Last month, Constellation Software (CSU) announced a $700m acquisition of Allscripts’ Hospitals and Large Physician Practices business, a top 3 electronic health record (EHR) software provider in the US. This is Constellation’s largest ever acquisition and equates to over 16% of all capital deployed since 2010.
On the same day, CSU also purchased an Australian software business with only 9 employees. We don’t know of any other listed company that has the capacity to make acquisitions on two completely different ends of the spectrum.
CSU could be at an inflection point for two reasons:
- The Allscripts investment proves CSU is serious about allocating large amounts of FCF at once even if the business isn’t growing organically.
- CSU seems to be on a sustainable run-rate of 100+ smaller, traditional VMS investments per year.
The combination of regular larger deals with a sustainable system to execute 100+ small transactions per year could market the beginning of Constellation Software 2.0.
Over the last 12 months we’ve seen a significant acceleration in FCF deployment - the question is at what rate of return?
We hosted an In Practise Investor Dialogue on CSU to explore the Allscripts acquisition and debate the growth in FCF deployment and long-run ROIC.
Not only is the Allscripts investment unique because of its size, the unit economics is also very different to CSU’s traditional investments. Since 2019, Allscripts’ Hospital segment revenue has declined ~12% and the gross margin is only ~35%, much lower than 80%+ for CSU.
This was Allscripts’ management discussing the sale:
“The Hospitals & Large Physician Practices segment has shrunk for 3 years and is expected to shrink again this year, which will make the third year in a row. And frankly, that will continue as far out as we can see. In fact, our thresholds that are tied to the earn-out targets are sequentially lower each year.” - Allscripts CEO, Q1 22
In 2022, Allscripts believes the EHR business will see revenue and EBITDA decline 3-4% and 10-15% respectively.
If we expense all R&D to align with CSU accounting, CSU is acquiring the business at ~7.5x EBITDA and 11.7x FCF before any improvements post-acquisition. On the surface, this is twice as expensive as a small, traditional CSU acquisition.
In the 2015 letter, after studying every CSU acquisition since 2004, Mark Leonard concluded the data showed no relationship between organic growth and IRR:
We have tracked the IRR for all of the acquisitions that we’ve made since 2004 (i.e. >95% of the acquisition capital that we’ve deployed). When we graph the IRR’s vs the post-acquisition OGr of each investment, there is little correlation. - Mark Leonard, CSU President, 2015
The next part of the comment is more interesting:
Based on the data, there are much more obvious drivers of IRR than OGr. For instance, Revenue multiple paid (lower purchase price multiples are better - no revelation there), and post-acquisition EBITA margin (fatter margin acquisitions tend to generate better IRR’s – somewhat intuitive, but needs further work). - Mark Leonard, CSU President, 2015
With Allscripts, CSU is paying double the FCF multiple for a business with half the typical gross margin.
This is particularly interesting to us because it seems CSU has made the first acquisition which truly relies on operational improvement to make the IRR work.