Constellation Software Inc. (CSU.TO) Earnings Call Transcript & Summary

Good afternoon, and welcome to the Constellation Software Inc. Conference Call and Webcast. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jamal Baksh, CFO. Please go ahead.

Thank you. Following our announcement last week of Mark Leonard's resignation, I've spoken with many investors, and a common request from all of them was to hear from Mark Miller to help with their understanding of Mark Miller's background and how management of CSI might change under his direction and hence the purpose for this call. I'd Therefore like to turn the call over to Mark right now for a brief overview of his journey at Constellation, and then we'll open up the line for our Q&A. So Mark?

Thank you, Jamal. So appreciate the opportunity to chat with everyone today and look forward to the questions. A bit of background on myself, started business with a couple of co-founders in the late '80s in '88, '89, and we were acquired by Constellation as the first acquisition in 1995 and I've been fortunate enough to be with Constellation now for over 30 years, and had an opportunity to learn how to as well as organically grow the business set that I initially cofounded to also learn how to do a capital deployment and acquisitions and over that time, have continued to build out that business inside of Constellation, which was in the transit area, helping sort of schedule buses and trains and allocate drivers to those particular vehicles. As we grew, we ultimately moved into new verticals, and we created an operating group inside of Constellation called Volaris and over time, have continued to grow Volaris and as well as serving as the Chief Operating Officer of Constellation and I have had the opportunity to work with the entire team at Constellation for many years now, and I'm very honored to have been appointed the President of Constellation and can't say enough about Mark Leonard, who founded and helped us get to this point and hope with the entire management team of Constellation, all of the operating group managers, who are exceptional in what they do, we'll continue to move the business forward as it has done historically. So that's a bit of an overview, Jamal. I think maybe turn it over to questions now.

[Operator Instructions] The first question comes from Richard Tse at National Bank Capital Markets.

Yes. Thanks for hosting this call, and I hope Mark Leonard is doing well. Mark, obviously, there's probably a lot of common ground in terms of how the company approaches capital deployment. That said, I can't sort of help but wonder whether are sort of differences of opinion. And so -- if so, what's sort of unique in terms of maybe your strategic priorities over the next year? And how would they potentially differ from how Mark Leonard looked at things.

Honestly, Richard, I really think it's business as usual. I Just continue to push ahead with the -- with our existing strategy. And I appreciate that sounds like an easy answer, but I think we just continue to push forward, continue to learn and try to get better at what we're doing within the organization. There's a lot of opportunities to improve how we do capital allocation, operate our businesses. So we'll just continue to focus on the same things that we always have here at Constellation and completely, in a completely decentralized fashion.

Okay. And I just have one other question. It seems like the pace of capital deployments over the past year has been running a little bit lower than in the past years. Curious as to what you may think about that. And if it is the case, what's your weighing in that rate of capital deployment?

I mean, over time, it's -- capital deployment has gone up, and it's gone down, and it's -- I cannot attribute it to any specific reason. And I feel very comfortable with what we're doing as far as covering our potential opportunities to deploy capital and just continue to try to improve upon that. So there's no -- I have no major insightful answer to that question, Richard.

The next question comes from Thanos Moschopoulos with BMO Capital.

Mark, could you provide some color with respect to how Mark Leonard has been focusing this time over the last couple of years and whether you envisage having the same approach to the role and the same set of priorities or whether different in that regard?

I mean I think one of the things that -- as the Constellation has grown and as our operating groups have grown, we tend to spend more time, and this would be the operating group managers and Mark sort of studying sort of the larger investments we're making and trying to support each other and thinking through how to do those and how to do those better. So I think that won't change. I think I will spend time with any of our larger capital employment opportunities, and really focused, I think focused on very much the same things Mark was looking at sort of compensation, making sure that we're optimizing our compensation to our team across the board as well as looking at continuing to share best practices amongst the operating groups as we're seeing evolution in technology, for example, with artificial intelligence, more capital deployment or just different things that are -- we see as an opportunity to improve our businesses. So I think very similar in a lot of ways. I probably am a bit more operational, I'm a programmer by background, and so I'll clearly want to think about how we can improve our businesses as well.

Great. And any other senior leadership changes that might stem from this transition? Or is that not something you'd expect out of the gate necessarily?

No. I mean I actually had the opportunity of, of course, speaking to all of the leadership team after the announcement was made. And I have to admit my comfort level increased, as I spoke to the team. I think we've got a great team around the table at Constellation and inside of lumine and Topicus. And we want to continue to just work with them. So there's no plans to change any of the management team at all.

The next question comes from David Kwan at TD Cowen.

Mark, can you maybe talk about what some of your top priorities are maybe for the first 90 days and the first year where you really might need to get up to speed more versus how you're running things at Volaris?

Okay. So I think the priority is capital deployment in my mind. So and then also making sure that we're continuing to develop our management team succession plans, what have you. So I'm immediately going to spend my time on any of the large opportunities that we're considering now from an investment perspective and that are outside of what I've been currently looking at. So I think short-term priorities will be capital deployment and making sure we have a good succession plan in place throughout the organization for the next level of leadership that will report into me. So that's what I'm sort of thinking right now.

That's helpful. And as it relates to the M&A program, obviously, I think Mark would have had a lot of great relationships that would help on the large acquisition front. Obviously, is not actively involved now. But do you expect any disruption with some of these larger deals as it sounds like you really want to get more involved with particularly outside of Volaris.

No, I don't -- we don't see disruption. We just -- I think just continue to focus on those, right? So I don't see any disruption there.

The next question comes from Jerome [indiscernible].

Best wishes to Mark. I think one of the main things Mark Leonard has been focusing on, as I understand, was finding new areas where to deploy a significant amount of capital at high rates of return. Mark, I guess you were involved in this initiative. So maybe if you can confirm this. And historically, management has sometimes been tempering expectations on this front, if you can provide an update.

Well, I think you probably covered it correctly, considering some other opportunities to do that, and the Board discusses it as well. So we'll -- as things evolve, you'll hear about them. But right now, there's really nothing further I can comment on that, apologies.

Yes. That's fair. The second one for me is you're a programmer by training, historically, the company has found that investing a lot in R&D wasn't generating returns on investment as strong as M&A. But I was listening to the call from Volaris the other day on AI, and it seems like improving the software is becoming key. So I'm wondering if there could be a shift in terms of how you think about the R&D spend going forward.

The R&D spend, you look at it on an individual business-by-business basis, and we have hundreds and hundreds of businesses, and I encourage all of our businesses to be close to their customers, setting their needs and developing additional products that they're able to provide those customers to help them run their businesses better. And I think that's been a historical focus. I think with AI, there's an opportunity to maybe do it faster, quicker. So I'm hoping that we can encourage some of our leaders that are open to that to use some of these new tools to do -- to try to improve some of the products and services we offer our existing customers across the world.

The next question comes from Samad Samana at Jefferies.

I want to echo the well wishes of the others for Mark Leonard and a speedy recovery. My first question is, should we think about the last 2 weeks where we've had 2 major update calls as a sign that maybe we'll be getting more regular updates with a broader audience and/or more engagement with the investment community. Particularly as we think about a transition as large as this? Or should we look at this as an outlier? And then I have one follow-up.

Honestly, I don't think we've decided on that. We're going to have a chance to chat about it over the next a little bit, and I think we'll revert on that question, but thank you for.

Great. And then maybe just as you think about -- you mentioned the succession planning. And as you think about maybe what might influence how to think about the succession planning going forward, just maybe help us understand the time line of the recent handoff. And as you think about future succession planning, does what's happening with AI influence how you're thinking about the type of leadership, whether it's more focus on somebody with strong capital deployment skills versus strong technology background. Just help us think about those influences.

No, we buy and hold forever. When we talk to our leaders and talk to the companies that we're hoping that we can invest in and acquire over time. We like to think over a very, very, very long horizon. So you need to be thinking about succession planning and in advance, thinking about who could be, for example, President of Constellation in 2040 or something like that. You need to be thinking about that well in advance. And so that's mostly what I'm concerned. As far as skill sets, whoever -- one of the biggest and most important skill sets on top of capital deployment is going to be the ability to develop other people. So we'll look for leaders who are able to develop people and deploy capital and have the wherewithal to think long term.

Great. We appreciate you doing this today. And I think investors would appreciate more engagement. So thank you so much. And look forward to staying in touch.

The next question comes from Daniel [Gerdes] at [indiscernible].

Thank you very much for hosting this Q&A. I have one question and one follow-up, please, on capital allocation. My first question is around -- I think it was on Friday, we saw that the Chairman and some other members of the investment team were buying back -- buying shares in their own name. My question is around the potential for share buybacks or a share buyback program. Is that something that is being considered by the Board. And if not, is that something that potentially shareholders can read into that the opportunity set currently for the business on capital deployment is more attractive than potentially buying back shares?

No, we're not considering buying back shares, and I don't think there's anything you can extrapolate into that other than both John and the Chairman and myself acquired some shares. We really just felt it was sending a signal to people that we were very comfortable with the company and its long-term future. That's all that's to be read into that.

And my follow-up question, please, is around -- also around capital allocation. Is there a separate committee of the board that approves larger deals or that the Board sits on to consider larger M&A deals for Constellation. And if there is, what changes are being considered or being implemented as part of the process going forward for these larger deals, please?

I think we have a very good process in place now that doesn't need to be changed. Before the actual -- a large investment arise at the Board of Constellation, the -- a handful of the operating group managers meet to discuss it with each other and kind of give it a bit of a thumbs up, thumbs down, which I think is pretty helpful. So I think that process works very, very well, and we'd like to do that. I think we'll continue to do that in the future. It's been a good process and it works really, really well. It's nice to get some feedback from your peers as an operating group manager to before you present to the Board a large investment. But there's no subcommittee of the board per se. That looks at investments.

The next question comes from Stephanie Price with UBS -- with CIBC.

It's Sam Schmidt on for Stephanie Price. Best wishes to Mark. Just one for me. What are you hearing from customers in the current environment, including around AI? And how do you think about the go-to-market approach evolving over time?

So I think it probably depends on -- I mean we have hundreds of businesses around the world. It depends on the sector. And so there's no individual -- there's no consolidated message you get from customers. We are -- I did -- I called the operating managers yesterday before anticipating some questions on this today. And our general census is we're -- we've got to get the people focused on it internally, and we're hoping that we're able to show some good examples to our businesses that are working closely with customers, implementing AI solutions to the other ones who have not yet done that and as normal within Constellation sharing best practices, ensuring better ways of doing things will continue in this particular front. We're using some very specific examples right now, which I think are pretty interesting. So we'll just kind of get the word out as well.

The next question comes from Paul Treiber with RBC Capital Markets.

Just a couple of questions. Just in regards to the AI, have you seen AI begin to influence valuations in the private markets and then influence in any way the pace of acquisitions that you've maybe done over the past year?

No, Paul. I mean, I've not seen anything -- any impact on pace or valuation, not at all. So stay tuned, I haven't seen anything so far.

And then a second question also related to AI. Have you seen, as a result of AI increase in competition at the business unit level, specifically within Volaris, any of the segments there? Has there been any change in competitive intensity over the last couple of years with new AI entrants or new entrants in general?

We haven't -- I haven't heard of any -- I'd ask that question [indiscernible] about it. Like what -- my question was sort of -- what sort of damage have you gotten from not -- from competitors in AI? And there didn't seem to be yet any concern about that so far. So one of the things important to note, as always, with our businesses in Constellation. We tend to be fast followers. So our business leaders, particularly our better business leaders are usually quick to respond to changes inside of their markets due to moves their competitors make or new entrants make into the market.

[Operator Instructions] The next question comes from Kevin McVeigh at UBS.

Best wishes to Mark and congratulations. I wonder if from an operational perspective, it sounds like you started in transit and transitioned up to Volaris, any best practices you kind of would call out over your career transition, which is kind of obviously a very rich history within Constellation that you would look to implement across the broader organization.

We've been very good at sharing our best practices. We speak at each other's events. We get together with everyone across the organization in various meetings. And I can't think of anything that I wouldn't have shared already. One of the more interesting -- to say one of the more interesting things that we get a lot of at Volaris was we made businesses smaller by breaking them up. And by creating like a couple of businesses out of one to be more focused on the customer strategy, I'd love to see more of that done across Constellation. I know Topicus has done a lot of that. And -- but we've done an extraordinary amount of that. I really do believe it positions us well to stay close to our customers, especially when you're in a buy-and-hold forever mode. When you're close to those customers, you're going to be able to be to adjust with them over time. And sometimes you might want to split the business by the large clients versus small clients or could be by geography. So thinking of best practices, there's 1 thing I could share is keep your team small. It allows you to develop your people better, allows you to be closer to your customers and create better products that are more suited to their needs. And even with the advent of AI coming out, it allows you to be more sensible as to how you apply it to the particular situation. So just as an aside, I think that's an interesting one. I'd love to see more done. But again, things aren't magically done by waving a wand at Constellation. We try to coach our leaders and let them meet with other people who have done things and hope that when it makes sense, they apply that best practice to their particular business or portfolio or situation.

Well, congratulations on a great opportunity.

Thank you.

Next question is a follow-up from David Kwan with TD Cowen.

Thanks. Mark, you're obviously wearing a lot of hats particularly within your various roles at Constellation. Can you talk about how you plan to allocate your time amongst the various roles you have in Constellation in particular?

So I think the focus of my attention is going to be on capital deployment. So -- and that goes across any of the roles I'm in. And the particular Volaris, I made myself Executive Chairman of Volaris a year ago, 1.5 years ago. And then just the talent that we have, right, at 3 particular groups, if you want to call it, Lumine being a separate public company, Modaxp, which is our transit business and essentially the rest of Volaris and the people running those are outstanding and doing a great job. So I really want to just help and focus on making sure that when we're looking at doing a large investment, that it's done wisely across the board at Constellation. And that's just a good place to spend my time. And as I said, I also want to keep a close eye on succession planning and make sure that we have continued to develop our -- not the people who are directly reporting into Constellation, but the next layer below them. So we've got an organization that will continue to last decades into the future.

That's helpful. And maybe just one follow-up as it relates to kind of these larger acquisitions. Obviously, Mark had structured that spinout is one way for you guys to be more competitive in terms of some of these large acquisitions and ones that are generating probably much better margins and growth than your typical acquisition. Can you talk about -- have there been a lot of opportunities that you've been able to pitch that structure over the last couple of years, at least since the Lumine spinout?

We try, and you need a combination of a good opportunity, as you suggested, a willing seller who would like to be involved in that. You need a particular vertical or geography that's a good enough size. And you also need a management team that is willing to take that on, like, for example, the Lumine management team. So you need all 3 of those to come together to make something like this spinout work and we're definitely open to doing more spinouts. So I think it's been really great to give people that ability, that separate accountability. And and it's another -- it's just another way to consider -- to do decentralization. And so it gives you another -- it's another tool in the decentralized model. But you need a few things to be ticked off before you can kind of do those, right. And we're very fortunate with Lumine to acquire a business called WideOrbit, and one of the better businesses that we've acquired over time. So I hope we can do more of those, but I can't predict when and where we'll just -- it requires a few things to come together to make them happen.

The next question comes from Charles Nadim with Urasowski Fraser.

I guess a question and a follow-up. And this is not me saying this is the current situation. But if you were in a situation where there's not enough, I guess, targets that meet your -- or especially large targets that meet your hurdle rate to keep the growth going. And the Board asked you to kind of make a recommendation, how would you rank the following lower the hurdle rate to keep the train going, which remains significantly above your cost of capital or pay a special dividend or let the cash pile up. I mean how do you think about those 3 items?

It's a hard question to answer, like lowering the hurdle rate, not a fan of, right. So last, we did a special dividend in 2018. And even after that we're debating should we have done that or not, right. So it's a difficult question, and I think it will be situational in how we answer it. So -- and we'll do what we think is in the best interest of our shareholders. And based on the right data. There's a lot more we need to do better as far as capital allocation as well. So I'd like to see an improvement in our coverage and our processes around covering the market, covering our potential investment opportunities over the next little while as well. So I'd love to -- so that would be my answer to that may seem [indiscernible].

Just to clarify, when you say improve our capital allocation, you mean like having hired more people to look at more deals? Or what do you exactly mean by that?

It's just like any processing side of any business that you do. it's just making sure that you get the right people doing the right things in the right ways to make sure you're covering the market optimally. So it's just continue to improve on what we're doing. So.

And just a clarification, the answer you provided before on the buybacks, is that just a philosophical thing where we're not interested in buybacks? Or is it a reflection of when you look at the valuation today relative to the opportunities you still think the stock is [indiscernible].

From my perspective. philosophical thing. We've never been a fan of doing buybacks at Constellation.

This concludes our question-and-answer session. I would like to turn the conference back over to Mark Miller for any closing remarks.

I just want to thank everybody at Constellation, the entire team. And of course, also wish Mark Leonard a speedy recovery and look forward to working with everybody on a go-forward basis. So thank you very much, and thank you very much for attending this call.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.