CGI and Constellation Software: My Core Tech Titans

There is plenty to choose from in the land of tech, although the field is sparse in Canada. CGI trades on the NYSE (ticker: GIB and GIB.A on TSX), but Constellation Software (ticker: CSU) is a standalone Canadian play. These are core, forever holds in my portfolio and you should consider them too. First, a brief note on Canadian tech.

The first chart below highlights the incredible performance of TSX software consolidators. They have outperformed tremendously, and 2020 was no exception.

Driving this performance are names like CGI (again. ticker GIB.A) and Constellation Software. When you see EPS growth in the 20%+ range for the past decade as indicated below, worth taking note. Constellation dwarfs its peers amongst most growth metrics. CGI complements Constellation in my portfolio with a focus on different aspects of the tech market, to be discussed below.

A closer look: CGI Inc.

CGI Group is the world’s fifth-largest independent IT services and outsourcing provider. They provide systems integration and consulting, IT outsourcing, and business process outsourcing services to clients worldwide, with offices in North America, Europe and Asia. CGI has $12B+ annual revenue, 77,500 employees, and $22B+ backlog of book-to-bill services. FY20 revenue streams are highlighted in the graph below.

A patient capital allocator with a strong M&A profile which is likely to gain traction in the rest of 2021 as valuations temper. CGI continually performs share buybacks to increase shareholder value. Management reiterated its aspirations to achieve double-digit annual EPS growth and double the size of the company in 5–7 years through its build-and-buy model.

CGI is a money making machine, with analysts expecting it to generate $1.6B free cash flow FTM (Forward Twelve Months 2021-22). Most of CGI’s contracts are multi-year (5+) in duration, ensuring visibility of revenue and cash flows. While temporary COVID-19 cost savings such as reduced travel may reverse in coming quarters, CGI is benefitting from structural improvements from higher use of collaboration software and work from home which may result in permanently higher margins. CGI also boasts an impressive track record of 19.4% Adj. EPS growth over the past ten years. 

With COVID forcing many companies and government organizations to fast-track their digitization plans and all that comes along with it (such as cybersecurity), the tailwind is in place for CGI to benefit handsomely in the short and long term. When it trades at or below its 200DMA, time to buy.

A closer look: Constellation Software

Constellation Software is a Toronto-based conglomerate that acquires, manages, and grows businesses that provide mission-critical ERP (enterprise resource planning) software that targets SMEs (Small Medium Enterprises, up to 1,000 employees) within attractive, niche vertical markets. Growth is driven via funding new initiatives and acquisitions using a disciplined ROIC approach. Constellation is a global company with $4.0 billion annual revenue, six operating groups in more than 100 vertical markets.

Constellation’s high hurdle rates (>25%) on small acquisitions have constrained the company to the highest returning M&A opportunities. While the VMS market is large ($180B TAM), only a small portion is for sale in a given year (e.g., Constellation acquired $531MM in 2020). Constellation generated $1.16B FCF in 2020, which is greater than the opportunities to deploy at these rates.  In the most recent shareholder letter, CEO Mark Leonard indicated a shift in strategy: the company will likely cut the dividend in order to re-invest 100% of FCF in acquisitions at lower (yet still high) hurdle rates that will sustain the compounding of capital. 

Constellation to date has only deployed capital in the VMS (vertical market software) market, which has an attractive underlying market structure. The potential move into non-VMS markets entails a higher degree of operating risk, given Constellation’s limited familiarity with these markets. However, given the management style of Mark Leonard and Constellation’s insistence on price discipline, they will without a doubt take market structure and long-term industry returns into its investment criteria. 

Take a look at any technology focused TSX chart (such as those above and below) and you’ll  notice Constellation at the top of the pack. Their ability to compound capital at very high (20%+) margins speaks to their knowledge and investment acumen. While it may be prudent to wait for a more reasonable valuation, that opportunity don’t come often — so if that is the plan, start saving and back up the truck when it arrives. 

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