If and when their reinvestment rate drops below 100%, do you think Constellation will adjust and consider buybacks below intrinsic value, or does the Leonard culture make that highly unlikely? Either way returns will increase through either attractive buybacks or cash build. Thank you for such highly informative articles.
Special dividends is more probable. If they want to buyback, I think they will consider a large block tender offer providing all the material info that shareholders need to make a decision, instead of open market. But I still think the reinvestment opportunities are much better than buying back at ~6% FCF yields.
I’ve really been enjoying this series on Constellation!
What would you look for as a sign that Constellation’s businesses are under threat from AI competition? One of the challenges I’ve always found is the diversity of businesses makes it hard to know what’s going on in any of them individually.
When I was thinking had a look at Roper as a comparison for their future. Any chance that they’ll be able to get back to 100% reinvestment given there do appear to be lots of large VMS businesses in the market to buy each year?
Try this thought experiment on the AI competition topic...
// Imagine you're an entrepreneur going into healthcare vertical. Your idea is to:
1. Help doctors/hospitals do patient aftercare
2. Identify potential risky patients
3. Link up services & analytics to drive revenues for hospitals and lower healthcare expenses for patients
4. Wrap the business plan with AI automation
// What you actually need to do to build this biz?
1. Buy data for illnesses to build a prediction model (eg. academic research)
2. Sequence medical IT systems/records, combine with your product, deliver consistent predictive outcomes
3. Develop a financial model to convince doctors/hospitals to onboard
4. Consider implications to national health insurance (each country is a vastly different know-how, esp in Europe where each country is different)
5. Make a payment system (could span across government, hospital, doctors, patients - systems don't talk to each other)
6. Sell/market your product, wrap it as AI solution
// Notice that the whole success behind building this biz is not heavily dependent on AI.
It's about understanding the industry, making relationships... there's hard software development which AI probably helps a little, but I would bet the context is more critical.
Tech is an amazing thing that lifts all boats, but if you can't understand how parties operate in the industry - then u can't sell your product. Your competitive edge is not AI, it's actually your vertical market knowledge.
Who has the collection 100+ vertical market knowledge? Its CSU.
Thanks for taking the time to reply. Couldn’t agree more!
Other question I had was re your valuation. Might be misunderstanding, but wondering if summing the present value of FCF’s is double counting?
I’m thinking that if most of the FCF generated needs to be reinvested for the business to grow at ROIC + OGr, then FCF isn’t really cash that shareholders can count as their own each year.
You're welcomed. No its not double counting. That FCF is indeed the amount that can be distributed to equity holders if there is no acquistions.
FCF is cash flow left over after all business needs are taken care of in order to maintain competitive advantage (ie. After maintenance capex). CSU has tiny amount of CAPEX, the money spent on acquisitions u can think of as "growth capex".
So u shouldnt minus it out from FCF. Otherwise u would be saying this "growth capex" is required to maintain the business, which isn't correct.
Solid breakdown on the ROIC degradation issue. The adjusted metric accounting for that 92% reinvestment rate makesway more sense than Leonard's original framework, since we've clearly moved past the 100% deployment era. I ran into something similar when analyzing another serial acquirer last year, they all eventually hit that ceiling where the best deals dry up and marginal returns compress.
Yes, a hopeful thing is that capital allocation skills are appliable to anything as long as they have the industry knowledge. So wont be surprised when they migrate outside vms.
Good job thank you !
If and when their reinvestment rate drops below 100%, do you think Constellation will adjust and consider buybacks below intrinsic value, or does the Leonard culture make that highly unlikely? Either way returns will increase through either attractive buybacks or cash build. Thank you for such highly informative articles.
Special dividends is more probable. If they want to buyback, I think they will consider a large block tender offer providing all the material info that shareholders need to make a decision, instead of open market. But I still think the reinvestment opportunities are much better than buying back at ~6% FCF yields.
I’ve really been enjoying this series on Constellation!
What would you look for as a sign that Constellation’s businesses are under threat from AI competition? One of the challenges I’ve always found is the diversity of businesses makes it hard to know what’s going on in any of them individually.
When I was thinking had a look at Roper as a comparison for their future. Any chance that they’ll be able to get back to 100% reinvestment given there do appear to be lots of large VMS businesses in the market to buy each year?
Try this thought experiment on the AI competition topic...
// Imagine you're an entrepreneur going into healthcare vertical. Your idea is to:
1. Help doctors/hospitals do patient aftercare
2. Identify potential risky patients
3. Link up services & analytics to drive revenues for hospitals and lower healthcare expenses for patients
4. Wrap the business plan with AI automation
// What you actually need to do to build this biz?
1. Buy data for illnesses to build a prediction model (eg. academic research)
2. Sequence medical IT systems/records, combine with your product, deliver consistent predictive outcomes
3. Develop a financial model to convince doctors/hospitals to onboard
4. Consider implications to national health insurance (each country is a vastly different know-how, esp in Europe where each country is different)
5. Make a payment system (could span across government, hospital, doctors, patients - systems don't talk to each other)
6. Sell/market your product, wrap it as AI solution
// Notice that the whole success behind building this biz is not heavily dependent on AI.
It's about understanding the industry, making relationships... there's hard software development which AI probably helps a little, but I would bet the context is more critical.
Tech is an amazing thing that lifts all boats, but if you can't understand how parties operate in the industry - then u can't sell your product. Your competitive edge is not AI, it's actually your vertical market knowledge.
Who has the collection 100+ vertical market knowledge? Its CSU.
Thanks for taking the time to reply. Couldn’t agree more!
Other question I had was re your valuation. Might be misunderstanding, but wondering if summing the present value of FCF’s is double counting?
I’m thinking that if most of the FCF generated needs to be reinvested for the business to grow at ROIC + OGr, then FCF isn’t really cash that shareholders can count as their own each year.
Thanks,
Tyler
You're welcomed. No its not double counting. That FCF is indeed the amount that can be distributed to equity holders if there is no acquistions.
FCF is cash flow left over after all business needs are taken care of in order to maintain competitive advantage (ie. After maintenance capex). CSU has tiny amount of CAPEX, the money spent on acquisitions u can think of as "growth capex".
So u shouldnt minus it out from FCF. Otherwise u would be saying this "growth capex" is required to maintain the business, which isn't correct.
Thanks! That makes sense.
Looking forward to reading more of your work.
Nice post and interesting way of approaching csu’s valuation. Thanks
You're welcomed :) hope the analysis turns out right!
Solid breakdown on the ROIC degradation issue. The adjusted metric accounting for that 92% reinvestment rate makesway more sense than Leonard's original framework, since we've clearly moved past the 100% deployment era. I ran into something similar when analyzing another serial acquirer last year, they all eventually hit that ceiling where the best deals dry up and marginal returns compress.
Yes, a hopeful thing is that capital allocation skills are appliable to anything as long as they have the industry knowledge. So wont be surprised when they migrate outside vms.