After a 40% drawdown, the market is questioning the M&A playbook. I believe it's missing the durability of the underlying engine, and the valuation is now attractive.
Thanks for reading and commenting! They both acquire and operate vertical market software companies, share a decentralized structure and grow mainly through acquisitions. Constellation is performing better indeed, but also with a clear premium in valuation.
My analysis is focused on Vitec's path forward from its current position. Given their small size and the long runway for acquisitions in a fragmented European market, I believe the potential for sustained high growth is significant. With a five-year horizon, my base case for Vitec is that a combination of continued earnings growth and a slight multiple re-rating can lead to a 20%+ CAGR (my target hurdle rate).
You might well be right that Constellation can achieve that too, or even more. I have not gone deep enough into CSU to confidently shape an opinion, as it sits a bit outside of my normal hunting ground.
You are also right to point out the difference in historical returns on capital between the two. To me, this comes down to a difference in strategy after they acquire a company. Constellation is famously disciplined, focusing on maximizing immediate cash flow, while Vitec tends to re-invest more into its acquired businesses to drive higher organic growth.
Vitec invests more organically, thus more organic growth
Constellation have learned that they get more back from each $ reinvested in M&A than in organic investments.
Constellation seem more willing to buy slower growth smaller companies.
Vitec only needs a couple handfill of acquisition per year to move the needle. Constellation needs closer to 100 (at least if small).
In total, Constellation has a higher ROIC, which allows it to grow at a similar rate without dilution and more leverage. On the other hand, Vitec has been able to reinvest »100% of cashflows, but this has been funded by dilution and higher leverage, which has worked out well.
The lower valuation of Vitec today comes with 1 positive and 1 negative. First, issuing stock is not that attractive anymore. Two, with their cashflows higher now relative to market cap, you don’t need that great execution anymore for decent returns
Thank you for the very thoughtful and well-put comment!
I really like the final points. The past success has to some extent been fueled by a high share price, that made acquisitions with stock very effective. Now, as you point out, that has partly changed.
For me, this is where the investment case gets extra interesting. The business must now rely a bit more on its own strong and growing cash flows to fund acquisitions, which enforces a new level of capital discipline. If they can continue to execute well during this period and become even better capital allocators, I believe the potential for long-term returns is significant.
Btw, the SaaS acquisition playbook for many - buy, hike prices, reduce staff - short term positive P&L effect is massive, but over the next 2-3 years they will see churn start to increase, competitors catching up etc.
This is a "trap" Vitec has avoided, rather valuing long-term gains over short-term impact.
Thanks a lot for this great article. I am considering investing in Vitec and for me, one of the potential red flag is the share dilution. Do you consider it as a concern ?
What makes it similar to Constellation? It cannot be ROIC, which isn’t even close to 10pc (long-term average).
I would consider it to be very expensive at +30 multiples.
Thanks for reading and commenting! They both acquire and operate vertical market software companies, share a decentralized structure and grow mainly through acquisitions. Constellation is performing better indeed, but also with a clear premium in valuation.
Isn't VITEC's valuation too rich compared to CSU?
My analysis is focused on Vitec's path forward from its current position. Given their small size and the long runway for acquisitions in a fragmented European market, I believe the potential for sustained high growth is significant. With a five-year horizon, my base case for Vitec is that a combination of continued earnings growth and a slight multiple re-rating can lead to a 20%+ CAGR (my target hurdle rate).
You might well be right that Constellation can achieve that too, or even more. I have not gone deep enough into CSU to confidently shape an opinion, as it sits a bit outside of my normal hunting ground.
You are also right to point out the difference in historical returns on capital between the two. To me, this comes down to a difference in strategy after they acquire a company. Constellation is famously disciplined, focusing on maximizing immediate cash flow, while Vitec tends to re-invest more into its acquired businesses to drive higher organic growth.
Thanks again for commenting!
main difference I’ve found between the two is:
Vitec invests more organically, thus more organic growth
Constellation have learned that they get more back from each $ reinvested in M&A than in organic investments.
Constellation seem more willing to buy slower growth smaller companies.
Vitec only needs a couple handfill of acquisition per year to move the needle. Constellation needs closer to 100 (at least if small).
In total, Constellation has a higher ROIC, which allows it to grow at a similar rate without dilution and more leverage. On the other hand, Vitec has been able to reinvest »100% of cashflows, but this has been funded by dilution and higher leverage, which has worked out well.
The lower valuation of Vitec today comes with 1 positive and 1 negative. First, issuing stock is not that attractive anymore. Two, with their cashflows higher now relative to market cap, you don’t need that great execution anymore for decent returns
Thank you for the very thoughtful and well-put comment!
I really like the final points. The past success has to some extent been fueled by a high share price, that made acquisitions with stock very effective. Now, as you point out, that has partly changed.
For me, this is where the investment case gets extra interesting. The business must now rely a bit more on its own strong and growing cash flows to fund acquisitions, which enforces a new level of capital discipline. If they can continue to execute well during this period and become even better capital allocators, I believe the potential for long-term returns is significant.
Btw, the SaaS acquisition playbook for many - buy, hike prices, reduce staff - short term positive P&L effect is massive, but over the next 2-3 years they will see churn start to increase, competitors catching up etc.
This is a "trap" Vitec has avoided, rather valuing long-term gains over short-term impact.
Interesting! May have to take a closer look myself at Vitec. Thanks for the details here
Thanks a lot for this great article. I am considering investing in Vitec and for me, one of the potential red flag is the share dilution. Do you consider it as a concern ?