AI Reinvestment Risks And Acquisition Pressures Will Still Support Long Term Earnings Potential

Catalysts

About Constellation Software

Constellation Software acquires, owns and operates vertical market software businesses that provide mission critical solutions to customers around the world.

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

• Although thousands of developers are now using AI augmented coding and productivity benefits are starting to show, there is a risk that much of this gain is reinvested into product road maps rather than sustained margin expansion, which could limit future improvements in net margins and earnings.
• While deep vertical knowledge and long standing customer relationships position the company to build AI powered knowledge networks over time, turning these efforts into meaningful new modules, usage based pricing or customer funded R&D has barely started, so future revenue growth from AI related products is uncertain.
• Although the Permanent Engaged Minority Shareholder approach broadens where growing cash flows can be deployed, minority positions in large public software companies rely on influence rather than control, which could lead to slower operational changes at those holdings and more volatile contribution to earnings.
• While recurring maintenance organic growth has been described as broadly consistent with prior years, some larger units such as Altera operate in tough end markets where organic performance is hard to improve, which may weigh on consolidated revenue growth if AI and product investments do not offset competitive and customer attrition pressures.
• Although the acquisition funnel remains active and private sellers have not pushed for materially lower pricing, persistent competition for vertical market software assets and the need to underwrite AI disruption and AI upside on a business by business basis could constrain attractive deal volume over time, which may temper future growth in consolidated revenue and earnings.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more pessimistic perspective on Constellation Software compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Constellation Software's revenue will grow by 14.2% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 4.4% today to 8.5% in 3 years time.
• The bearish analysts expect earnings to reach $1.5 billion (and earnings per share of $69.59) by about April 2029, up from $512.0 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $2.0 billion.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 45.3x on those 2029 earnings, down from 72.6x today. This future PE is greater than the current PE for the CA Software industry at 37.2x.
• The bearish 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 7.98%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• AI enabled coding is already raising developer productivity across hundreds of teams, but management is explicitly choosing to reinvest most of those efficiency gains into faster product road maps rather than cost savings. This could cap long term upside in net margins and limit the flow through to earnings.
• Management reports that AI related modules, usage based pricing and customer funded AI projects are still at very early stages, with no material new revenue or revenue loss yet. There is a risk that AI spending becomes a long duration cost item before it becomes a meaningful contributor to revenue and earnings.
• The Permanent Engaged Minority Shareholder approach intentionally shifts more capital into minority stakes in large public software companies, where Constellation Software relies on influence rather than control. This could make the performance of that capital more variable and introduce wider swings in consolidated earnings over long periods.
• Some portfolios, such as Altera, operate in structurally tough markets where management does not expect strong organic growth. If similar end market pressures show up in other units, the group’s recurring maintenance and total revenue growth could be held back even if M&A and AI initiatives continue.
• Competition for vertical market software assets remains strong and private sellers are not lowering price expectations, while AI disruption risk is now a core part of deal modeling. It may become harder over time to find enough acquisitions at attractive returns, which could slow the compounding of revenue and earnings that many shareholders expect.

Valuation

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

• The assumed bearish price target for Constellation Software is CA$3477.92, which represents up to two standard deviations below the consensus price target of CA$4203.86. 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 more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$5628.62, and the most bearish reporting a price target of just CA$3477.92.
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be $17.3 billion, earnings will come to $1.5 billion, and it would be trading on a PE ratio of 45.3x, assuming you use a discount rate of 8.0%.
• Given the current share price of CA$2442.51, the analyst price target of CA$3477.92 is 29.8% 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.