Constellation Software: Principled, Profitable, Permanent - [Business Breakdowns, EP. 97]

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Feb 16, 2023

Chris Cerrone, a Partner and Portfolio Manager at Akre Capital Management, dives deep into Constellation Software, a leader in vertical market software. They explore the genius of founder Mark Leonard and his strategic focus on decentralized management and acquisitions. The conversation highlights the company's innovative employee compensation plans and its exceptional growth since its IPO. They also discuss the balance of organic growth versus acquisitions and the ethical considerations in capital allocation, offering fascinating insights for investors.

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ANECDOTE

Mark Leonard's Career Path

Mark Leonard was told he'd be a terrible banker and should explore the firm's clients for career ideas.
This led him to venture capital, then to vertical market software (VMS), and finally to founding Constellation Software.

INSIGHT

VMS Advantages

Vertical market software (VMS) serves niche industries with customized products, leading to high customer retention.
VMS businesses benefit from high switching costs, limited competition, and recurring revenue models.

INSIGHT

Unique Compensation Structure

Constellation's compensation structure prioritizes cash bonuses and requires reinvestment in company shares.
This aligns employee incentives with shareholder interests and fosters long-term ownership.

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This is Zack Fuss, an investor at Irenic Capital, and today we’re breaking down Constellation Software. Constellation is a conglomerate which owns more than five hundred vertical market software businesses. It was founded by Mark Leonard in 1995 and has delivered remarkable returns to shareholders since going public on the Toronto stock exchange in 2006.

To break down Constellation, I’m joined by Chris Cerrone, a Partner and Portfolio Manager at Akre Capital Management. We discuss Mark Leonard’s genius, why Constellation is the gold standard for employee compensation plans, and how the business has perfected its acquisition engine, which allows it to buy dozens of software businesses each year. Please enjoy this breakdown of Constellation Software.

For the full show notes, transcript, and links to the best content to learn more, check out the episode page here.

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Show Notes

[00:02:37] - [First question] - How Chris and Akre came across Constellation Software

[00:05:21] - An overview of Constellation

[00:08:40] - The origins of Constellations’ 30-year legacy of extraordinary returns

[00:11:57] - A deeper explanation of vertical market software as it relates to Constellation

[00:15:30] - The impressive scale of Constellation despite its niche-targeted portfolio

[00:18:04] - Their incentive structures and their avoidance of stock-based compensation

[00:21:05] - Additional ways in which Constellation stands out, relating to the Rule of 40

[00:23:20] - The barriers that keep competitors and copycats from overtaking them

[00:28:00] - The three legs of Constellation’s acquisition engine

[00:32:57] - Recent spin-offs of assets as opposed to straight acquisitions

[00:35:45] - How Constellation is planning for the future

[00:38:13] - Why they’re considering expansion towards non-VMS acquisitions

[00:40:30] - Capital allocation and Mark Leonard’s outlook more broadly

[00:43:46] - How the business reflects Mark’s nature and values

[00:47:31] - How much technology risk does the business face?

[00:50:56] - Is organic growth a concern?

[00:57:40] - Lessons for operators when studying Constellation’s story