Introduction
Topicus is the product of a spinoff of Total Specific Solutions (TSS) from Constellation Software in 2020. Topicus is something like Constellation Software in its early days when it was an unknown 6 billion-dollar company. The last time CSU was at 6 billion was in 2015. It’s now sitting at 35 billion. That’s a 32% growth rate, because I’m conservative, and because the company does have different margins and therefore a lower ROIC than CSU, I’ll use a lower rate to figure out what I think this is worth. But we will cover that later.
Let’s quickly compare and contrast CSU with TOI.V. Topicus has better Organic Growth than CSU, but this, in turn, leads to lower margins (for now). I don’t see this being a huge difference-maker in the future of the company. As they grow, I think margins will improve closer to CSU. Other than the fact that Topicus does business in Europe, there really aren’t many more differences from the parent company.
I’ve seen some speculation that management won’t go through some of the growing pains that CSU is now going through due to the internal hurdle rates that CSU has for its acquisitions. Now that they’re larger, they need larger companies in the M&A pipeline in order to keep the machine going. But deals that scale with the company have been harder to come by. The cure for this issue is to lower the hurdle rate on larger acquisitions, which will allow new companies to get acquired. CSU knows this and in 2019, lowered the hurdle rates for equity investments of at least $100 million. The hope here is that Topicus won’t have the issue of cash sitting on their books with nothing to do with it, a problem that CSU has run into in the past.
One thing to keep in mind is that this company as a consolidated company between Topicus.com and TSS was only formed in 2020. However, they have both been around for many, many years. This is the only reason I’m interested in it. Companies that are a flash in the pan are easy to find if you want 100%+ revenue growth. But they’re often associated with negative profits, which doesn’t interest me. So I will be making many forward-looking statements using CSU as a guide for the future of Topicus.
Destination
I’m a long-term investor, so I’m looking at where a company’s destination will be a decade from now. To me, I think things would look pretty damn bright for Topicus. Let’s look at the past to see what the previous M&A looked like before and after it was acquired by CSU. From 2006-2013 TSS had 8 acquisitions. From 2013 to the present, they’ve had 73 acquisitions. So they went from having 1 or 2 a year to 16 in 2020. So clearly, this is a rapidly growing area.
The beautiful part of the Vertical Market Software business is there isn’t a shortage of acquisitions targets. As long as Topicus grows its free cash flow, it can then deploy that cash to acquire other high cash flow businesses, then repeat those steps for decades. For CSU in 2015, they acquired 31 companies for $247 million dollars. In Fiscal 2021 they spend $1.5 billion dollars on acquisitions. I can see a firm number for the number of acquisitions they executed. If we look at 2015, the average price per acquisition was ~$8 million per acquisition. Given that they have been making larger acquisitions, I doubt their average is still the same number. But even if we assume their average acquisition cost has doubled, you’re looking at 100 acquisitions in 2021 (again, don’t know the exact number).
So if Topicus acquires companies at a growth rate of 18% (this is CSU’s growth rate from 2015 to 2021) by 2032 we would have about 83 acquisitions in that terminal year. This doesn’t seem anywhere out of the realm of possibility. Seems a little conservative, but let’s go with that. Let’s look at historical revenue and net income growth rates. Revenue has grown at a 20% clip CAGR since 2018, Net Income is a bit of a sticky situation. The reason for this is that Topicus had a large 1-time event that ended as a cost on their income statement, giving them a massive loss in Net income. But this is not a recurring event. If we look at YoY quarterly comparisons, their net income 2ent from €12.9 to €2, a 110% increase. I also don’t expect anywhere close to that kind of increase in Net income either. So we are left with using a Net Income Margin from fiscal 2020, which was 12.8%. In 2019 net margins were 11.1%, 2018 was 13.3%. We’ll use a 12% net margin, which is super conservative, as this should go up as the business scales, but it provides us with a decent margin of safety.
In 10 years if revenue grows at 20% we would be looking at €4.6 Billion in revenue. At a 12% net margin, that’s €552 million. If we assign a super conservative PE of 20x to this business, we get a market cap of €11.04B. This gives us a 14% rate of return (this was used when its Market Cap was ~€3 Billion. Pretty damn good. I think this will be the absolute low end of evaluation on this business. If we crank the PE up to 25 and 35 (which isn’t unreasonable given the high levels of recurring revenue and quality of the business), we get a value of €13.8 billion and €19.32 billion representing 16% and 20% rates of return.
We still have to look at what events need to happen that will be required by the business to reach these numbers. In my opinion, they literally just have to keep doing exactly what they’re doing now and they should be able to get there. They have the full force of 25 years of CSU experience on their board and in their DNA. So outperforming the parent company doesn’t seem out of the realm of possibility.
A breakdown of what they need to keep doing in order to reach the destination I’ve outlined above:
Keep acquisitions coming online at ~20% rate of growth. Or if the total number of acquisitions decreases, make sure acquisitions are going to provide a higher FCF compared to lower-priced acquisitions
Have a wide pipeline of acquisitions targets to keep their FCF on the books as low as possible. They shouldn’t need to give a dividend or buybacks. Just keep pumping the money into other high ROIC opportunities and let the model churn out FCF for more acquisitions
Provide high value to their new acquisitions. Acquired companies will join Topicus over other options for a variety of reasons. As long as they stay disciplined to the benefits of being acquired by Topicus they should have a steady stream of
Avoid share dilution. I don’t see this being an issue. They should produce enough FCF to fund more acquisitions. If not, they can use debt to buy more.
Debt
Revolving Credit Facility €46 million, Loan from CSI €29 million, Term Loans €96 million. Their 2021 Interest expense on Debt was €8.797 million.. 2021 Cash From Operations was €176 million. So they can easily wipe all debt off their books if they chose to.
One thing that is important about this thesis, is that equity financing can’t be used to fund future acquisitions. As there has been significant dilution, some might find this a concern. But it was a conversion of preferred shares. If you look at CSU’s history of shares outstanding, here is what you get since 2012: 21.2 million. 2022 TTM: 21.2 million. I don’t see any reason why Topicus will need to issue equity for debt purposes, and as they have learned from working with CSU, they don’t need to in order to grow.
Capital Allocation
Let’s have a look at their ROE for 2020: Net income was €63 million. Shareholder equity was €264 million. Giving us an ROE of 23%. As of 2021, there is €355 million of equity. In the 4th quarter of 2021, they had €27 million in net income. If we apply that forward a full year with zero growth (which clearly won’t be the case) then we get €108 million in net income. Sure equity might be higher at that period but as of now, you’d be looking at an ROE of 30%.
Now you can see why Topicus has no business paying a dividend or share buybacks. They aren’t going to generate 23-30% returns on either of those options. So they stick with what they know: acquire other great companies that earn high returns on equity.
We need to check CAPEX and R&D spend as well to see if either of these will rise and cut into FCF at some point. Let’s first examine Maintenance CAPEX as this is an ongoing expense the company must pay in order for it to function properly. Their maintenance CAPEX (I’m using the purchase of Property and Equipment) for 2021 was €5.4 million, 2020 was €2.4 million. This maintenance CAPEX spend for 2021 is 3% of OCF. This maintenance CAPEX for CSU is a negative working capital number. So I don’t think this CAPEX number will ever become a concern.
R&D for 2021 was €99 million and in 2020 €65 million on €742 million and €493 million. So these can be expected to increase as the company scales. These numbers as a percentage of revenue are 13% in 2021, and 13% in 2020. Given that the company does have a higher emphasis on organic growth, I think this R&D spend is probably here to stay. Perhaps as the company scales, it will decrease as a percent of revenue, but as long as they make organic growth somewhat of a priority, this expense should remain meaningful.
I haven’t finished my analysis on this company yet, but it’s clearly quite promising. The share price has gone up since I wrote this. Even with the numbers, I have given, the 14% base case has zero margin of safety. Everything would have to be executed perfectly in order for this to happen. I like a 50% margin of safety in my investments, so prices are currently too high for me to open a position. But I’ll definitely be following this company closely and waiting for weaknesses in price to shove a lot of cash into this company.
Whenever I get around to part 2 of this analysis, I’ll be covering the following areas:
Growth Opportunities
Management
Industry
Competitive Position
Competitive Advantage