Getting ready for another CSU bought deal

They’ve hit us twice this year so far, and I think we Constellation Software (CSU:TSX) shareholders are ready for another whack. Really. We can take it. 😉

Way back on January 17th (see prior post “Make your 2012 fee budget — bid CSU“), I suggested to my Tech I-banking friends that the time was nigh to bid the key CSU shareholders, OMERS and Birch Hill Equity Partners (on behalf of TD Capital Canadian PE Partners), for part of their massive block of stock. The rationale was simple:

At the time of the “[CSU is] for sale” press release [April 2011], with the stock at $65/share, the market cap was around $1.385 billion; before any takeover premium. That’s a hefty M&A bite for most software or service firms, leaving only big players such as INFOR as viable bidders. I’m sure that Merrill and BMO did a good job on the sell-side, but with a tough debt market limiting PE options and an apparently unwilling management team, the outcome might not have been much of a surprise. At least with the benefit of hindsight. Just because it has been a great investment post-IPO doesn’t guarantee a successful sale transaction, unusual as that is to say.

Now that the stock is over $84, thanks in part to a new 5% dividend that pushed the quote up despite being pulled off the market, perhaps there’s still a deal to be done at CSU. The two original backers still own 40.3%, or just over 7 million shares. What better time for a bought deal? It worked for Macdonald Dettwiler and CAI years ago, with improved liquidity rewarding existing and future shareholders. The stock is up almost exactly 30% from the time of the April “alternatives” announcement, which is kinda what a traditional M&A premium looks like to most of us.

So, if you run the tech practice at a local i-bank, dust of your bought deal letter and fire it off. Get the control block folks a bid north of $80 and they might just hit it. At 4% commish on almost $600 million of jointly-held stock, you’re staring at a $24 million fee pie. Keep 35% for yourself, and the 2012 revenue budget is made…and it’s not even the end of January.

Now that MKS is gone, Joe and Jill Retail need a new tech dividend name. And the dividend-oriented mutual fund managers will like the fact that it’s got a decent market cap to it, with stable cash flow. But with just 7,300 shares/day trading hands on average, how can any PM ever build a useful position?

A $100 million block came in early February (see prior post “$100M CSU block doesn’t feed the ducks”). At $84/share; a couple of bucks below the illiquid quote. And then a formal secondary offering came about five weeks later. This time it was OMERS, selling 1.972 million shares solo at $87.50. The full shoe was exercised, and the bank-only syndicate was led by RBC Capital Markets and BMO Capital Markets, with CIBC, National Bank Financial, Scotiabank and TD Securities in the deal.

A good-sized offering, but it didn’t look very well organized to the Mr. Market. Two deals in the space of five weeks might make you scratch your head. Whether or not OMERS and Birch Hill were working together to manage the “leakage” of their position into the marketplace over the course of 2012, you’d hope that the ECM desks at the dealers would get this stuff right (assuming they were the deciding vote in the matter).

The pair of offerings also ignored the many Independent investment banks that had been providing excellent research coverage of CSU to the very institutions that wound up buying the huge deal. As of today, CSU is actively covered by eight institutions (BMO Capital Markets, Cantor Fitzgerald, CIBC World Markets, Cormark Securities, National Bank Financial, RBC Capital Markets, Stifel Nicholas, TD Securities) according to Bloomberg.

During the last 90 days, the top three traders of CSU have been RBC, TD Securities and Cantor Fitzgerald. After that, the stats drop away quickly. As much as PE shops need to pay the banks for the debt they borrow on their other PE and real estate deals, one should never ignore the positive impact that the independent dealers have on the Canadian tech landscape. Who holds the tech conferences? Who provides the research to firms with market caps below $100 million?

The early stage innovation companies traditionally get more attention from the non-bank part of the market. And if OMERS and Birch Hill want to help support the ecosystem that breeds firms like Constellation, it should spend its commission dollars more broadly, just as you see south of the border. A 10 dealer syndicate costs just as much as the six dealer version: since the independents aren’t making much off their CSU share trading commission, it’s the 3-10% syndicate position that truly keeps the lights on.

Since the two known equity offerings, there have been another three large sized blocks in the August-September timeframe; clearing in the $93.66-$104 range. Looks as though close to 1.75 million shares were moved in those three trades. Whether or not that came from one or both of the key shareholders, the stock has surged over the past 90 days; hitting $120 earlier this month.

With a long list of acquisitions under his belt in 2012, CEO Mark Leonard has positioned CSU for an excellent future. That’s why I continue to hold the stock personally.

Which is also why we can handle another big chunk on stock before Christmas; the plan is working. CSU’s daily volume has improved as a result of these offerings, just as we promised last January. It’s now 58k shares a day, versus the 7,300 we saw this time last year. Buyers of their earlier blocks have been rewarded as the stock has vastly outperformed the NASDAQ: up 33% over the past six months versus a 5% gain for the world’s tech index.

Whether it’s for the dividend, capital appreciation, exposure to IT, M&A roll-up strategy…investors are happy.

Come ‘on folks. Bid ‘em again; I’ve not led you astray yet. But please think about sharing the wealth a bit more broadly this time.

MRM
(disclosure – I own CSU personally)