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Another Tech Surprise
Posted by: Gordon Pape (IP Logged)
Date: October 6, 2012 12:16PM

All the attention that has been focused on Research in Motion (RIMM) in recent months has pretty much eclipsed the rest of Canada's small but important technology sector.

The trials and tribulations of the embattled Waterloo, Ontario smartphone giant have commanded investors' attention as the company fights to stop its dramatic slide and regain market share. Hopes that the upcoming release of the BlackBerry 10 will revitalise the company's fading fortunes have propelled the stock to a 30% rally after it touched a multi-year low of $6.10 in intraday trading on Sept. 24. The shares hadn't been that weak since early 2004.

However, the reality is that no one has yet seen the final BlackBerry 10 and the launch date is still vague with the company saying only that it will be available sometime in the first quarter of next year. Until the product is actually out there and the reviews start coming in, there's no way of knowing whether BB10, as it's being called, will mark the start of a RIM renaissance or the company's last gasp.

Meantime, other Canadian technology firms are operating below the radar as far as the media and most investors are concerned. Vancouver-based MacDonald, Dettwiler (MDDWF), which was recommended here in July, has seen its share price come under pressure because of the possibility that the U.S. Justice Department might veto its proposed takeover of Space Systems/Loral Inc. of Palo Alto, California (see Updates for more details). CGI Group (GBI), an August selection, has performed well for us so far but its business is so colourless that it rarely gets any media attention.

One company that has been almost completely overlooked for reasons I do not understand is Constellation Software (CNSWF). It's a Toronto-based operation that is aggressive, profitable, and pays a decent dividend, yet few people have ever heard of it.

The company was founded in 1995 with the goal of combining several vertical market software suppliers with the potential to be leaders in their fields into a single organization. Since then it has expanded rapidly through a combination of acquisitions and organic growth, developing a large, diverse client base comprised of over 30,000 customers operating in over 30 countries around the world.

Constellation supplies software and services to a select number of industries, both in the public and private sectors. The mission is to acquire, manage, and build market-leading software businesses that develop specialized, mission-critical solutions to address the specific needs of its target industries.

In the public sector, these industries include local governments, public transit operations, law enforcement, public housing, electricity and water utilities, school administration, and public safety. In the private sector, Constellation provides software solutions to construction companies, van lines, medical centres, health clubs, real estate brokers, wineries, pulp and paper manufacturers, private clubs, and more. The company has six operating groups, each of which has its own areas of specialization.

Here are a few specific examples of the kind of work the company does. In August, one of its units announced a contract with the City of Edmonton to provide the Edmonton Transit System (ETS) with a comprehensive intelligent transportation solution. This includes computer-aided dispatch and automatic vehicle location (CAD/AVL) technology which will be integrated with real-time traveler information solutions. The end result will be to provide riders with critical pre-trip information such as real-time arrival and departure information at bus stops, on the Web or via text messaging as well on-trip information such as next stop announcements on the bus.

During the same month, the company announced a similar type of deal with the Australian Capital Territory, which is responsible for the public transportation system in the Canberra area.

In mid-September, another subsidiary was awarded a contract by the county of Pasco, Florida (in the Tampa Bay area) to implement its customer information service.

As these examples show, Constellation operates on an international level, providing important geographic diversification to the business.

The company is aggressively acquiring new businesses to add to its portfolio. The latest, announced on Oct. 2, is a $15 million purchase of Computer Software Innovations (CSWI) of South Carolina. CSWI develops and markets software as well as distributing computers, network and communications hardware, and interactive collaborative classroom technologies. Its clients are mainly education and local government agencies and not-for-profit organizations in the southeastern United States. In the 2011 fiscal year, the company reported revenue of $55.1 million and total assets of $22.9 million (all figures in U.S. currency).

In a research report published after the deal was announced, RBC Capital Markets analyst Paul Treiber said that in revenue terms this is the third-largest deal in Constellation's history and brings the total spent on acquisitions this year to between $95 and $99 million, a record. He estimated the deal will add $0.05 to Constellation's 2013 earnings per share, which he now projects will be $8.40. He rates the stock as a Top Pick with a target of C$115.

Constellation's second-quarter results showed revenue of $209 million, an increase of $14 million (7%) from $195 million for the comparable period in 2011. For the first six months of this year total revenue was $404 million, up 8% from $373 million last year. (Constellation reports in U.S. dollars.)

Net income for the second quarter $18 million ($0.83 a share) which was down dramatically $56 million ($2.64 per share) a year ago. However, the company pointed out that the 2011 numbers included a significant deferred income tax recovery "that was unique to the prior period". Excluding that, net income increased by 3% year-over-year.

The same tax distortion affected the first half numbers. Stripping it out, net income increased by 18% to $28 million in the first six months of 2012 from $24 million in the first six months of 2011.

The company's revenue growth is coming mainly from the private sector, which generated $61 million in the second quarter, a 25% improvement from a year ago. The public sector, which represents about 70% of Constellation's business, showed an increase of only 1% to $148 million.

Constellation's balance sheet appears to be in good shape with only $27.5 million in bank debt and over $200 million in deferred revenue. At quarter-end it was holding $21.7 million in cash and $24.3 million in liquid equities.

The stock pays a quarterly dividend of $1 a share ($4 annually or C$3.92 at current exchange rates). Based on Friday's closing price of C$104.50, it yields 3.75%. The last trade on the U.S. over-the-counter Pink Sheets was on Sept. 26 at US$105.92.

At the current price the shares represent good value. The forward p/e ratio using Mr. Treiber's 2013 earnings per share estimate of $8.40 is about 12.4, which is very reasonable for a high-tech growth company.

To sum up, Constellation offers an impressive growth story, a good yield, and above-average growth prospects. The stock is not cheap - it is trading only a couple of dollars below its all-time high of $106.49 which was reached in mid-September. But if the earnings estimates are anywhere near correct, the price is not out of line.

Action now: Buy for income and long-term growth.



Stocks Discussed: RIMM, MDDWF, GBI, CNSWF,
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Another Tech Surprise
Posted by: Cornelius Chan (IP Logged)
Date: October 6, 2012 08:01PM

Thanks for an interesting article. I was unaware of these companies.


Stocks Discussed: RIMM, MDDWF, GBI, CNSWF,
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Another Tech Surprise
Posted by: Patience Investing, Inc. (IP Logged)
Date: October 7, 2012 11:07AM

How about the valuation? I noticed they have high P/E like MacDonald, Dettwiler (MDDWF) – P/E 22.25; CGI Group (GBI) – P/E 19.28 and Constellation Software (CNSWF) – P/E 31.90. I wonder whether there is any margin of safety at the current prices.


Stocks Discussed: RIMM, MDDWF, GBI, CNSWF,
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