had some sort of attractive tax assets associated with them. And it just kind of shows that he could be thinking more broader and could steer constellation into a potentially a new area, if he believes that makes sense. And so it is a little odd as an investor where you are trusting Mark Leonard completely, but their whole history is only in vertical market software. And so if they go out and buy an oil asset, how are you going to feel as an investor? Are you going to still have the same level of trust in him? Or are you going to start to wonder whether or not that is a sign that they're running out of runway? And so I think that is something an investor will need to answer for themselves. Yeah, and I would caveat not only, you know, just trust Mark Leonard because at this point, I mean, it's definitely you're trusting an instilled culture. It's kind of like, maybe this is too extreme, but Berkshire Hathaway, I mean, can you trust that the machine that Warren Buffett is bill will persist after he's gone? I think, you know, the market probably thinks so otherwise. If you're thinking everything's going to go away and he would go away, I think it'd be at a bit of a lower market value. So, I mean, one interesting thing, we didn't really put in a numbers to return on an investor capital, I don't believe. Can you touch on what they've historically returned and then what you sensitized around in the DCF? I mean, what does an investor need to suspect? And then of course, you know, it kind of reminds me of our evolution discussion when they were running 60% operating margins. You go, man, how long can that be sustainable? Is there going to be some reversion to the mean? And of course, that's always the question, like how long can great companies sustain greatness? And that's one question definitely need to be answered. Yeah, in terms of their ROIC, you're looking at roughly like a mid 20% return going back at least a decade and somewhat higher before that. And part of that too is the IRGA liability has dropped it a little bit more recently. I will stop talking about the IRGA liability starting now. But you are looking at a pretty strong 20% plus return on an investor capital. For many years, you're looking at closer to 30, though, or at least a mid 20s figure. And then in our reverse DCF, we were sensitizing around a starting ROIC of 25% and then having that fade. And that was in one scenario. Another scenario was 20% and another was 15. And we were having these ROICs fall in accordance with the size of annual acquisition spend. And so as they were spending more and more on acquisitions, we just assumed the ROIC would fall down. And so in terms of how much they spend on acquisitions, our first scenario is 100%. And we have an 80% and 50% of three cash flow spend. And then that also starts fading off over time. In our most, I guess you would call it, draconian scenario. We have them spending just 50% of their free cash flow, which then drops only 15% by time free cash flow exceeds 15 billion, which it sounds like a lot now given their out of 15th of that. Except if you do a reverse DCF, you're doing it out until 50 years, 60 years. And I believe ours was 50 years. And that may seem a little long and far-dated to do this out. But of course, when you're buying a stock at 40, 45 times earnings, you're assuming this company is going to be around for a long time. You can make implicit what your growth rates are in a perpetual value formula if that makes you feel better, but you are effectively paying for a very long duration of cash flows in order for this to really make sense for the investor. And that's just mathematics. You know, and of course, in the way I was looking at it, you start looking at the numbers, you know, you're 15, you're 16. And you kind of, the way I'm thinking about it is like, you see these large mega private equity funds, they'll raise, you know, 15 billion dollars and they'll lever it all the way up. And again, I mean, I'm not going to compare Mark Lender to the, you know, blackstone giant private equity funds. But you see those guys' returns, even with the amount of leverage they're using and you kind of go, man, they're going to have to deploy that every year for a very long time. And you can see how you should have some caution, a little trepidation about that. But I think we're coming to my favorite segment that we just started on evolution. We're going to do a bear case, bull case, with Drew, because we've talked about a lot. So let's start, you know what? Actually, I'm going to take that back. Let's do risks first, and then we'll do a bear case bull case. All right. And then, so let's go through some of the risks that you outlined for consolation. Obviously, I've been talking about more of the, how to put investor risks, right? Which is consolation as a business will probably be fine. But if you pay up very high price for it and they, you know, fail to deploy at large amounts of capital at high rates of return, then you'll probably have a bad time as an investor. But the business will probably be fine. Talk about some business risks. What could actually go wrong fundamentally with them? Yeah, I think the, the most boring one is, of course, they're just deploying capital at a lower ROIC. They're doing some of these big acquisitions that don't work as well. That's problematic. They lower their hurdle rates again, because they wanted to deploy more capital. This is maybe a little different is the high stock price could erode their comp system. If they are telling their employees they need to buy stock in the company, and the stock price continues to go up. Maybe at some point, they feel like that's not fair for them to do that. Or maybe at some point, it just doesn't work as well. If the stock price drops a lot, you get a bunch of employees that are incentivized, and then you got to either figure out another package for them or potentially they'll churn, and that's not great either. And you've got to feel psychologically, it's kind of like, you know, you're trying, you're forced to buy back the stock for these herculean assumptions. And you're the one on the ground who's like fighting and trying to get into these VMS deals and deploy at these high ROICs in the markets. Like, yeah, we expect that. Like, you're not, like, that's what you're supposed to be doing. Yeah, I could see how I could get a little, get a little disheartening. Yeah, and then another one could be just more competition, more consolation software. Copycats, going after their acquisitions, stealing their playbook. Another one could be, you kind of get another like VC bubble, and so a lot of money floods in to a lot of SaaS companies that start investing on economically. And then you're, you're having a compete against that. And another one could be Mark Leonard or other top management leaves in culture starts corroding. Essentially, they invest in new markets, and these new markets don't go as well. Or you could have something a little more at a left field. Maybe there's a cyber attack that hits a bunch of their companies, and the huge liabilities they got to deal with for a long time. And maybe that's also a huge turn event. And maybe there's something in there with AI. If AI is able to write and create its own software, I'm not banking on that one, but that is perhaps a risk there. Well, he's getting creative. But you know what I like? I like when Drew has to get really creative with the risks. You know, you can kind of, he's racking his head. He goes, you know, "Oh, AI can write new chicken coop software. We're in trouble." Yeah, you know, definitely we are. One thing I want to not push back on one of the risks, I just wanted to look at from an evidence standpoint, was obviously, you'd say 2021 was some of that VC bubble, you know, all the kind of zero rate environment. I mean, did you, there wasn't really evidence of them struggling to deploy capital. I mean, I think in the AGM they brought up that they're working out a bit, but they still, you know, put money to work in it, right? Yeah, it was actually more an issue in like 2015, 2016. I think when there was more of these SaaS companies, that's when they started talking about it on the calls when there was a lot of money. And so maybe I don't know if there could ever be another sort of cycle like that with those companies or it could be played out, but either way, that's a short term sort of distortion. Right. All right, so you know, we gave the people the risk. I think we've gone through some of the, you know, the risks as much as Drew could be created with him. I think there's always a new segment I'm going to like to end the show on, which Drew might hate because he just got to rattle off a lot of facts and that we only do one take on this, so we better get it right. But we're going to do bear case bowl case, all right? Take me through what it, what am I, if I'm an investor and I'm gun hell and I want to just love this company out. Tell me why I should love it. And then, you know, if I just sold it yesterday, you know, why did I do that? I mean, the bull case is constellation software continues to deploy capital at a high ROC and the bear case is it doesn't. (laughing) You're right, you know, there you go. Bear case, bear case. No, don't deploy cash flow bowl case, they do. Yeah. I know we're not done until we get a vein in my forehead. So let me go out. Yeah. All right. If you're looking at the bear case, you're looking at a company that's trading at roughly a 2% free cash flow yield. And so the question as to why you would pay that is because you really expect them to continue to deploy capital at a very high ROC for a very long time. But now you are in an environment where people not only understand their playbook but are actively copying it. And you're not only getting that from copycats that try to copy the conglomerate model constellation software, but their very own employees are now leaving. And in some cases are either starting their own copycat firms or starting their own startup. And because you have very high expectations for not only what their reinvestment rate is going to be, but for how long that reinvestment rate is going to occur. And so when you're looking at a company like constellation, and if you're doing the math out, you are expecting they'll be able to deploy tens and tens of billions of dollars over the next several decades in order to rationalize their terminal value while simultaneously not reducing their hurdle rate. And of course, that gets much harder when there's more and more copycats coming into this area. There's more people that are aware of what, not only the attractive economics of vertical market software, but the attractive business that constellation it is in and are more actively competing against them. And in fact, constellation employees are now being hoached sometimes to go to these copycat places. And on top of that, you also now see that as they will get up into more middle market in these larger acquisitions, it's going to be a much more competitive bidding process. They'll be bidding against private equity companies in some cases where they will be more than happy to accept a much lower hurdle rate than what constellation will offer. So ultimately, you're basically expecting that they will be able to continue to deploy ever greater amounts of capital capital that will reach tens of billions of dollars in a couple of decades every year and at adequate ROIC's. And this is coming from roots of really only deploying $5 million on average in an acquisition. And so you are really betting on a transformation in this company and a transformation in their ability to continue to allocate capital in new ways. - Okay, no breaks, just get right into it. - Okay, what case is that you are looking at Mark Leonard, someone who figured out not only a very idiosyncratic way to investing capital multiple decades back, but has been a good harbinger of culture while also simultaneously transitioning dumb and you see evidence of this and the fact that they have moved from the small VMS acquisitions into these larger ones. You could look at the deal multiples implied a couple of years out and you see that they are able to get at least so far, successfully these large acquisitions and deploy ever greater amounts of capital. And you also see now that with their size comes the ability to issue these sort of debt instruments. A decade back, Mark Leonard is talking about this kind of ideal debt instrument where he's always gonna have more flexibility and ability to defer interests if necessary. And now he's actually getting the ability to get these sort of financial instruments that will help them leverage their returns and potentially take them into the next inning. That alongside now getting the scale where they can now go and take down some of these larger deals. As you noted, they're 40 to 70 of these a year and they've only done three of these deals so far. And so you don't need to assume that they're doing too many of those to see that they do have a much longer runway and capital allocation. And of course, you also can't put it behind them that they may also find a new area to invest in. It doesn't necessarily mean that they will continue to leave vertical markets off or but if they find another sort of venue that can also give them attractive returns, then you could see that this model could last for much longer than previously thought. And then in terms of the actual businesses themselves, the VMS businesses, we know that these are very high quality businesses. You have not only recurring revenues and a product that can very often not be replaced, not only is it mission critical, you have the pricing power there. And on top of that, you usually don't have any sort of alternatives. And so for many reasons, the VMS companies are pretty hard to compete against. And so even if you do see that they're not able to deploy capital as much as they thought or as high as a rate of returns that they previously thought, you could still see that their existing businesses will at least help return at least a somewhat adequate scenario in sort of a downside. And so that is all to say that they do have to continue to form and all of that, but they've had nothing but a track record and history of performing and outperforming expectations. - Someone gets this man an oxygen tank or something. I don't think he took a breath in the last three minutes, but man, was that in, I mean, you know, you, it's also like I want to stop doing these because if you listen to those in the next seven minutes, I mean, you know, those are pretty good synopsis of the synopsis. So yeah, we might be, we might be putting ourselves out of a little discussion here, but yeah, I think this is a really informative discussion. Of course, you can always find the long form research report as well as the Excel models at speedwellresearch.com. They're available to subscribers for speed well subscriber plus. You can get the Excel models or the underlying research report drew anything, you know, you'd like to add before we head out. - Yeah, I think just when you are thinking of constellation software generally, it is a very interesting business because, and we've hit on this a little bit, but it is very much you are trusting them to continue to make good decisions and exhibit good judgment. And so in that respect, it is very similar to a Berkshire perhaps even a Marquette where it is somewhat an investment management company that you are invested in. And so we understand their existing businesses and we could have confidence in the lower bound on the quality there and what the earnings generated there would be, but to the extent that the future is highly predicated on them continuing to acquire these new companies and transition to this larger model, it is sort of a bet that they will be able to do something that they haven't quite been able to do yet and at a larger scale and at a continually larger scale than they have before. And so it is somewhat running up a treadmill that keeps getting higher and higher, but they have also executed very well in the past couple of decades, but that's not to say that expectations could be the enemy of good results. - All right, you're, I mean, let's just break it down. Here's this, bye. (upbeat music) (upbeat music)