Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.
Analyst 1: With Constellation, most of us are in it partly because they are a great capital allocator. At first glance, seeing that they had deployed that much capital, my reaction was very positive. Getting into the deal, I was a little surprised that this deal, besides being the largest one they’ve ever done, is not typical in other ways, as well. The gross margins of the Allscripts business are 30% versus the 60%, 65% of where they usually acquire things; EBITDA margins of 10%, 15% versus 25% to 30%. This business seems more labor-intensive. It was interesting to look at the Allscripts conference call and how they described it. They said it had shrunk for three years, this being the third year in a row and they think it will shrink as far as they can see. Of course, they are selling it and they have mismanaged it for a long time, so I would take what they say with a grain of salt. They also said it was working capital-intensive and something about cash flows being more delayed in that business.
This is what Constellation does. They haven’t done anything this big but I suspect what they will do is will be some combination of price increases, adding capabilities to software and pruning. My initial reaction is positive. As I get into it more, there are some more things to think about because it’s not so typical for them but I’m willing to give them the benefit of the doubt.
Analyst 1: Everyone made a big deal about the multiple being 0.75 times sales, or something like that. But when you work through it a little bit, yes, the multiple on free cash, today, seems higher than what they had done. Maybe somebody else has some thoughts?
Analyst 2: I think carve-outs are some of the most attractive places to be if you have a long-term home and you have a different cap structure to some of these larger entities. Effectively, the larger corporates are always a price taker in this scenario. Let’s call the EBITDA that was reported might be 120ish, clean, pre the working capital movement because I think that just washes through in a Constellation world. Effectively, there’s likely to be at least a 20% to 30% upside, in terms of that post-operating model structure.
For a deal like this, I suspect that a Constellation would never pay anything north of a 6X cash flow metric, just to be able to get back to their 15% long-term IRR. If you were to ask me, it’s more likely to be a 15% to 20% because the entity would have been price takers, so I suspect they would have taken a discount and this is just a bit of smoke and mirrors where, in press releases, you have to tie it back to a reported figure that is auditable. When it comes to the operating model, it’s a very different scenario, in terms of the actual M&A team.
Analyst 2: I don’t think I know enough information to tell whether it’s going to be the growth topline or bottom line. From my perspective, it’s more about what the rolled-up IRR is on the capital deployed. Even with a 3% net drop in revenue, if they were able to get 20% IRR, then I’m okay with the 2% to 4% net dropping off, long term.
It’s more that I took a little bit of solace that in a previous life, having prepared PR documents like this, that go out to the external world, they can be a very different number to what is actually in the model, in terms of IRR. There could honestly be a delta of 20% or 30% between the EBITDAs reported in both those documents because one is an internal working doc; I’m sure lots of people here know that that is very normal.
Analyst 4: I don’t have any view on the specifics of the deal, per se, but when I first saw it, I thought, the size of the capital deployment, just the reinvest rate, with this one acquisition, I don’t know if it is a change in their strategy to say they are going to be looking more for these types of deals or if it was just opportunistic? They did mention that they had been looking at Allscripts and talking to them for a period of time.
One of our concerns, in 2020, was can the redeployment continue, close to 100%? You saw that it had gone down to around 60% of owners’ earnings; how is that going to look, going forward? That was a big question mark. I would say that you trust Mark Leonard to be not paying more than 6X free cash flow. If you can deploy 700 million in one shot, that’s amazing. That was a gamechanger, in a sense, for at least the near term, which doesn’t really matter, but it shows that these guys blew what expectations I had in 2020 out of the water, in terms of redeployment.
This document may not be reproduced, distributed, or transmitted in any form or by any means including resale of any part, unauthorised distribution to a third party or other electronic methods, without the prior written permission of IP 1 Ltd.
IP 1 Ltd, trading as In Practise (herein referred to as "IP") is a company registered in England and Wales and is not a registered investment advisor or broker-dealer, and is not licensed nor qualified to provide investment advice.
In Practise reserves all copyright, intellectual and other property rights in the Content. The information published in this transcript (“Content”) is for information purposes only and should not be used as the sole basis for making any investment decision. Information provided by IP is to be used as an educational tool and nothing in this Content shall be construed as an offer, recommendation or solicitation regarding any financial product, service or management of investments or securities.
© 2023 IP 1 Ltd. All rights reserved.
Subscribe to access hundreds of interviews and primary research