Chit Chat Stocks - Will AI Kill Constellation Software? With Drew Cohen From Speedwell Research (Ticker: CSU)

Episode Date: February 11, 2026

On this episode of Chit Chat Stocks, we speak with Drew Cohen of Speedwell Research about Constellation Software (Ticker: CSU). The stock is in a deep drawdown, its largest ever. We discuss: (00:00) Introduction (03:50) Understanding Constellation Software's Business Model (06:40) The Bear Case: AI Disruption and Market Concerns (15:45) Acquisition Strategy (19:45) Leadership Transition and Its Implications (28:29) Cultural Impact and Decentralization in Business (29:04) AI's Influence on Acquisition Strategies (31:48) Valuation Metrics and Market Perception (35:51) Stock Buyback? (43:11) The Unique Culture of Constellation Software Speedwell Research: https://speedwellresearch.com/ ***************************************************** Sign up for our stock research service, Emerging Moats: emergingmoats.com  ********************************************************************* Chit Chat Stocks is presented by Interactive Brokers. Get professional pricing, global access, and premier technology with the best brokerage for investors today:  https://www.interactivebrokers.com/  Interactive Brokers is a member of SIPC.  ********************************************************************* Fiscal.ai is building the future of financial data. With custom charts, AI-generated research reports, and endless analytical tools, you can get up to speed on any stock around the globe. All for a reasonable price.  Use our LINK and get 15% off any premium plan: ⁠https://fiscal.ai/chitchat  ********************************************************************* Disclosure: Chit Chat Stocks hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Learn more about your ad choices. Visit megaphone.fm/adchoices

This episode is presented by Interactive Brokers. Will the U.S. Consumer Confidence Index be above 101 in March 2026? Turn your view into a trade with IBKR Forecast Trader and earn a dollar per contract if you're right at ibkr.com slash forecast. Last trading day is March 22nd. More on this later in the episode. Welcome to Chit Chat Stocks. On this show, hosts Ryan Henderson and Brett Schaefer analyze businesses and riff on the

world of investing. As a quick reminder, Chitchat Stocks is a CCM Media Group podcast. Anything discussed on Chitchat Stocks by Ryan, Brett, or any other podcast guest is not formal advice or recommendation. Now, please enjoy this episode. Welcome into the Chitchat Stocks podcast, a podcast to help you find your next great investment. Today, we have Drew, founder of Speedwell Research, as well as his own investment advisory services. Speedwell Research produces in-depth, high-quality reports on companies we've covered before on this podcast, such as Coupang, Airbnb, stuff we've covered with Drew, and many others. I'd go ahead, if you like what Drew has to say today, if you want to learn more about Speedwell Research, we will have a link to the

website in the show notes. But today, we're taking an in-depth look at a company that is in its sharpest drawdown ever. It's a FinTwit favorite. It's one that has turned into a bit of a battleground stock, the Canadian national champion Constellation Software. Drew, let's kick things off with why it's in a drawdown. It's down 50% from highs. Before this, the only ever drawdown I think it had was maybe 20 to 25% a few times. What's happening today? AI. That's it in a nutshell. And everyone is concerned that they have no idea what this means. And to be fair, it is kind of hard to wrap your head around exactly what the future could look like. And so we'll talk about different scenarios and different specific risks. But I think it is

somewhat a case of the baby being thrown out with the bathwater before kind of figuring out and thinking through what the actual ramifications would be, you see something like Anthropic rolling out a bunch of different coding tools, creating software. And a lot of people try to make this connection that, oh, well, they're a software company. They own a lot of software. And if you look at the UI of the software, a lot of it's not good or great. A lot of it's kind of old software. So shouldn't this be very easy to be replaced? And I think that's kind of the very superficial sort of take a lot of people are just doing. And they're kind of shooting first, asking questions later and that's just kind of the overview of why it's sold off so much because

nothing has shown up in the financials yet uh in terms of you know deterioration of financials churn anything like that it's all hypothetical what could happen in the future okay and i want to get in want to dive deeper into hopefully debunking this ai myth i don't know if it's too far to say ai myth but this ai uh narrative but before we do that let's just for anyone less familiar with Constellation Software, can you give us the basics of the business and sort of how it's evolved to in sort of greater scale today? Yeah. So very simply, Mark Leonard, who was the founder of this company, basically realized early on that there's all of these very small niche vertical market software companies that sell software to stuff like cemetery operators,

chicken coop software uh software to dentist office all sorts of very specific things bus scheduling software for the ontario municipality and this software doesn't have a great natural home to be sold to because the markets are very small sometimes you're talking about a five million dollar tam and so a private equity company doesn't want to buy that uh and the owner of the software company eventually is going to want to sell it and he's not going to have a lot of options of who to sell that to. And so this was back in the 90s, he started noticing that he could buy a lot of these very small businesses and just own them, similar to Berkshire Hathaway. I'll just own the business. It'll produce cash flow. There's no reinvestment opportunities really in these

businesses because the TAM is already fully exploited, but I'll take that money and buy other ones. And so that was what Constellation Software was. It was an acquisition machine of all of these vertical market software businesses that he'd try to buy at 20% plus hurdle rates. And so even though there wasn't a lot of investment opportunity in each individual business, he took the extra cash flows to continue to acquire more businesses. Now, what's been happening, and if you're aware to have this call, you know, a year ago, the real kind of risk in the business model was how long can you continue to do this? You know, you have over $11 billion in revenue now, over $2 billion in free cash flow available to shareholders, and how long can you

continue to deploy this in all these small little niche opportunities? And that's a fair question. And so they've been transitioning their business model a little bit from focusing just on these really small software companies to also doing, you know, one-ish acquisition of a larger software company a year. And that's what's been taking up kind of more of the cash flow deployment as of late. And so if we go back, you know, again, a little bit ago, that was kind of the risk is how much can they continue to deploy free cash flow at these high rates of return? And so they've de-risked that a little bit by showing they can do these larger acquisitions. I think we'll talk a little bit later on more on capital allocation, maybe moving outside a little bit of traditional

vertical market software, but that is the business in a nutshell. And I'll say one other thing is that this is a business because again, all these vertical market software companies, they kind of dominate the TAM it's already in. These aren't growth businesses. These aren't businesses that were ever assumed to be growing a lot and so they pay a very low price for them the return is high but they're not businesses that are assumed uh to you know have a very high terminal value in some sense they'll own the business uh they'll run it as best they can you know give customers whatever features they want and all that but it is ultimately more about you know pulling the cash flow out of the business and putting it elsewhere rather than reinvesting in you know a massive tam

opportunity or something like that and so that's kind of a distinction between a lot of the other software companies you'll hear about in constellation these are mature companies that are ready cash flow cash flow profitable and the cash flows they're getting they're not putting back in the business they're pulling them out so i'm picturing like with these smaller acquisitions i'm picturing sort of a three to four million dollar revenue business obviously it can totally vary maybe founder-led four or five developers on the team i obviously this is kind of a random scenario. But how often when Constellation makes that acquisition, do the founders or whoever was running it stick around? Or is it like curious how they're run once they're under Constellation's

umbrella? Yeah, so it's very decentralized. So keep it as an individual business. Very often, the founder will stay around for some period of time during a transition. Maybe there's an earn out or something like that. But they try to keep as much of the original employees there as possible, not dismantling the business, which is part of kind of the selling point of why someone sells to Constellation Software is the fact that they're going to take care of the business. You know, he says, when you sell your business, it's like your baby. You don't want someone coming in and ripping it apart. And so it stays kind of its own autonomous unit. As people, you know, kind of leave, they probably won't continue to hire more people under there. But there's all

these, there's, you know, the overall, the conglomerate as a whole, Constellation Software has these six different business units. And then each of the business units have subcategories, The subcategories have business units under them, and then each of those will have their own kind of array of different companies that they acquired. Okay. Let's not waste any time. Let's get right to the question I think everyone wants us to ask. Why does the market think – I guess let's talk the bear case here first. Why does the market think Constellation is at risk of disruption, and do you believe that? yeah so let me try to give the strongest um bear case i can so right now you basically have the ability to spin up code very cheaply very quickly something that used to take many months a lot of

iteration can now be done on the fly you can get a product that is as good or better than the existing software product the ui can be better it could be custom made to a person and then you also don't have to pay monthly or annual fees to anyone because you could just build the software yourself and now it has you know and it could look better it could be customized for you and then maybe over time too, you have AI agents that can use the software for you. And so you don't even need to use the software yourself. It's now an AI agent that's doing everything for you. And so that's kind of the scariest scenario to paint because you're kind of disrupting or disintermediating Constellation software in two layers there. You're disintermediating the software, the tool,

and then also the end user too with an AI agent. So we're getting rid of the software and we're getting rid of the user of the software because it's going to be AI all around. That's kind of, I think, the fear that people have. And so it's a fair fear to have. And maybe if we're looking on a long enough time frame, I don't know what time frame that would be, it could eventually happen. But if we're talking practically about the actual moats that exist for these companies and how hard it would be and also the risk involved in doing all this today, it seems pretty far out. And I'll start kind of refuting kind of this bare thesis that we just laid out where, once again, it's kind of two layers to it. One, AI creates the software, the software is cheaper. So people

use the cheaper software. This could be a business owner that does it themselves. And so they're replacing Constellation softwares. Or it can be someone else who's a new AI company that builds the software and then tries to go out and undercut them on price and sells it much cheaper. And then the third sort of thing kind of off in the distance is this AI agent idea where maybe you don't even have a user of software altogether because it's AI all around. And so kind of taking those in order, The first one, the thing to keep in mind is that whenever a business builds a product, having a better product than a competitor is not sufficient enough to build a business. It really isn't.

And, you know, one example, we could just think of Coca-Cola and blind taste test. A lot of people prefer other sort of drinks. They'll prefer Pepsi. They prefer new Coke to old Coke. But still, Coca-Cola, their advantage isn't in the fact their product tastes better. It's in the fact they have the brand. It's in the fact they have the distribution. You could get it, you know, all over the world, basically.

And so there's all these different business factors that lie outside of the actual product itself. And so what's happened when AI can now create software and create it really cheaply is it means there's more competition on the product layer, but it doesn't change distribution. It doesn't change the fact that you don't have a sales force going out that's going to a farmer out in Oklahoma who's using your chicken coop software, and how are you going to get him to switch? And so it doesn't change all these other dynamics.

And by the way, a lot of the software constellations customers use is already really old. The UI is already really antiquated. And so this was never software that was hard to create. There was already an opportunity for a single engineer to recreate the entire software stack of this VMS company, but it wouldn't be a successful endeavor for them because you won't be able to get them to switch. Because then this kind of gets into the second aspect of this, is that it's not just about finding the customer, which by the way, is not easy in the distribution of that.

It's not just about the service element of it too, which if you have an AI product, where's the service involved in that? People still need a human to be able to convince to trade and all that, change software. And in case something goes wrong. But then on top of all of that, you have the fact that, sorry, we're talking about the AI software product. And then we're saying on top of all that, you have the fact that whenever there is an issue with that, you're going to need a service element for that.

You're going to need someone to be able to fix the AI software. And so there's all of these kind of elements at play here. And then the most important piece of which is going to be the mission-critical aspect. And so we could think of kind of the asymmetries involved whenever you're switching something like that that is mission-critical. Okay, I save, you know, one point of margin, less than one point of margin. Maybe it's even negligible. And I'm risking potentially losing all of my revenues. I'm risking losing customers because if there's any issue whatsoever in this new software I'm introducing, I have no idea how to fix it.

I just went to a chatbot to create it, or I just was sold it by some AI company that has no support team. And so that is kind of an issue with that. When you're thinking of the software running the entire business, it is critical to all of the revenues you generate. And if you pull this out and it doesn't work, you do not have a business. You are not functioning an hour later as a business. And that is a scary thing. And so even if you got to the point that people are really convinced it works, it's a little like AV right now, right? A lot of stats show autonomous vehicles are more efficient than a human driver. But guess what?

We still don't roll out AV because we're still kind of scared of it. And we want it to get to the point that it is much, much, much better than a human driver before we go ahead and push this out all over the world. And so it's a similar thing.

It's not enough that it gets close, which by the way, AI is not at the point that is as good as existing software because AI is still probabilistic. And very often when you're creating software, it's deterministic. And so any sort of mistake in that whatsoever, it can wreck everything. And there's other mistakes too, involving integration. And then

there's an entire aspect of retraining your employee base. And so just to kind of stay on this idea of it being mission critical and why you don't want to switch, it's just not a good risk reward. If we come back to this idea that every sort of product you have has to have a sort of benefit to the consumer, we could think about what is the consumer benefit of this software being created by AI. The only real benefit is a lower cost. There's a lot of times where businesses are not thinking about saving money if the cost is potentially a loss of efficiency, which is if I'm retraining employee base

or potentially losing customers, losing revenue. It's just not a good trade-off that I don't think most people realistically make. Will there be some business owner that loves playing with tech and say, hey, I could vibe code this whole thing and he rips it out and replaces it? There's gonna be stories like that.

I think it will happen, but is that gonna happen in mass across all of their different businesses, all the different verticals? No, because the average person who's buying the software is not that tech savvy. A lot of the software, by the way, is still on on-prem. They don't disclose how much, but that means it's on an old server. It's not on the cloud. It's not even internet software. And so this is very old stuff that you download with a disk.

These are not tech forward sort of businesses. And so here's all these different aspects to kind of just summarize real quickly. You have the fact that it's mission critical. You have the fact that the employees are kind of trained on it. They're used to it. You have the fact that there's an asymmetry involved in a small amount of cost saving, potentially losing loss of revenue and customers and all that. And so that's kind of addressing this first aspect of the software, you know, them being able to create their own software to replace it. And then it's also touching on a bit to the idea that these AI native software companies are going to be eating the whole world because they're still going to need the distribution, the support and all that. And

then by the way, Constellation Software has a professional service line item of revenue in their revenues, which if you look at that, what that is, is that's them actually very often sending a person to the company to build the software that the customer wants. And so in that case, they're already customizing it to the way the customer wants it. And so that's kind of addressing that too, when you're talking about the AI software company. And then the last one is AI agents. We could touch on that in a second, but I feel like that was a lot right there. no yeah we can do a separate maybe ai ai agent talk but maybe we can hit on some of the other bear cases that have popped up i know when a drawdown occurs there's always a lot of things

that come out of the woodwork um price can drive narrative people can go why is the stock down some guy comes up with an idea was probably because of this and it was there the whole time And what fair case, if you were a shareholder or any listener was a shareholder, what fair case against Constellation would keep you up at night? Which one would scare you the most today? Which one do you think has the most validity as a potential concern for the business over the next, say, decade? Will the U.S. Consumer Confidence Index be above 101 in March 2026?

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Go to ibkr.com slash forecast and turn your views into IBKR Forecast Trader contracts today. Last trading day for this contract is March 22nd. I think we have to have humility whenever you're dealing with the future and something as open-ended as AI and what that could really mean for technology. And there's a reason why Warren Buffett

doesn't invest in technology companies. And that's just because you have to acknowledge there's tail risk of uncertainty all the time. And maybe you don't know what you don't know. And I think that for me lies a little bit more in this AI agent risk. That one is a little harder for me to really understand how that could all play out, whether or not that can happen at the OS layer, whether or not that's getting to the point that it's actually sitting on your computer, this sort of agent, and it's using the software or it doesn't need to use the software because it's an interface layer that's an abstraction for

it and it could go deep into the database itself. I know it's kind of hard to really understand all of that. I know that certainly we're not at the point that businesses would feel comfortable with having an AI agent kind of run loose in their business processes, doing all sorts of things that they can't understand what it's doing. But at some point in the future, once it's really proven itself, is that possible? Yes. Then there's also a bunch of slew of companies that are trying to integrate it into their products to give it guardrails. And so maybe that's also the way we go. So the software, it's the software plus the AI agent. And maybe the software interface doesn't actually really matter so much. It's the AI agent aspect of it that becomes more important. And I'll

have a video dropping on ServiceNow probably by the time this releases, which you can find at, if you go to YouTube, just searching Drew Cohen money. And that talks a lot about this AI agent risk. And ServiceNow is trying to kind of be a wrapper that keeps the AI on their platform. but there's some risk that the AI is not within any individual's platform. It's kind of outside of all of this, just operating on its own and circumventing everything. And it's a little weird because when you think of disruption, you're usually looking at like one vector of attack. But this is kind of something that's hard to conceptualize. The AI agent can attack the UI on the front end because it's a new interface. It can go right through all the middleware,

all the software, the platform as a service stuff, go directly into unstructured data, just read that it doesn't mean that's how everything's gonna you know unfold and all that but it's just like a lot of open possibilities as to what is possible and so all of that is scary but then again you know the future doesn't tend to change that quickly even you know in this AI era you have AI that makes a lot of mistakes and we're not at the point I don't think that you really want to trust your business to it and I don't see that happening in the next several years and when you think about, you know, their businesses and the point I was making earlier on them not having a lot of terminal value is these are not, these are already end markets that it's kind of unclear

if they're going to be around in 15 years from now, 20 years from now. I mean, it depends the end market, but some of them, you know, they service software for linear TV stations. Is a linear TV station going to go and redo all of their tech stack for something AI forward right now? I don't think so. But, you know, who knows if all of a sudden it's like basically free and included in like a windows os update or something then maybe but it when it gets too far out there because i can always at least think of very far out risks that could kill a business or almost always and it does just because the risk exists that doesn't mean you believe it's going to happen at the end of the day these are humans making all these decisions and humans tend to be pretty

habitual and they don't tend to want to risk everything uh on the farm they don't tend to want to you know swing for the fences with this whole new ai process that could potentially blow up their business for a small gain and maybe that because the gains in efficiency that ai brings you could get them traditionally while still keeping it kind of within a software wrapper which by the way constellation is already doing constellation can introduce ai to all their processes to all their software so now the question is whether or not they want to go outside of their existing software vendor to do it on their own to save a little bit of cost that's where i'm skeptical it yeah two points there like the for the linear tv software i can't imagine the

there's like a huge startup competition there everyone trying to go after that market like the new cs grads from stanford or whatever like let's go get linear tv software but the other one And this is the idea that customers are going to build it themselves. I have, I disagree with it to begin with from a lot of software companies, but for Constellation Software specifically, it makes no sense to me. Like, I was watching your video and one of them, one of the ones you called out was like software for the dentist's office. Who at the dentist's office is going to build this alternative? The dentist seems busy. The assistants seem busy or might not have the technical expertise. It just, yeah, it really doesn't make a whole lot of sense to me. Uh, one thing I did want to touch on, and you mentioned it earlier, is the moving towards larger companies for targeting acquisitions. Do you, I guess, maybe talk through that evolution a bit. How has that played out for them?

And is there risk that they are having more competitive deals on the larger size, having to pay more or kind of compromising on price because there isn't enough as much deal flow as with smaller companies yeah they still um benefit from being in kind of a weird area where there's not a ton of competition when you're talking about like middle market software companies and they'll find these special situations i mean there are private equity companies that work there and all that but they'll find these special situations where for whatever reason, they're the best home. Optimal Blue was part of Black Knight and it was part of a divestiture to get an acquisition closed. It needed to happen quickly. They got

paid, I believe it was a high single digit EBITDA multiple and they were able to buy that asset very quickly and it's a permanent home for it. There's another one, Allscripts, that's more healthcare kind of IT software. And so that was another instance. That business was kind of suffering though, but it was part of a carve out of a larger corporation and they were able to just take out that one little piece of it. So they find these opportunities to do it. Is there competition for these deals? Of course. Everyone, if they see free money, they're going to go for free money. But there's usually enough opportunity out there that for one reason or another, people are freaked out. They don't analyze the deal right. They don't

want to put in the work, whatever it is, or the size is just wrong for the private equity firms out there. They've been able to find something, at least for the past several years. More lately, for the first time, they just did an equity investment in something called a SECO. That's a Polish IT company. And so they're not even buying the whole company. They're doing an equity investment in it too, which has been something new for them. But as long as it's a good investment, that could kind of make sense for shareholders and gives a new way for them to deploy capital outside of absolute acquisitions. That puts them a little bit more like Berkshire Hathaway, who will buy public equity. So they have been scaling that up. I think I wrote the

report in three and a half years ago or something. And at the time, they were doing 150% less in free cash flow. And so right now they're doing 2 billion. And so they've scaled up cash flow that much. And I thought it was very doubtful whether or not they'd be able to scale the acquisitions up alongside that. But they have. But if you're looking at it since then, they've been able to deploy more than 100% of free cash flow and acquisitions. And they've been able to do more than 100 because they've taken on a little bit of debt on the individual company level. So it's ring fence debt just on the company, not on the holding co level. But that's how they've been able to deploy even more capital. And so not not that I'm a huge fan of debt. But if you are able to

take on a little bit of debt, it does help, you know, improve the returns and help some, you know, take up even more invested capital. And so that transition has been going pretty well. There's a question what happens um if they run out of the you know the vms opportunity is going to still be there but you're talking about you know knocking out 500 billion dollars of free cash flow a year what do you do with the rest of it um you're that's where they're going to need to keep doing these larger acquisitions so that they're going to have to continue to do that and they've stayed mostly in software they've gone you know a little bit outside with like horizontal um software um or stuff that takes up a whole category, healthcare and all that. But that is something

that is still kind of pretty related to software. Everyone knows in 2021, Mark Leonard is talking about looking at oil assets for the tax advantages. So they have looked at other stuff. They're right now toying with the idea of getting more into payments. It sounds like a lot of that too relates to just the payments, their company's process, but there could be an opportunity there for them. So a lot of different areas they could go. Sure, that brings more risk though, if you're going outside their core competency there. But they've always been pretty conservative. Yeah, that does answer one of our listener questions,

which is what industries do you think they're going to go after? I think you answered that. Let's talk about the other large change to the business, which is Mark Leonard's. I think it was an abrupt retirement. He had a health issue and we have new leadership in place. Maybe talk about that transition and what you think the impact will be or not

because no matter how great a business is, if it's founder-led, there's always that big risk. The second leader, are they going to keep the culture going as Leonard built it up? What do you think about that? And do you think it's a risk to the business today? Yeah, so a few things. One, it was weird because they had this like AI special call

and then like a couple of days later, it's announced Mark Leonard is stepping down for health reasons. And just those two things kind of going together, I think it made it look like he was stepping down because he wasn't a fit leader for this transition to AI. That I don't believe for a few reasons. One, Mark has always been a very private person. I was never really done. There's only one podcast I think he's ever done, never really talked publicly and all that. Even stopped doing communication on writing the letters in 2017, save one he wrote in 2021 because of COVID. And so he's always been a pretty private person protecting information about himself. So it's not crazy to me that he wouldn't, you know,

want to talk about his health stuff on a call in front of all these other people. The AI call itself, I guess it was a little weird. I'm sure they're fielding a lot of investor questions and in kind of line with the way they communicate, they didn't really answer any of them. They just kind of said, like, there's a risk and, you know, it could be an opportunity. And I think that because of how frank and honest they are with their communications, probably also unsettled some people. And in terms of Mark Millard, though, you know, he's been around basically since their first acquisitions, I believe, since Trapeze, late 90s and all that. So I could be wrong in the name there, but he's been there a long time. And so this is not, you know, someone

coming in new that's going to change the culture. He's been there since the beginning. And on top of that, it's a very decentralized culture. And so where I can see him having the most impact is them going into new verticals, because at least last they disclosed any capital allocations below $20 million were being done at the business unit level. It was only when you did these larger acquisitions that it was being kicked up to the overhead office to kind of have a say in that. So these large acquisitions, yeah, and that's going to be a good chunk of capital he's going to be allocating. But, you know, again, he's not a newcomer. He's been there pretty decentralized operations and all that okay going back to the ai discussion does it do you think that it increases

or decreases the potential acquisition universe for constellation like is is this going to create a lot more potential businesses for them to acquire or is it it sounds like it's not going to hurt some of these legacy software companies but i guess curious any thoughts there I don't know, is my answer, because I could see it both ways. I could see that more software companies, it's easier to start one. And so if there's a problem, you could spin up a software company as, you know, a single engineer, get some salespeople and try to go after a small little market to sell it. I could also see, though, that it makes it much easier for existing software companies to extend out into different verticals. So if, you know, we were, you know, an ERP

management system for this legal software in finland well hey you know it's very easy now we're going to also we can also offer you hr support oh you're using someone else for that why don't you use us uh we'll you know discount it so because at least that's what i'm seeing when you're looking at service now salesforce uh microsoft some of these other big sas companies you know horizontal software they're all going into each other's lanes they're all starting to compete into other areas because they all realize that point solutions probably are going to be a very strong competitive position to be in in the future. If all you do is you just do someone's HR employee onboarding workflow, and that's all you did, then you're probably not going to make

it because someone else's AI is going to be able to take that function. And so we're going to want to create as much functionality across as many departments in each individual business in order to entrench us as much as possible. That's what ServiceNow is trying to do. That's what Salesforce is trying to do. That's what Microsoft is trying to do when it's talking about this AI agentic layer that could go the way of disappearing the platform as a service layer that usually sits on top of the infrastructure. And so all of that is kind of a big transition happening right now. And so what it means for if there's more or fewer software companies in the future, very hard for me to say. I would imagine if you're a legacy VMS company, you're not going away.

It probably means you have opportunities to expand out into other areas within that. But I also maybe I could see some of these companies, if there's like, you know, two different sort of versions of software existing, then maybe there's a little bit more kind of consolidation in that respect. Or maybe you do have software going across into different departments within that individual business that maybe before they were using QuickBooks or something. And now it's, hey, you know, we'll do your chicken coop software plus your chicken coop accounting. Yeah. And yeah, the chicken coop software makes me laugh. What was I going to ask about this as a follow-up? I think maybe, why don't we just talk about the valuation and we can come back to any other follow-ups.

The stock's down 50%, as we alluded to in the intro. Do you believe it's cheap today? And when you're looking at a company like this, what sort of metrics are you looking at? I guess if you could also include any metrics you're looking at as, okay, well, this one's increasing or decreasing, or it's getting worse. And that's maybe an indicator that the AI bear case is playing out. Yeah, so whether or not something is cheap is ultimately going to be a byproduct of an investor's own kind of required returns and

what they're hoping to get. But right now, you're looking at about $2 billion, $40 million of free cash flow available to shareholders. That's a metric, they make it adjust out, you know, the non-controlling interest. There's one adjustment I make to that number, which is I add back the IRGA liability. This is a really nerdy adjustment for those Constellation nerds out there, which is basically if they have a right to buy a larger portion of Topicus, one of their subsidiaries, and as that valuation changes every year because Topicus becomes more valuable, they mark that basically as a cash outflow that they'll eventually have to pay out to them in order to acquire that stake i back it out because it's going to be a one-time stake and

you're then going to be getting you know that earning stream so it doesn't make sense to put a multiple on it because if you put a multiple on it and capitalize it you're kind of implying it's going on forever and it's not it'll be a one-time thing so uh you make that adjustment you're looking at about 20 21 times in uh times uh free cash flow multiple uh depending on what day and given how much the the market hates the stock uh that's that's that multiple and so okay you know you look at a lot of companies you know 20 times is it that cheap and all that um keep in mind they've been growing uh free cash flow at a mid-teens rate for a very long time with returns on invested capital uh over 20 and so this is you know a company has a long history of compounding

capital at a very high rate of return and growing uh free cash flow they don't have any stock-based comp the share count is actually the same for the past 30 years 21.2 million and a lot of the other things you see going on adjustments you have to make in other businesses is really not the case with them. And so, uh, if you, if they were, if you were able to basically own this whole business today and, um, and then be able to just take all that cashflow back, uh, and hold it for a long time, you know, this sort of reverse DCF, uh, would show you, you know, uh, low double digit mid-teens, high teens return, depending on how much you want to assume they're able to reinvest that capital. So that that's kind of the range there, but then of course there's always risk.

um you know just you shouldn't there's always the risk that you know the ai is a lot more formidable than people think and uh it is able to permeate a lot more uh widely and quicker than people think i think the thing other investors miss all the time is that um just because you don't believe a risk doesn't mean it goes away and so there's always a risk something can happen you just take an opinion or a judgment on whether or not the reward is worth that risk and i think this is, you know, very salient with Coupang, for instance. You know, right now they have a data leak. People are very worried about this data leak being the end of Coupang. I'm not going to say it's impossible. The Korean government says that because of this data leak, we're going to stop

service altogether. There's some talk of that. That's certainly a risk. I just don't think that that's going to happen. But the risk exists, right? Just because I don't think that happens doesn't mean the risk doesn't go away. I just think that, you know, if you're doing sort of the math of the probability that happening versus maybe the probability that of the reward if you will the risk reward kind of trade-off uh you think that that's an outsized sort of return you make enough bets like that you create a portfolio of that it tends to give good returns over time and so that's kind of just a few thoughts on that do you think there's any chance that constellation software changes its approach around buying back stock

yes would now would now be the time for them to change that approach go through there go through what the approach is for for listeners that don't yeah so yeah mark leonard hasn't liked buying back stock and they never had because he always felt like the company had more information on the business than the investors so he kind of felt like it was like insider trading and stuff and they've talked about this he's kind of at least in the last agm been like, yeah, I guess maybe if we, you know, vocally say it out loud, what we could do well in advance or give a price or something, I'd be open to it. But also now he's stepped down. And so I don't know that he doesn't seem like he would quite have the temperament to like insert his

opinion on something like that after he left. And so it's possible that changes. It's also possible that they still find better reinvestment opportunities, though, that return more than their stock. And so, you know, that's kind of something to keep in mind, because they do have a hurdle rate of 20%. And that assumptions of getting the 20% on a stock repurchase here, usually, it'd be a hard, it wouldn't be in all scenarios, you would get a return like that. And so that's kind of my way of saying that they probably would want to be even more conservative when repurchasing stock. Having said that, if they don't see other opportunities or something, or they want to deploy some capital, it's possible. The other thing that's kind of

interesting to think about the stock sell off is the thing. Another thing people are worried about a year ago or so is that with the stock being really expensive and employees being forced to put like 70 percent of their cash bonus into the stock, there wasn't like a great probability of high returns at that point. And now that the stock's a lot cheaper, maybe employees actually want to stick around more. They're more motivated and all that. And so just kind of something else I think that's worth mentioning there. But yeah, they could change their approach to buying back stock, but I wouldn't be surprised if they don't. All right, folks, before we move on, let's talk about our home for investment research, Fiscal AI. Fiscal AI is the complete

stock research platform for fundamental investors. We use it every single day here at Chit Chat Stocks. It has everything you need to research individual companies from 20 years of financial data to company-specific segments and KPIs, earnings call transcripts, Morningstar reports, and insider ownership data, and much, much more. And they just lowered the price of their highest tier by 60%. If you want a complete enterprise-grade financial data terminal, check out Fiscal.ai. If you use our link, fiscal.ai slash chitchat,

you will automatically get two weeks of Fiscal Pro for free, no card required. And if you want to upgrade, our link will get you 15% off any paid plan. Again, that's fiscal.ai slash chitchat. The link will be in the show notes. All right, listeners, I want to take this time to remind you about the Emerging Moats Stock Research Service,

a newsletter that will produce a stock research report every four weeks, regular updates on existing stocks in the Emerging Moats universe. We have an upcoming schedule, including a research report on Wix.com. We have Interactive Brokers, American Express, Nintendo, Airbnb, Nelnet, and much more. Please, if you want, reach out and get a complimentary free trial. You can do that by contacting me through the link in the show notes and giving me a dm on substack i hope you'll try out the service if constellation did not perform well as an investment let's say by not by not perform well let's say it's flat over the next five years

the stock or the earnings the stock okay why do you think that would happen or actually maybe let's say earnings didn't grow uh over the next five years why do you think that would happen That would be much more concerning. Anything can happen with the stock for any sort of reason. But cash flow is not growing. I think there would have to be some version of this thesis turning to be true, where AI and software is kind of cannibalizing some of this business. Or for some reason, churn is just much higher than people anticipated. It really would have to be something like that, because this is not something we've seen in the past 30 years. So it'd have to be a new risk that's weighing on the business. okay i think we're kind of we've touched most of the basics with constellation software i guess it's kind of interesting because it's like i don't know if i've ever seen a narrative change so quickly on a company where well i shouldn't say that but it felt for like five to ten years like this was a company that could do no wrong probably every time yeah yep and now everyone And, well, not everyone, but a lot of people seem to think it's really at risk.

What do you think most investors misunderstand about Constellation Software? I think it's maybe also a misunderstanding of business in general, which is just that just because you have a product doesn't mean you have a business. And there's all sorts of stories of startups historically that created similar products that then their competitors or something went on to be very successful. and that's because the product is seldom sufficient to create a successfully lasting enterprise. You know, you could think about why Friendster failed and Facebook was successful and a lot of people might think

it has something to do with the product, their go-to-market and all that. Nope, it has nothing to do with that. It's actually very simple. They did not properly spend on servers when the business required them to spend more on servers and instead they spent it on marketing and other sort of tools that they're busy creating

instead of just putting more compute behind that which slowed webpage times And when web page, when web page time slowed to, you know, 20 seconds, 30 seconds, some people reporting people just turned. That was it. It was really simple. It was not, you know, anything crazier than that. And then why was Facebook so successful?

Well, one of the things they did really early on was they gated growth. If you remember, they started in colleges and they went college by college. Now, we may say, we may look at that and say, oh, they were testing the product and reiterating it. know. He knew that whenever he opened up to a new college, everyone would join on it if it was successful and they did not want to offer a poor experience. And offering a customer a poor experience is the best way to make sure they never come back. And so he gated growth for a very long time. It was college by college, just the IVs, then just education, then just focusing on a long

time before he opened it up to anyone that could create a Facebook account. And so the lesson there is that if you are looking at some of these companies that create, you know, very impressive looking software, they don't have a business yet. You still need someone to sell that you need someone support that you need someone to support the software, every iteration of it, every potential mistake that can happen with it, every customization that a client can want, you need sales, you need all sorts of different things to support the actual business. And so I think that that's something worth kind of keeping in mind, because there's a lot of instances where someone can have a better product, but that doesn't mean it's going to be a winning business. Yeah, that's a good

point i can ask claude to build me a crm tomorrow but it's a lot harder to go out and get the fortune 500 as customers uh let me uh let me ask one more question around yeah culture what what makes the constellation culture special people say oh they have a great culture well what exactly do you think they've built and why is that durable i think it's just a strong meritocracy with a lot of buy-in because they have employees, you know, forced basically to buy stock in the enterprise. And it's not, they don't, they're not given RSUs and they're not given stock options. They're forced to use their own cash to buy the stock. And that creates a sense of ownership. And that means you care about the business, you care about the results, and you

actually have a skin in the game. And it's not just, oh, well, you know, if this goes really well, I'll have a few million dollars of stock options. If it don't, whatever, I'll go to the next company and can play this game again. It's a no, this was your actual money that is now on the line. And the downside is you lose the money you invested in it. And so I think that's been a big part of it, real meritocracy. There's also the fact that you have all these different business units that are competing for these deals. So there's a healthy level of competition to get deals done. But then you also have Mark Leonard, who for 30 years was very strict on the return on invested capital. He has his own investor letters, very similar to Buffett, who would write

And that really instilled a lot of culture, a lot of focus on return on invested capital. The important things, not focusing on growth, focusing on investment returns. And a lot of times people confuse that. Even big CEOs confuse that. They go for market share and revenue growth, even if it's not actually a good return on invested capital. The same thing that can happen with acquisitions, and it happens very often, actually, this tricks investors a lot, is a business will call an acquisition accretive because the

EPS went up. That does not mean it is accretive. If you are deploying capital, your earnings better go up. The question is whether or not your return on invested capital of that incremental deployment was net beneficial to the business or destructive because you can go out and borrow a million dollars and go buy a business that has a 5% return on invested capital and increase your earnings. You didn't do a great job. And so this is something else that I think he's really helped instill into the culture is the return on invested capital framework. And then also a lot with experimentation. There's a lot of times they've looked at their organic growth and they said, it's not really high. Why is that? And so they've run different experiments where they say, let's spend more money on R&D. Let's track what the returns of that is versus if we just spend it on acquisitions. And they ultimately figured out the return on R&D wasn't as high as just buying

more of these companies. So they stopped investing that much organically. But this was something that they ran the test for and you talked about it for like four or five years in the investor letters. And so there's this other idea that, you know, of experimentation being kind of modest with your knowledge. I think the AI calls a great example of that. You see some of these CEOs go out right now and they're just, you know, very adamant on why they know exactly how the world of AI is going to unfold and why their business is going to benefit from it and be the best. And instead, they go out and go like yeah there's some risk out there they don't give anyone any comfort with that but they're just being intellectually honest that the risk exists and ultimately as an investor

that's your judgment uh to decide um whether or not you you think the world will unfold one way or another yeah it shocks me that more more companies have not adopted the approach of is forcing the wrong word uh forcing employees to buy shares i mean compelling yeah convincing and it's remind me it's like as a percentage of their bonus they are yeah bonus okay yeah and i think they get a small discount it might be 10 15 uh to whatever the stock is at the time but yeah yeah you'd think more people especially well maybe prior to this drawdown people would point to constellation and say we should we should copy that model because it's a good reminder of the ripple effects it has across the business like

if you're a ceo and you have hurdles revenue hurdles or like pure any hurdles without a denominator you're you're going to sell it to to investors whereas if you just own the shares outright and you made that investment you probably want to be as honest with yourself as possible because there's no point in lying it's not like you're getting stock options based on it so yeah and you know nassim talab uh has kind of talked about skin in the game he has his book on that and he makes the point that having skin in the game isn't just participating in the upside it's participating in the downside too and that changes the decision framework when you have uh skin in the game on the downside as well and so this is a way to actually create that because

you're not just looking at options that oh if it goes above you know uh 250 amazon strike price then i'm going to be a millionaire instead it's i'm looking at a million bucks right now in my bank account and this goes away unless unless they unless i you know act properly in the business as well. And so I'm going to work towards something greater. And I forget the exact stat. I wish I remembered it. But he at one point said Constellation Software like created more, it was like over a thousand millionaires or something like that. It was a lot of millionaires because of this forced, you know, stock buying and then also the stock and business doing really well, which then, you know, makes people want to buy into that. It's one of the few businesses out

there that is truly aligned with, at least in my opinion, executives, employees and shareholders customers I'd say so as well but I think that about covers it Ryan unless you have anything else you want to add there Drew tell us where listeners can find you YouTube channel research website whatever you want people to go click on to find more all right here are all of the plugs there are many plugs to do right now so research can be found at speedwellresearch.com that that's will have an in-depth Constellation software report. It actually was sent in to Mark Leonard. He commented on how thorough it is and all that. So you could read that actual report there. And then I do quarterly updates on Constellation software. We also cover some other 20 businesses.

You get access to all that other research there. We have a podcast that is free. The Synopsis is the name of the podcast. We have a podcast episode that's two hours long just on Constellation software, breaking it down. We've also more recently talked about them too, more updates and all of that. If you go to speedwellmemos.com, that's where you get the free stuff. And then my YouTube is you could search up Drew Cohen Money. There's a Constellation software video, a lot of other software videos coming out there. And then one last plug, if you go to drewcohenmoney.com, there's another free newsletter called 5-Minute Money. That is shorter write-ups I'm trying to do because my research reports are like 100 pages and no one has time for that. So 5-Minute Money,

which you could get at drewcohenmoney.com. That's going to be really quick newsletters, easy to read, usually not five minutes, usually more like eight. But I think that's all the plugs. It's perfect. I mean, you guys are putting out so much stuff. Yeah.

All right. I think that's going to do it. We'll have links in the show notes. Thank you, Drew, for joining the show. Thank you to the audience for tuning in. Hope you enjoyed this episode. We want to remind listeners that Brett and I are not financial advisors.

Anything we say or discuss here on this, anything Brett or Drew or myself say is not formal advice or recommendation. We may be shareholders in the securities discussed in this podcast. Thank you all for tuning in and we will see you all next time. Thank you for having me. Don't you wish you could just hit skip on the worst parts of your life? You know, the same way you can skip an ad? I get it. I'm Siyaya and I live in Ice Cove.

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