AI Adoption And Permanent Minority Stakes Will Transform This Vertical Market Software Compounder

Catalysts

About Constellation Software

Constellation Software acquires and operates mission critical vertical market software businesses around the world.

What are the underlying business or industry changes driving this perspective?

• Company wide adoption of AI augmented coding, with thousands of developers already upskilled and hundreds of teams set to move through accelerator programs, has the potential to support a faster flow of product releases and feature updates, which can feed into revenue and earnings growth over time.
• Deep domain expertise in vertical markets and long standing, trusted customer relationships position Constellation to embed AI agents, small language models and machine learning directly into customer workflows, which could support higher recurring revenue per customer and more resilient net margins.
• The push to build knowledge networks that connect customer process know how, data assets and AI tools across the portfolio creates scope for new, higher value software modules and services, which may widen the revenue base and improve earnings quality.
• The Permanent Engaged Minority Shareholder approach, starting with the Sabre investment, widens the opportunity set into larger public software businesses while keeping a disciplined IRR lens, which can support more consistent capital deployment and long term earnings power.
• Use of AI tools in the M&A process, including scoring prospects for quality, AI disruption risk and upside, can help focus capital on higher quality targets, which is likely to support aggregate portfolio returns, cash flow and net margins over time.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more optimistic perspective on Constellation Software compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts.
• The bullish analysts are assuming Constellation Software's revenue will grow by 16.5% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 7.6% today to 11.5% in 3 years time.
• The bullish analysts expect earnings to reach $2.3 billion (and earnings per share of $103.17) by about August 2029, up from $961.0 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $1.6 billion.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 42.3x on those 2029 earnings, down from 49.1x today. This future PE is greater than the current PE for the CA Software industry at 39.0x.
• The bullish analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.96%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• AI adoption across Constellation's portfolio is still at a skills and tooling stage, with management saying it is really early days for monetization and that they have not yet seen much new revenue from AI capabilities. This introduces a risk that AI related investment spends may run ahead of actual customer willingness to pay, putting pressure on revenue growth and net margins if commercialization lags for a prolonged period.
• Management highlights that some acquired businesses, such as Altera, compete in tough markets and were never expected to deliver strong organic growth, and that expectations for private company multiples have not softened while competition for deals remains strong. This could limit the contribution of organic growth and put a ceiling on returns from acquisitions, affecting earnings and cash flow generation.
• The new Permanent Engaged Minority Shareholder (PEMS) approach expands into minority positions in large public software companies where Constellation has less control, potentially increasing exposure to governance or execution issues that it cannot fully influence. This may make capital deployment outcomes more variable and could weigh on long term earnings and return on invested capital if some PEMS positions underperform.
• AI related disruption risk is explicitly acknowledged and is now a lens in the M&A process, with management expecting that some portfolio companies will adapt better than others and stating that there will be winners and losers among software players. This means parts of the portfolio could face erosion of their terminal value or customer bases over time, which would pressure revenue, recurring revenue quality and long term earnings power.
• Constellation continues to rely heavily on decentralized decision making, including for AI product direction and pricing, while also running thousands of products and hundreds of businesses worldwide. This can create uneven execution and slower response in weaker units, and if some leaders misjudge AI threats or pricing power, those pockets of underperformance could drag on aggregate organic growth, net margins and earnings.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bullish price target for Constellation Software is CA$5082.63, which represents up to two standard deviations above the consensus price target of CA$3959.78. This valuation is based on what can be assumed as the expectations of Constellation Software's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$5503.36, and the most bearish reporting a price target of just CA$3291.14.
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2029, revenues will be $20.0 billion, earnings will come to $2.3 billion, and it would be trading on a PE ratio of 42.3x, assuming you use a discount rate of 8.0%.
• Given the current share price of CA$3089.46, the analyst price target of CA$5082.63 is 39.2% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.