Dividends are usually viewed by management as sacrosanct. Except at Constellation Software Inc., where Mark Leonard, the company's CEO, just told his shareholders the quarterly payout could disappear at any moment.
Constellation is an acquisition machine, so it might need the money for a purchase, Mr. Leonard said as the company announced earnings.
The company has dozens of companies under its umbrella, largely serving corporate and government clients' specialized needs. It is seeking 20 to 30 purchases in 2014, and if that happens, "it is likely that much of our free cash flow from operations will be consumed," he told shareholders. Any recession or economic upheaval could also create opportunities, and those tend to be bigger than Constellation's usual bite-size purchases and come when raising capital can be tough.
"Under either of the above scenarios, we would not hesitate to reduce or even eliminate the current quarterly dividend," Mr. Leonard said in his dividend announcement. "Our sense is that our shareholders have confidence in Constellation's abiity to deploy capital at attractive rates of return, and that the majority of them would support the elimination of the dividend if other attractive soruces of capital are not readily available."
On the company's conference call Friday morning, Mr. Leonard amplified his thinking, saying he is "torn" on the issue.
"Finance theory says if you need the cash and you are paying a dividend and there's no transaction costs, it's a legitimate place to go and raise capital," he said. On the other hand, he feels "this obligation" because the dividend the company instituted two years ago is one of the things that has since attracted shareholders.
Analysts took notice. "While we see being opportunistic acquirers as a positive, a potential dividend cut would be disruptive for certain income-driven investors," said Blair Abernethy, an analyst who covers the company for Cantor Fitzgerald.
Realistically, though, it's hard to see shareholders getting too angry with Mr. Leonard if he wants to funnel the cash into a purchase. Yes, they would miss the $1 per quarter per share. But considering the stock has risen by about $200 per share in the last three years, the real money at Constellation comes from capital gains.
The reason the stock is on such a roll is Mr. Leonard's ability to acquire on good terms. He looks for small software firms, often family run, that he can buy. The returns on his purchases are stellar (so much so that in 2012 I called him my "acquiror of the year" in this column. )
He said he wants to continue to focus on smaller acquisitions as long as he can, because it's a more attractive business model than large acquisitions that require leverage to reach necessary returns.
"We're going to keep acquiring a lot of small businesses. I wouldn't see us touching this large leveraged transaction model until we have exhausted the small businesses."
He said he doesn't really have a good sense of how the M&A pipeline is looking. Big transactions tend to pop up unexpectedly and small ones have proven hard to gauge in the past.
Mr. Leonard said he would like to see the rate of acquisitions rise to 50 a year. If that happens, or a large target appears, shareholders may have to give up their quarterly cheques.
"What I wanted to do was signal to shareholders that the dividend is always up for consideration by the board. If we were to stumble across an attractive acquistion in one of our key verticals and needed the capital, we would sacrifice the dividend, absolutely."