Historically, the benefits for Constellation to stay as one company have included better access to capital for larger deals and enhancement of operations within acquired companies through sharing of best practices. As Constellation and the operating groups get larger, these become less important and factors such as employee focus and incentives become more important. Constellation has always operated in a decentralized manner but has continued to push autonomy down to the operating groups, most notably shifting the capital allocation down to the operating groups. Constellation today is often described not as one company, but six mini-Constellation Software’s under one umbrella.
In May 2020, Constellation’s subsidiary TSS acquired Netherlands-based Topicus.com BV (I’ll call the pre-merger Old Topicus) with a plan to seek a separate listing of the combined companies which would be named Topicus.com. Constellation had originally planned to complete the spin-off by November 2020, but for undisclosed reasons has delayed it to a future date. The stock will be dual-listed in the Netherlands and on the TSX Venture exchange. The total purchase price is valued at EUR 217.4m with TSS paying EUR 133.6m and IJssel (the seller) buying 9% of TSS for EUR 83.8m. IJssel will also commit an additional EUR 27.6m loan to TSS. The debt required to finance the deal will be funded entirely at the TSS-level without recourse to Constellation Software.
TSS was acquired by Constellation in 2013 and is the only operating group that solely operates in Continental Europe (mostly in the Netherlands and Central Europe). The Topicus.com prospectus tells us that TSS has 85 software businesses which, in the future, will be organized into three TSS operating groups: TSS Public for the public and healthcare sector, TSS Blue for the private markets, and Old Topicus upon completion of the merger. Maintenance organic growth at TSS has grown faster than Constellation as a whole.
Old Topicus focuses exclusively in the Netherlands, and is a dominant provider of software for education, healthcare, and finance markets. Growth has not come from acquisitions, but from a cultivated culture that hires smart people (average IQ of 130+) and gives them space to explore new ideas. Employees are grouped into cells of 7 to 10 who have responsibility for a product and, if an employee has a new idea for a business, Old Topicus will help explore and incubate the idea to create “in-house start-ups” where the employee retains equity interest in their idea. This process has resulted in successful products such as the ParnasSys pupil tracking system which has an 85% share in primary education, the FinDesk platform which has an 75% share in mortgage advisor software, and practice management software which has an 85% share in GPs.
Impressively, Old Topicus did not use any outside shareholder funding in its growth and as a condition of merging with TSS, insisted on maintaining its identity; hence the listing:
“The plan to create a publicly listed operating group made up of Topicus and TSS was a key part of our discussions with the Topicus founders. They didn’t want their legacy disappearing into the craw of an omnivorous conglomerate. While they knew that Topicus would have autonomy within Constellation, they also wanted identity. The public listing is expected to afford our Netherlands-based businesses a platform from which to celebrate their culture and achievements.”
– Constellation press release – May 20, 2020
The combined TSS + Old Topicus will be more focused on organic growth and internal product development than Constellation has historically been. With Old Topicus CEO Dan Dijkhuizen being the CEO of the combined post-spin company (TSS CEO Robin van Poelje will be Chairman), it will be very interesting to see how the company approaches capital allocation and acquisitions given its historic focus on internal growth. As with the rest of Constellation Software, bonuses will be paid based on return on invested capital and revenue growth and managers must invest a portion of their bonus into the stock. I’m not sure if the programmers at Old Topicus will have the same bonus and compensation scheme, though I’m sure the internal start-up concept is something that Topicus.com will want to maintain.
The entire spin-off has been designed in a way to set incentives and give autonomy for the new company while ensuring that Constellation retains control and retains cash flow to invest. Constellation will have a share that gives it majority voting (50.1%), and control of the board. Constellation and Joday/IJssel (the former owner of Old Topicus) will also own preferred shares that pay a 5% dividend of about EUR 61.8m per year. Detailed financial information on Old Topicus has not been disclosed, but TSS + Old Topicus earned EUR 518m in revenue in 2019 and likely low-mid EUR 100 million in EBITA (proxy for pre-tax cash flow), so the preferred share dividends will initially use up a large chunk of annual cash flow. With a relatively stable invested capital base, management is therefore incentivized to focus on organic growth rather than face pressure to deploy a growing capital base. The preferred shares are convertible into common stock at some point in the future based on a variety of conditions, so Topicus will slowly get access to its cash flow over time. Constellation itself would also be retaining a decent chunk of TSS cash flow that can be used for its own purposes and since most of the initial cash flows are flowing back to the owners of the preferred shares, employees and shareholders investing in the stock of Topicus.com will truly only participate in the growth and value-creation of the entity going forward.
Possible spin-off of Volaris
Another Constellation Software Operating Group, Volaris, has also quietly reorganized itself and created two new companies, each with its own CEO and branding: “Modaxo” to focus on people transportation, and “Lumine” to focus on communications and media. Long-term followers of Constellation Software may remember that Volaris used to be called Trapeze, which focused on public transit software, so Trapeze has gone full circle in separating itself as a new vertical. Since Volaris is one of the larger operating groups and even has its own “Volaris University” in training up capital deployers so perhaps CEO Mark Miller wants more autonomy. We will see what happens.
To sum it all up, the Topicus.com spin and the reorganization of Volaris are simply next steps in the evolution of Constellation Software into a mature organization and it will be fascinating to see how many tricks Mark Leonard has up his sleeve as Constellation Software continues to grow.