Constellation Software Competitive Risks

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I imagine that's a sleepy bunch?

Constellation focuses on a great segment of the market which is niche businesses that are typically later stage. Because it's a full buyout without any further liquidity event for management, it self-selects the type of assets Constellation invest in. In our environment, there is a five-year exit horizon and, as a result, you can align the management's incentives to drive towards that exit.

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Constellation did 134 acquisitions last year; how long can that continue?

I've wondered about that for many years. I was talking to an auditor, in 2012, who told me it couldn't go on forever. While interest rates have been low recently and people were doing stupid things, the pace of new company creation exceeded acquisitions. I don't have exact numbers to prove this but that's what I feel. The database of tracked software businesses was increasing every year up until the time I left. We weren't scrubbing the database clean but it was in the hundreds of thousands of companies. Maybe a third of those weren't a great fit, but the number was growing, not shrinking.

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What are the risks of this model or process besides some obvious ones? Running out of targets won't happen and the execution seems to be nailed down firmly.

Things are getting more competitive, and there's a question whether other competitors will accept a five percentage point lower hurdle rate than Constellation. If that is acceptable, it becomes a race to the bottom. Constellation have a strong enough reputation and they have the capital, which attaches a premium to selling to them, but that only lasts so long. There could be a lowering of returns over time. Another risk is the quality of software businesses Constellation buys, which has declined on average since I was there. That doesn't show itself in the first few years; it shows up much later. These are businesses with antiquated legacy software with a handful of customers, which is like buying an annuity stream or a mine which gets mined dry over time. The risk there is their organic growth rates are not great. If that turns negative at some point, it will be a challenge to manage.

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