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High-tech darling Constellation Software reported a rare miss Thursday, unveiling first-quarter earnings of $1.50 (U.S.) a share compared with analysts’ expectations of $1.83. (Nadezda Bugaeva/iStockphoto/Nadezda Bugaeva/iStockphoto)
High-tech darling Constellation Software reported a rare miss Thursday, unveiling first-quarter earnings of $1.50 (U.S.) a share compared with analysts’ expectations of $1.83. (Nadezda Bugaeva/iStockphoto/Nadezda Bugaeva/iStockphoto)

Constellation's hunt for buyer takes toll on results Add to ...

A failed attempt to sell itself has dimmed the lustre of Constellation Software Inc. , at least temporarily.

The high-tech darling reported a rare miss Thursday, unveiling first-quarter earnings of $1.50 (U.S.) a share compared with analysts’ expectations of $1.83.

In reaction, the stock, one of the best performers over the past year on the Toronto market, tumbled 6.9 per cent to $88.80 (Canadian).

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Analysts say Constellation’s attempt last year to find a corporate buyer for its business distracted management and led to lower profits.

“Essentially, they had put everything on hold while they went through that sale process. My expectation is that the company will more than make up for it in the second, third and fourth [quarters]” said Jason Donville, president of Donville Kent Asset Management, which owns the stock as its largest holding Constellation has been a stellar performer, with a five-fold rise since its initial public offering in 2006. A year ago, it began a review of “strategic alternatives,” usually a synonym for putting itself on the auction block. The decision was likely based upon the wishes of OMERS, the Ontario public sector pension fund that is Constellation’s principal shareholder. The sales effort was abandoned in January.

OMERS, which declined to comment, owned 34 per cent of the company at the time, and may have thought it could gain quick upside from a sale.

As it turned out, shareholders appear to have benefited from the failure of the sales attempt. Even with Thursday’s loss, the shares are up about 35 per cent from the $65.40 level they were at when the sale plan was announced. That doesn’t count the dividend, currently more than 4 per cent. Even shareholders who picked up stock in early April, when OMERS unloaded about a quarter of its stake in a secondary offering at $87.50 a share, are still ahead, albeit marginally.

The company’s fans say Thursday’s drop is a buying opportunity. “We’ll be adding to our position at these levels,” said Mr. Donville.

Constellation is in the software business, but with a twist. The company is basically an acquisition machine. It hoovers up smaller, mostly private companies that sell software catering to specific industries or market niches, such as auto dealers, real estate officers and courts. At last count, Constellation had assembled more than 100 of these corporate Lilliputians under its banner.

Small, private companies typically change hands at valuations about 30 per cent less than similar but larger public entities. Constellation profits by collecting them under a corporate banner that benefits from the richer valuation of a publicly traded firm.

There are risks in doing acquisitions, but Constellation appears to have had very few bloopers. Tom Liston, research director at investment bank Versant Partnerssays the firm is considered one of the best in the business in terms of assessing takeover candidates and integrating them successfully.

Constellation is capable of generating large amounts of cash, which it is plowing back into the business through acquisitions, Mr. Liston said. If the firm can’t find suitable buyouts and wanted to return more money to shareholders, it could double the $1 quarterly dividend.

Mr. Liston has a “buy” rating on the stock and a one-year target of $105 a share.

However, one knock against the stock is OMERS. It has signalled it continues to be a willing seller and it still owns 25 per cent of the firm.

 
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