Learnings from Constellation Software Shareholder Letters
Constellation is a conglomerate of only software businesses whereas Berkshire is a conglomerate of several different types of businesses.
Mark Leonard, a famous capital allocator who created one of the biggest SaaS companies in the world. Let's dig deeper into how he did it. Although it's not so popular like Amazon, Google, Facebook, Tesla or anything else but it exists and is very familiar within the investor community.
As you proceed you will come to know about terms like Revenue per share, Net maintenance growth, ROIC, Tangible net assets/net revenue, cash flow from operating activities per share in almost each of his letters. Some of them are very familiar with the investor community, some we will learn through this content.
For me, it was an amazing study. Those who are in the SaaS business should at least study this once. Constellation is an embodiment of how compounding really works. As of today, your 1 Re would be 255 Rs over the 19 years period at 34% CAGR. It's amazing, right? It's like a manual handbook for business owners or investors.
Let's see how to make something like this. The company's main objective is to be a perpetual owner of inherently attractive software businesses. Part of a perpetual owner's job is to make sure that energetic, intelligent and ethical general managers are running their businesses and that the GMs are intended to enhance shareholder value over the long term. Their philosophy is to acquire businesses in their entirety or to own them forever.
As I was studying, I was reminded of Berkshire Hathaway's principles. It's like I was reading Berkshire Hathaway 2. If I compare both the businesses, then it would be the difference by industries only they cater to. Constellation is a conglomerate of only software businesses whereas Berkshire is a conglomerate of several different types of businesses.
Most of his letters are concerned with return on capital like in 2016 letter, he mentions that the company's strategy is to be a good owner of hundreds or thousands of businesses of growing autonomous small businesses that generate high returns on capital. 3 things that stand out here - Good owner, autonomous business and return on capital.
Initially, just after the IPO of the business, Mark guided that they would achieve 20% average annual revenue growth per share between Jan 1, 2006 and Dec 31, 2010. The target was set. Although there were quarterly hiccups, ultimately, they achieved more than their expectation within that time frame.
Mr. Leonard has always emphasized long term shareholder value creation till he was running the business. He promptly accepts the business's weakness. In 2016 letter, he mentions two factors that were causing the business's slowdown.
1. External - He mentions that the competition is too intense. Competitors like Roper Industries, Thoma Bravo and Vista Equity are aggressively eating away the company's revenue.
2. Internal - Investment discipline, overhead expenses, lack of investment in growth.
There's a lot to learn from his letters. Some of the important metrics he described are worth studying with other SaaS businesses. Let's discuss some.
1. Revenue per share - For ex, you have delivered 100 cr revenue and your total no of shares is 10 cr. So your revenue per share would be 10.
2. ROIC - Another important metric. It is calculated by adjusted net income with average invested capital (Think ROE, not exactly but near alternative).
3. Cash flow from operating activities per share - Same thing like revenue per share but it considers the cash flow from operating activities.
Some of the acquisition criteria.
1. "We are comfortable providing them with capital to purchase businesses that won't be immediately accretive but that have the potential to be long term franchises for the company." (2011 letter)
2. Another acquisition criterion is buying the business from its founders. As Mark believes, "founder businesses tend to be a very good cultural fit with Constellation. When founder invests the better part of a lifetime building a business, a long term orientation tends to permeate all aspects of the enterprise: employee selection and development, establishing and building symbiotic customer relationships and evolving sophisticated product suites". (2012 letter)
3. "When we analyze the attrition and customer acquisition economics at the individual business unit level, the jury is still out on whether our high churn businesses are as attractive as our low churn businesses. Sometimes the higher churn is because the client's switching costs are low. Sometimes, the higher churn is because lots of new potential clients are created and old ones are going bankrupt and merging. It it is the latter, these software businesses may be very attractive. If it is the former, then the software businesses are likely to be unpleasant, requiring tremendous effort to stay in much the same place." - (2013 letter)
Lastly I would like to add some book recommendations from Mr. Mark.
A. One Man's Medicine: An autobiography of professor Archie Cochrane
B. Effectiveness and Efficiency: Random Reflections on Health Services by Archie Cochrane
C. Thinking fast and slow by Daniel Kahneman
D. The evolution of co-operation by Robert Axelrod
Also I would want you to read his 2011 letter where he mentions about managing the stock vs managing the company issue, capital investment philosophy, selling the whole business, intrinsic value of the business, difference between long term and short term shareholder philosophy and so on.
Thanks for reading
Take care
Rabi
Disclaimer: I'm not SEBI registered. This content is for educational purposes only. Do your own diligence.