Tag: CSU

The price to sales ratio, as it relates to software as a service valuations

I have been busy looking at the entrails of the various publicly traded software-as-a-service companies.

One thing that strikes out at me is the price to sales (or price to revenues) ratio.

Intuitively speaking, let’s say your market cap is $10 and you make $1 in sales a year.

Even if your cost of sales, G&A, R&D and the like is zero, the most profitability you can have as a company is a 10x P/E.

Of course 100% profitability will never will be the case – even if the company has completely outsourced its sales functions and just took a royalty on its product or intellectual property and had zero R&D function, there will always be costs associated with obtaining revenues. Of course, the “stripped down to taking royalties” company will be a calculation about the residual future demand and sales of said products.

While Boston Pizza Royalties (TSX: BPF.un) is as far away as a software-as-a-service company as it gets, the valuation concept is similar – BPF.un takes a 4% slice of every dollar of revenues that its franchises generate. The trust has zero employees, and in 2025, the trust’s administrative expenses was about 3% of revenues. The trust itself has some leverage expenses and is subject to income taxes payable at the trust entity level. When baking in all of these other expenses, they are still able to retain 53% of its revenues after-taxes which flow to the unitholders.

Based off of this, the market is giving BPF.un an enterprise value-to-sales (EV-to-royalties) ratio valuation of about 13 times. This is a ceiling, given that it is very unlikely that Boston Pizza will miraculously proceed to monopolize the restaurant scene in Canada and extract a disproportionate amount of pricing power – they are engaged in a highly competitive and mature industry with limited opportunities for growth.

Back to the SaaS side, we look at two other companies that are generally considered unassailable in their domains – Microsoft and Autodesk (AutoCAD is not going to get vibe-coded out of existence). Microsoft’s EV/S number is about 9.1x, while Autodesk is 6.4x. Both companies are far from being “royalty-like” in that they have huge operations, staffs, supports, R&D, etc.

Synopsys (Nasdaq: SNPS) is not exactly a household name, but their software is generally regarded as the industry leader in semiconductor design, has a EV/S of 10.5x. They are even less likely than Autodesk to get vibe-coded, and their valuation shows it.

One advantage of using EV/S as a lens is that it sidesteps the distortion caused by stock-based compensation, which is pervasive in software (particularly among newer companies) and can be a genuine pain to normalize across peers when trying to make apples-to-apples earnings comparisons.

Now for the more vulnerable end of the spectrum. Adobe (Nasdaq: ADBE) is currently trading at approximately 3.7x EV/S. Constellation Software (TSX: CSU), after losing over half its market capitalization in the past year, is roughly 3.3x.

If the market perceives a particular company’s software offerings as less defensible against AI, the EV/S ratio will continue to compress. Conversely, if you believe Adobe’s product suite has the same long-term survivability as Autodesk’s, it is not unreasonable to think its EV/S ratio should rise in the direction of Autodesk’s.

This analysis is very broad brushed, a view from 100,000 feet. But as a first-pass filter for what the market currently believes about the durability of a given software franchise, it is hard to beat for simplicity.

Yield-seekers – a 13.3% coupon on investment-grade debt!

This is a couple months late, but one of the casualties of the high-CPI environment is the issue of debentures that Constellation Software (TSX: CSU) made many years ago.

At the end of every March, they update it to CPI plus 6.5%. This year, bondholders will get a coupon of 13.3%!

CSU has the right to call the debt with 5 years’ notice in the last 15 days of March each year, and otherwise it matures on March 2040.

If they exercise this right, and if the 13.3% coupon keeps up for the next five years (doubtful), you are looking at a 3.3% yield to maturity, due to the fact that the debt is trading at 38 cents over par.

But for current yield seekers, I find some humour that the largest coupon available on the debt market right now is from a top-rated company.

The next TSX-traded debt issuer that has the largest coupon is Valeo Pharma (TSX: VPH) with a 12.0% coupon. With a market cap of $44 million, it is miles away from the financial condition that CSU is in.

Constellation Software – valuation

There is no doubt that (TSX: CSU) is well-managed and the CEO’s instincts on return on investment from acquisitions is spot-on. Software has a “sticky” component where the cost to transition systems is so high that it creates a barrier to entry. With existing licensing regimes, it can create recurring revenues that can be increased over time (especially for institutional customers – much less price sensitive than consumers).

Glossing over the year-end results, this is what I see (from the cash flow statement) – note this is a really crude, paper-napkin styled analysis:

The balance sheet in relation is fairly neutral – they gave out $500 million in dividends in 2019 which impacted the cash balance, in addition to spending nearly $600 million on acquisitions. Despite this they still have about $100 million net cash on the balance sheet (and another roughly $250 million in lease obligations). Thus, I’ll ignore the balance sheet since this is obviously a cash flow valuated concern.

We use the $633 million number (the 2019 run-rate for free cash generation), divided by 21.2 million shares outstanding. This gives us about $30/share.

(An original post completely forgot about the fact that CSU reports in US dollars when their stock trades in CAD, so the numbers below have been corrected as appropriate, with some mild embarrassment for my own distraction as I was looking at the crude oil futures)

CSU’s last trade was at US$995 per share, which gives a 33 times valuation.

Let’s say they can grow earnings at 15% a year (ignore all the myriad forms of assumptions that would go into this), they will need about 3-4 years growth at that rate to get to a 20 times valuation with their stock price being constant.

That seems to be relatively expensive. Who knows, they might be able to grow faster than that.

CSU is good at what it does, but quality comes at a high price. The question is whether that price will get higher, either through growing the bottom line or a continued expansion of the price to cash (or earnings) ratio.

Book Review: The Outsiders – and outsized returns

The Outsiders: Eight unconventional CEOs and their radically rational blueprint for success – by William Thorndike.

I’ll recommend this book. Although it is becoming somewhat dated (copyright date was 2012), it gives the reader a 50,000 foot above the skies satellite view of some hand-picked CEOs that were able to strongly defeat the GE Jack Welch / S&P 500 record during multi-decade periods. They shared a single characteristic – they were able to allocate capital with discipline and ruthless efficiency. Operationally they were able to delegate to competent individuals and decentralization to the point of abdication was another theme.

If this book was written today and for Canadian CEOs, I would think Mark Leonard of Constellation Software (TSX: CSU) is an obvious candidate. He has delivered 42% compounded annual returns over the past decade, and 38% since going public in May of 2006 – notably still earning this return through the 2008-2009 economic crisis.

Reading (mostly written by) Mark Leonard’s Shareholder Q&A letters is fascinating insight on the company and how management thinks. It is indeed a shame that I never heard of this company until it was far, far too late. Sadly they are looking at future returns in the upper teens from their current size.

I have also taken great pleasure of reading Tyler’s compilation of quotations by TransForce’s (TSX: TFII) CEO Alain Bedard, which is a trucking and logistics company. TFII has performed at 22% compounded annually over the past decade, and about 13% since going public in October 2002 (in both cases dividend-adjusted). For a low margin business such as trucking, this is needless to say impressive.

There is a bit of retrospective bias in this book, however. Most individuals would probably regard Prem Watsa of Fairfax (TSX: FFH) as being a very good CEO, but his dividend-adjusted CAGR over the past decade has been 9%, and over the past 20 years has been 6%. Compare this with CEO Duncan Jackman of E-L Financial (TSX: ELF), which has been approx. 9% over both the past 10 and 20 year period. E-L Financial, in my opinion, is the least attention-seeking publicly traded corporation with a market cap of over a billion dollars.

For the sake of comparison, the TSX’s performance (dividends reinvested) over the past 10 years has been 6.6%. The main index (dividends not reinvested) over the past 17.7 years (which is how far the data goes back when they did a major change to the index) is 4.5% – adding in dividends would be another 3% or so. So a 9% CAGR performance is a slightly overperformance over the TSX, but posting returns into the teens and better is clear outperformance.