Topicus

Constellation Software's Baby Bro

Dec 08, 2023

Introduction

Everyone and their mother is searching for the next Constellation Software CSU 0.00%↑, a Canadian darling that’s generated more than 36% compounded annual returns for shareholders and created life-changing wealth for those lucky sods who got in early and never let go.

But what if the next Constellation Software… is Constellation Software? Or rather, Constellation’s baby brother, Topicus TOI 0.00%↑, a spinoff from the behemoth itself, a company that follows an identical business model of targeting niche vertical software markets, with the only difference being that it operates in Europe instead?

There’s a lot to like about Topicus. It’s following not only the footsteps of giants but also a repeatable and scalable model for resilient growth. The potential opportunity can’t be understated either - Topicus is a chance for investors to rewind the clock by nearly a decade and invest in Constellation when it had the same market cap as Topicus does now. Since then, Constellation has been an eleven-bagger.

Let’s dive into Topicus and see if this business has the potential to repeat that success and deliver fantastic returns to investors willing to be patient and play the European consolidation game.

*Disclaimer: I am not a financial advisor, planner, analyst, or any other certification related to finance. This article, and everything else from Hourglass Investing, is intended for research and entertainment purposes only. Please don’t make any investment decisions based solely on what you read.*

**Disclaimer: I do own shares in Topicus and as such may have optimism for or bias towards the company’s future potential for success**

Only Got 5 Minutes? Here’s What You Need to Know

Topicus is a spin-off from Constellation Software, a behemoth in the space of vertical market software (VMS) acquisitions, and offers investors an opportunity to potentially rewind the clock on Constellation’s >1000% gain over the last decade.
Similar to Constellation, Topicus is a serial acquirer focusing on consolidating small, cash-flowing, and very niche VMS providers. Acquisitions are wrapped under a decentralized management model and organically grown through revenue expansion and cost synergies.
The management team is highly incentivized to create shareholder value and align themselves with shareholders through compensation structures.
Unlike Constellation, Topicus operates in a much more fragmented European market that may offer even more opportunity for growth than Constellation has seen.

Snapshot (as of Writing):

Market Cap: $7.8bn
Enterprise Value: $8.3bn
Revenues: $1.1bn
Gross Margins: 35.3%
P/E: 84x
EV/S: 5.3x

Note: As Topicus is a Canadian listed co., all dollar values in this report will be in $CAD unless otherwise stated. However, please note that Topicus filings are reported in Euros.

The Company

A dive into the company history of Topicus as we know it today is actually a dive into what used to be two separate companies - Topicus, and Total Software Solutions (TSS).

They are both very similar companies. TSS is based in the Netherlands and runs a very similar business to Constellation Software - creating and acquiring vertical market software (VMS) offerings. Vertical market software refers to software that is designed specifically for some vertical niche or specific use case within an industry.

Where Constellation’s business has primarily focused in North America, however, TSS operated in the even more fragmented European market (and at a much smaller scale). TSS operated as a leading software provider and decentralized acquirer in an array of niches within this European market, qualities that attracted Constellation’s interest in the early 2010s.

Looking to pursue expansion into the European market, Constellation acquired TSS in late 2013 for $360m. After a short ramp-up period, the company was in full swing as an operating group of Constellation. Under this arrangement, TSS managed itself autonomously to acquire VMS providers in Europe while having access to Constellation’s cash reserves and organic growth playbook. This allowed TSS to significantly ramp up its own acquisition rate:

Topicus, similarly, is a Netherlands-based company with a dominant position as a European niche software provider, particularly in the areas of finance, education, and healthcare. However, where Constellation and TSS have grown with a focus on acquisition, Topicus has placed more emphasis on in-house creation of software verticals.

Though Topicus still makes acquisitions, they also created an entrepreneurial culture focused on encouraging growth through creation. It’s an environment where engineers are free to create their own niche VMS, A/B test products, or even branch out to more random creations, such as creating their own beer labels or building a pizza oven for the staff.

Topicus employees are incentivized to work on these problems for the personal challenge and entrepreneurial opportunity, but also for potential ownership - Topicus has in the past spun out several entities that started as a group of 5-7 engineers working to create a specific software solution.

Topicus was acquired in 2020 by TSS, and Constellation’s management announced soon after their intention to spin off both TSS and Topicus as a combined entity under the name Topicus. The ‘new’ Topicus would work the same as TSS had pre-acquisition, essentially operating as the independent European arm for Constellation Software, which retained a 30.35% ownership stake in the spin-off to go alongside a super voting share.

But the spin-off provided a few advantages: a separate public listing allows Topicus to raise more capital for accelerated expansion and acquisition in the fragmented European market. It also created a unique environment for the acquisition playbook from both Constellation and TSS to blend with Topicus’ focus on organic creation of businesses. Finally, it allowed Topicus to retain a sense of culture - part of the package deal in getting acquired by Constellation. Despite the autonomous operation, Topicus wanted to ensure the strong culture that’s allowed its success didn’t get swallowed up in a conglomerate.

This spin-off was completed in early 2021 and shares of the company went public on the TSX under the ticker TOI. Since its IPO, Topicus has delivered a total return of 42% (13.4% CAGR), while revenues over that same period have grown from $494m to slightly more than $1bn.

Its growth prospects as a public company are identical to those that Topicus and TSS had as private and independent firms - acquire and/or build smaller firms providing niche software offerings across a variety of different industries.

To this end, Topicus has three operating groups (OG) of its own that specialize in various areas of growth - TSS Blue, TSS Public, & Topicus. Under the signature decentralized management structure deployed by Constellation and Topicus, each OG can contribute to growing the company in the way they are best able.

Given that this growth is being added to a base of more than 8000 employees across 26 European countries and the >135 acquisitions over more than 40 vertical markets, not to mention the proven growth model of Constellation, I think this business has growth runway for years to come.

Company Grade: A+

The Business

The combined entity of Topicus and TSS, which from now on I will just refer to as Topicus, is focused on consolidating niche software offerings across an array of different vertical markets.

The playbook is centered around Topicus’ operating groups and their acquisition and/or building of smaller business units (BU) that provide VMS. Typical acquisition targets are stable and cash-flowing businesses that have growth opportunities and are very focused on specific niches. These businesses are then folded into the company’s larger operations to achieve cost and growth synergies while maintaining autonomy.

Post-acquisition, these BU are able to continue managing themselves and making decisions on products, pricing, investments, etc., but with decisions on excess free cash flow and capital allocation heading up to the management of the larger operating groups. Note that BU management teams are still able to make their own re-investment decisions if they wish and can send less capital towards the OGs if they see re-investment opportunities are. In fact, they are somewhat incentivized to do this to deliver higher revenue growth, as this is written into compensation packages for executives (more on these later). They are also incentivized to provide higher ROIC, which requires sending more of the cash flows up to management at the OGs - it’s a fine line to ride between revenues and ROIC, but ensures that managers are making decisions for the long-term.

It should be noted, though, that each operating group (OG) under Topicus is focused on a different area of growth. TSS Blue handles acquisitions and VMS for the private sphere, while TSS Public is more involved with a similar model but in the public sector. These are the original OGs (the OG OGs, if you will) of TSS, while the Topicus OG was brought on through the acquisition and spin-off process. It focuses on growing through creation within its four primary vertical markets of healthcare, finance, education, and social service.

Here’s a rough visualization of what the overall corporate structure looks like:

*Keep in mind that there are potentially dozens of BU under each of the operating groups.*

While the TSS OGs continue to grow through acquisition, the Topicus OG continues to focus more on “incubation” - creating smaller cells to serve vertical markets. I want to focus for a moment on this growth model, as it’s quite distinct from the model that the other two operating groups are utilizing.

The Topicus OG gives its employees the capacity to start their own projects. It provides the opportunity for employees to be involved in a low-risk entrepreneurial effort with the added bonus of significant resource backing from management.

This process typically starts with small teams of 5-10 employees (often driven by one leader) working on fixing a problem in one of the four vertical niches that Topicus serves (typically in their own time). If the projects they create show promise, they get a larger team and more resources to turn their solution into an actual business. From there, the entity can get spun off into a separate cell under the Topicus OG umbrella.

Usually, at this stage, more defined management structures come in, the cell moves into a separate office space, and a businessperson more experienced with scaling takes over management of the cell. The original team is welcome to continue working at the new cell, return to the parent company, or begin working on creating new cells.

While it may seem strange to replace the original founder, I actually like this move - creating and scaling are entirely different ballgames, and I like that Topicus is focusing on maximizing the value of the spun-off cells by implementing management that’s more experienced in scaling. This also leaves their more entrepreneurial workers to begin the next creation and really embrace the ‘serial entrepreneurial attitude’ that Topicus looks for in its employees.

Business Model

As I’ve covered, the growth model revolves around the acquisition and/or organic creation of vertical market software. Once under the Topicus umbrella, these separate entities are wrapped into the fold and grown organically. This acquisitive / consolidation flywheel is one of my favourite business models (and one I’ve written about several times now).

Even with the Topicus OG focusing on organic creation, serial acquisitions remain the name of the game, and will be how Topicus continues to grow into the future. But organic growth plays a significant part in the business model as well.

Under Topicus, VMS providers have access to the combined organic growth playbooks of the Topicus and TSS operating groups (and, by extension, Constellation as well), which led to an 8% YoY organic growth figure in the most recent quarter (Q3). Below is a chart demonstrating the organic growth figures for Topicus - it’s normal to see organic growth figures fluctuate quite a bit, but the 6.1% average over the last nine quarters demonstrates some impressive ability to grow acquisitions organically.

Organic growth for acquired businesses is largely driven by reduced expenses through economies of scale, more efficient business operations, and proven strategies for revenue expansion. The ultimate impact is more money and better margins for the acquired businesses, which serves as an attractant for other private VMS firms to join Topicus.

On top of funneling more acquisition opportunities towards them, the organic growth is also able to squeeze some extra cash flows from Topicus’ acquisitions, giving them the fiscal capacity to take advantage of those acquisitions. Finally, being able to immediately improve the underlying businesses that they acquire drives down the effective multiple that Topicus is paying for individual firms. None of these acquisitions are large by themselves, but the cumulative effect across all the businesses that Topicus acquires still serves to drive meaningfully lower “true” costs.

The actual revenue sources for Topicus vary, simply due to the fact that many of their acquisitions have slightly different business structures. The vast majority of revenues come from maintenance and recurring fees, and to a lesser extent professional service fees. Hardware sales (from third parties) and license fees also contribute very small pieces of the puzzle.

Maintenance and recurring fees are revenues recognized from customer support, as well as fees from subscriptions from those businesses that are structured under a SaaS model, hosting services, and combined software/support contracts. Professional service revenues are driven by installation services, customized programming, and training/consulting on the use of software.

Hardware fees make up only a small portion of revenues and come from the resale of third-party hardware and, occasionally, internally developed hardware for custom requirements. Fees on this are only realized if customers require hardware capacity to accompany software. Finally, licensing revenues are derived from multi-year agreements on software provision - these come from companies that receive revenues from a contract model as opposed to a SaaS structure.

Acquisitions

This will not be a list of Topicus’ recent acquisitions (we would be here a long time if it were), but rather an analysis of the underlying acquisition strategy. As I mentioned above, the acquisition strategy focuses on cash-flowing and stable companies with growth potential. These businesses are typically very small but highly focused on providing software solutions for a very specific use case or vertical market, and because of that are highly attractive to Topicus, for a few reasons.

Highly specific VMS is typically critical to operating and succeeding in an industry, which makes it very sticky with its customers. In addition to that, they face less competition than a more broadly serving software might, giving their customers very few reliable options to choose from. This gives firms pricing power and makes customer turnover very minimal - as a result, the businesses that Topicus is acquiring are very steady cash flow generators. They typically also have little need for excess cash flow to re-invest in the business beyond CapEx, so whatever isn’t needed from those cash flows gets sent up to management for re-allocation into further acquisitions.

The TSS operating groups follow an interesting model within this acquisition strategy. They will often acquire 2-4 companies that are competing with each other in the same vertical market and, through them, will have essentially a monopoly in that vertical. While this might be frowned upon (or litigated upon) in larger markets, the small nature of these acquisitions means they typically fly under the radar. It also offers each of these firms the ability to unanimously raise prices without fear of customer churn and to collaborate on improving each individual operation within the industry. The end result is better products for their customers, higher margins, and more cash flows floating to the top for Topicus.

Other bonuses from focusing exclusively on these small and specific acquisitions is that Topicus is at very little risk of significant goodwill impairments and often don’t have competition from private equity firms that typically only target bigger and growthier opportunities.

However, there is a drawback to making small acquisitions as well, and it lies in the underlying reason for these companies being small - they serve very targeted niches. And while this results in less competition, cash, loyal customers, etc., it also means that growth opportunities are quite limited, and that the markets that Topicus is acquiring in are already saturated. This con is entirely mitigated by continuing to make acquisitions, however.

And Topicus should be good at making acquisitions. Constellation has its capital allocation and acquisition process down to a step-by-step masterpiece, with stringent hurdle rates and targeted valuations that keep them disciplined with acquisitions. This methodology has undoubtedly worked its way down to TSS prior to the spin-off and subsequently to the operating groups as well, and gives me a lot of optimism for the ability of Topicus to continue growing via acquisition.

Expansion Strategies

Use the Playbooks

The growth strategy for Topicus going forward is fairly simple - rinse and repeat on Constellation’s growth, management, and M&A playbooks while blending this approach with the Topicus OG’s increased focus on creating their own VMS and spinning them off. The advantage here is that, where Constellation had to learn for itself and grind through several years of figuring out the ideal system, Topicus has access to the perfected playbook from the word go.

Take Advantage of the European Market

Constellation has found immense success in the North American VMS market, and Topicus has the potential to outdo that success in the much more fragmented European market. This offers Topicus more acquisition targets, but it also offers their customers more growth opportunity. As their customers grow across borders, Topicus is able to “follow them” into more countries and expand alongside their customer’s success.

Competitive Advantage

Lack of Competition

This is perhaps one of Topicus’ biggest competitive advantages, even if it’s not the most exciting one. There simply isn’t as much competition within individual verticals due to saturation and lack of huge growth opportunities that may make more competitors attracted to the space.

Not only is there less competition for the individual VMS that Topicus acquires, there’s also not a ton of competition for acquiring them. Private equity often doesn’t compete for these smaller and non-growthy opportunities, despite the attractiveness of the business model. However, it should be noted that this advantage rang much more true for the Constellation Software of a decade ago - the immense success of that business model does seem to have placed some more eyes on the potential of this market, though I think it’s still safe to say it’s not an incredibly competitive market.

Culture & Size

The culture at Topicus is everything. It’s an important metric for all acquirers - very few founders want to sell their baby to a conglomerate that’s going to supply a toxic and corporate culture, even if it comes with revenue and margin expansion opportunities. Having a positive culture helps to attract acquisitions, but Topicus really goes the full mile.

Both the Total Specific Solutions and Topicus OGs sport some strong cultures that help to set them apart from other competitors. This was on full display prior to TSS’s acquisition of Topicus and subsequent spin-off when it helped land the fintech firm Able in 2017 - a big leap forward into the finance vertical. Competing with more than 10 other firms to make the acquisition, Topicus was able to land the firm due to its strong incubator culture and focus on organic growth and decentralized management (according to the CEO of Able). That would suggest to me that even if more companies try to target the VMS acquisition market that Topicus operates in, the strong culture should be a key differentiator. This is further reinforced by Topicus being awarded a ‘World-class Workplace’ quality mark, which can only be awarded based on employee reviews.

Furthermore, the small size and decentralized management style that both Topicus and Constellation employ is something that Constellation CEO Mark Leonard has talked about being integral to the success of the company. It helps to retain employees while keeping them closer to products, impassioned about the success of their companies, and motivated to continue building and improving.

Learn from Constellation

I hate to keep harping on this topic, but it’s so crucial for Topicus’ future success to have backing from Constellation. As I mentioned, there are more eyes on this market now and therefore more competition than perhaps Constellation itself would have seen in the past. But few (if any) companies have mastered the M&A process in the VMS serial acquisition space like Constellation, and that passed-down knowledge will give Topicus a huge leg up over competitors, even if there are more of them.

It’s the little things that will help in this regard. Mark Leonard has talked in the past about regretting not lowering his hurdle rates for returns from acquisition sooner - as Constellation grew larger, it was harder to find acquisitions that hit those strict hurdle rates and meaningfully moved the needle for the business. It led to a buildup of unused cash on the balance sheet that actually slowed the potential growth of the business (and led to a sort of silly dividend). Learning directly from Constellation’s playbook and these sort of mistakes will potentially allow an even smoother path to growth for Topicus - in this example, by lowering the hurdle rates on acquisitions sooner to continue growing at a decent clip even once Topicus has become larger.

Business Grade: A+

Unfortunately, I wasn’t able to find a Glassdoor rating for the combined companies post spin-off. Both of these Glassdoor pages are from the original companies prior to the acquisition and spin-off, but updated recently, so perhaps Glassdoor doesn’t know there’s been a merger.

Regardless, the Glassdoor rating on both companies are fantastic. Topicus came in nicely with really strong approval for CEO Daan Dijkhuizen (who I will be calling Daan from now on, for obvious reasons - more on him in a second though) and a nearly 80% overall rating on the business overall. Reading into the reviews, most of the cons were similar to the one in the picture above - low pay at the start compared to others tech companies in the industry.

If Topicus came in nicely, though, TSS came in sizzling. This is the first time I’ve ever seen a 100% approval rating for a CEO on Glassdoor, and I’ve looked more Glassdoor pages than I’d care to admit. Admittedly, a very small sample size with just 6 ratings, but it’s what we’ve got to work with. Similar to Topicus, the complaints on TSS revolved around a lower salary.

While salaries are a valid concern for Topicus (typically lead to lower retention), I don’t think it’s worth ringing the alarm bells. Topicus offers enough long-term incentives and opportunities for growth (through spin-offs) to attract the kind of employees they want: very intelligent, young, and entrepreneurial engineers. The strong corporate culture will also play a big part in retaining talent at lower salaries, and these Glassdoor ratings seem to quantify that culture.

CEO(s)

Above are the four leaders of this company - Robin van Poelje (top left) is the CEO of the entire Topicus organization following the spinoff. He founded TSS in 2006 under Strikwerda Investments, where he worked as an investment manager. van Poelje has been the CEO since 2010, and remained in that role after the acquisition by Constellation in 2014, giving him a decent chunk of experience under the Constellation umbrella. His educational background is in economics with a post-grad in marketing and strategy.

The two fellas on the right are Han Knooren (top) and Ramon Zanders (bottom), who are the CEOs of TSS Public and Blue respectively. Knooren joined TSS in 2015 and took over as the CEO of Public in 2017. He has a pretty wide range of experiences, making stops in multinational private equity and VMS startups along his journey to TSS. Zanders joined TSS in 2011 and worked his way up to head of M&A before taking over as CEO of Blue in 2014. Prior to TSS he worked a number of management roles with some impressive tenures at each stop along the way.

Finally, Daan Dijkhuizen. Daan shows up as the Topicus CEO on Glassdoor because he is the CEO of the original Topicus, and has retained the chief role of the Topicus OG under the larger corporate umbrella. He initially joined Topicus in 2014 as a managing director before working his way up to chief bigwig in 2017. Prior to, he got a degree in engineering & management and worked for nearly a decade in a variety of managerial roles at ING.

There’s nothing terribly inspiring from the management team here - it was hard to find a ton of information on them, and interviews or anything along those lines were just about impossible. This style is very much after the heart of Mark Leonard himself, whose modus operandi is to operate in the shadows as the world’s most elusive billionaire. However, I’m fine with a more discrete management team for this business model, and the positive reviews on the Glassdoor pages put any concerns to bed for me. As an added bonus on the management front, Mark Leonard is also serving on the Board of Directors to help guide the long-term direction of the company.

As a quick note, since I usually get into the Chief Financial Officer as well, the CFO of Topicus is also the CFO of Constellation - Jamal Baksh. His compensation is tied up with Constellation’s results rather than those of Topicus, but I think investors can rest assured he’s up to the job, having served as the CFO of Constellation for more than a decade (over which its delivered >1100%).

Compensation & Ownership

The ownership structure of Topicus is largely dominated by controlling interests (public companies) like Constellation and other groups with ownership over Topicus and TSS prior to acquisition. Retail investors own a significant amount of shares as well, with institutional ownership remaining comfortably low overall at just 21% - this last figure presents better opportunities for self-directed investors to find value in Topicus shares.

Insider ownership is quite low at a surface glance, but a deeper look into this figure puts this worry aside, though it requires some deeper digging into the executive compensation. In 2022, van Poelje earned nearly $2.1m total, with $356K coming as base salary. Zanders earned $1.05m with $243K base, and Daan $811K with $363K base. Knooren isn’t listed with the rest of the management team under the pay structure for reasons that are honestly unknown to me, so I couldn’t find anything on his salary.

Compensation on top of the base salary has a very interesting structure that helps drive both insider ownership and alignment with shareholders. Firstly, bonuses are awarded based on management’s ability to hit targets on net revenue growth and ROIC metrics. For Daan, as the Topicus OG has a slightly different focus, the key metrics are organic revenue growth and ROIC. This helps to align management’s pay structure with creating value for shareholders. Furthermore, if all targets are hit and bonuses paid out, only 25% of the bonus is paid as upfront cash. The other 75% is required to be put towards buying up Topicus shares on the market and are locked up for 4 years after purchase - hence why the (currently) low insider ownership isn’t a worry. Over time, this will pick up dramatically and further improve the alignment of executives with shareholders.

Capital Allocation

The merger between Topicus and TSS should create a unique blend of capital allocation strategies. Each company has historically focused its capital towards different facets of growth - organic growth from Topicus, M&A growth from TSS.

Combining these two approaches allows each to benefit from the playbooks of the other and will, in my opinion, drive a lot of synergies. van Poelje as CEO may have a slight preference towards acquisitive growth, having served as CEO of TSS for so long, and that may rub off on the Topicus OG. Alternatively, Daan may help to instill more of a focus on organic growth on the other OGs, but it’s impossible to say for certain. For the most part, I imagine each OG will just continue to allocate capital the same as they always have - organic growth, creation, and spin-offs for Topicus, and acquisitions for the two TSS OGs.

Team Grade: A

The Industry

The European VMS industry presents a lot of challenges for Topicus - challenges that stem from operating in a region with 24 official languages, 50 different countries, and countless different cultures. Firstly, there is figuring out UI for websites & software in multiple different languages - a harder task than it may sound. Then there are the varying regulations, laws, and business practices that vary from country to country, adding an extra layer of difficulty to moving businesses across borders in Europe the same way that Constellation is able to in North America.

However, within these challenges come opportunities for Topicus - the cumulative result of these problems is a much more fragmented market for European VMS than in North America. Other firms may lack the capital or personnel required to deal with these problems, but if Topicus can successfully create a playbook to address these problems, it will be able to turn that crisis into opportunity and take full advantage of that fragmented market. I don’t have ironclad proof that this is the case, but given the long history of TSS and Topicus OGs in the European market, I’d say my assumption that they have solutions to these problems seems valid.

More opportunities arise from some very interesting research from McKinsey on the differing mentality of European business owners towards operating and selling businesses. European businesses tend to lead towards lower-risk and more conservative operating styles, which may lead to owners being more likely to sell their own businesses rather than to buy others - offering more willing sellers on existing potential acquisitions than are available in North America.

Taking a quick peek at Constellation’s revenue growth by geography over the last 5 years (2017-22) seems to back up the better opportunities available in the European market (I’m using this as a proxy as this would include Topicus’ reporting with an easy comparison to the North American market). Revenues in North America (Canada & U.S.) grew at an 18.4% CAGR over that period, while European revenues grew at a 22.6% clip. The pace of this growth has increased post-spinoff, too, with European revenues generating a 20.4% CAGR from ‘17-’20, and a 25.9% CAGR since. It’s a small sample size, but this may demonstrate the success of blending the Topicus and TSS models together and/or the increased growth capacity made possible by having more capital available as a separate listing.

In summary, I think the European market is actually more attractive than that of North America’s: it’s more fragmented due to the challenges, and together with the cultural differences towards business practices and risk tolerances, this provides more buying opportunities for Topicus.

Total Addressable Market (TAM)

It was difficult to find data on the European VMS market, but the global market should serve as a reasonable stand-in. While North America is the largest VMS market and the APAC region is the fastest-growing, a $400bn+ TAM by 2032 still leaves plenty of room for Europe’s VMS market.

It should be noted that other reports had way larger figures than these - I decided to choose a more conservative estimate, but some research had this market at $328bn in 2023 and growing towards a $473bn TAM by 2027. Either way, Topicus should have plenty of room to operate going forward.

The industry is also growing very fast, no matter which TAM figure you use - software is increasingly taking over the world and as more and more business operations move online and new services are created that require software usage, the uptick in vertical market software will be significant. This growth is also projected to receive tailwinds from the integration of 5G technologies, which will allow yet more online services. The VMS market will grow significantly and leaves Topicus lots of opportunity to grow, even if more competition enters the VMS acquisition space.

Competition

To be clear, there is a lot of competition in the VMS space - however, there is significantly less so in the market of VMS acquirers, and that’s what this section will be focused on.

Private Equity

Private equity firms are the primary competition for Topicus. Though they don’t pay as much attention to smaller and non-growth opportunities, this is beginning to shift due to the success that VMS acquirers like Constellation Software and Roper Technologies have had. There are increasing levels of attention being paid to serial acquisition in the VMS space, and there are very few barriers to entry. There are barriers to being as successful as Constellation, for sure, but that wouldn’t necessarily stop competing firms from increasing the competitiveness of bids, driving up valuation multiples, and ultimately reducing the number of targets that would be able to hit Topicus’ hurdle rates.

While the strong culture at Topicus will help to mitigate this risk somewhat, there will always be firms that are willing to accept selling to a less ideal acquirer for double (or more) the price that Topicus is able to offer, restricted as it is by the hurdle rates. Business models in this space that are oriented towards acquisitive growth at whatever price are inferior to those that focus on disciplined M&A - but they are still viable, and that may encourage PE firms to drive up prices simply to build out such a network. This would significantly hamper the number of acquisitions available to Topicus and limit the attractiveness of the market overall.

Large Cloud Providers

While these companies aren’t competing on Topicus’ acquisition targets, which are too small to meaningfully move the needle for them, large cloud providers are increasingly creating targeted VMS that pushes out smaller players and reduces the number of potential acquisitions for Topicus.

VMS Providers

An interesting result of consolidation business models is that their competitors are also their ticket to growth. Some small and niche VMS providers will compete with VMS providers under the Topicus umbrella, but are also simultaneously acquisition targets - especially with the TSS method of acquiring multiple players offering the exact same software solution.

Industry Grade: A

At a Glance:

Revenues (TTM): $1.08bn (+25.4%)
EBITDA (TTM): $165.2m (-9.1%)
Total Shares Outstanding: 81.9m (+0%)
Free Cash Flow (TTM): $224.5m (+17.7%)
Interest Coverage Ratio: 6.9

Balance Sheet: The Good

Diversified Revenue Base

Due to the nature of the Topicus business model and focus on many business units providing smaller VMS, the revenue base is extremely diversified - no single customer provides more than 5% of revenues. This gives Topicus a lot of resistance to sudden drops in revenues/cash flows if a single customer were to drop off. While such an event may impact a singular BU, downside is limited by all the other BU. They are also diversified across Europe, but because this is the only market they operate in they are subject to macro-economic downturns in the wider region.

Strong Capital Efficiency Metrics

On a TTM basis, Topicus sports some strong capital efficiency metrics:

ROIC: 7.9%
ROE: 12.7%
ROCE: 17.4%
ROTC: 10.5%

These are some very good numbers and show that Topicus is able to generate strong returns from their business model. I particularly like to see the high ROE and ROTC figures, as well as solid returns on invested capital, one of the north stars for this business (since its one of the metrics targeted by management’s compensation plans).

*Note: The 5-yr average on ROE in the chart above is skewed just due to some funny structuring from the spin-off, so the better figure to analyze on that metric is on a TTM basis.

Debt Management

Net Debt/EBITDA sits at a very well-managed 0.7x. This is a very reasonable level for a business model that leans heavily towards acquisitions. Much of the successful management of debt/EBITDA levels will come down to the strict hurdle rates set on acquisitions that help to keep Topicus from overpaying and, as a result, keep the net debt/EBITDA figure low. This is also helped by strong free cash flows that help Topicus to make the majority of its acquisitions with cash rather than debt (yet another reason that free cash flow is so important to this business).

Free Cash Flow Growth

Since IPO, free cash flows from Topicus have grown steadily from $150m to $225m, good for a 16% CAGR. Free cash flows drive the ability to continue acquiring businesses and to build a strong balance sheet, so this strong growth in free cash flows is great to see.

Very Little Stock Dilution

Since the IPO was completed in early 2021, there has been next to no shareholder dilution through stock issuance. Total shares outstanding have only increased from 79.9m to 81.9m - many acquisitive businesses come at the expense of significant shareholder dilution, but Topicus has so far kept dilution to an absolute minimum.

Bottom Line Growth

Despite posting a loss in its first year as a public company (which was largely due to IPO and structuring costs), Topicus has since posted net income of $53m in 2022 and $64m over the last twelve months. Despite a recent IPO, Topicus is no young growth company that’s going to post losses for years to come. It’s already an established and mature company with a positive and growing bottom line, and that’s a good sign for investors.

Balance Sheet: The Bad & The Ugly

You’ll find this section is a little shorter than in my normal articles, as it’s difficult to get a sense of what may be a worrying long-term trend vs. just a short term fluctuation from the current economic environment, due simply to the fact that Topicus hasn’t been a public company for very long and data is limited.

Shrinking Capital Efficiency Metrics

While Topicus’ capital efficiency metrics are strong, they’ve also declined a bit since the 2021 IPO. I feel obligated to put it on here, but it’s not anything I’m worried about - firstly, it’s a small sample size and it’s normal for these figures to fluctuate a bit over shorter periods. Second, we’re in the middle of a less-than-fantastic economy (if you haven’t heard), which can impact income and the immediate returns on investments and make it seem as though capital is being employed inefficiently. Constellation has seen similar (or worse) downturns in capital efficiency over the same period, though on the ROIC front this is partially due to lowering hurdle rates on acquisitions.

Margin Retraction

Free cash flow, gross, operating, and EBITDA margins have all declined since the 2021 IPO, but for the exact same reasons I’m not worried about the capital efficiency metrics, I’m not fussed about this. Retraction has been pretty minimal as well, and net profit margins over the same period have actually grown 100 bps.

Key Performance Indicators (KPIs)

Organic Growth

If acquisitions are the fuel that keeps Topicus chugging along, then organic growth is the fuel tank. Organic growth rates help to enable truly effective acquisitions, attract more potential acquisitions, and drive higher cash flows for Topicus to continue acquiring. This is the #1 metric I track for my investment thesis with Topicus.

ROIC & Net Revenue Growth

These are the two metrics that management seem most interested in driving value for shareholders. Net revenue growth helps to encompass both acquisitive and organic growth, while ROIC is a great metric to watch for management’s ability to drive value for shareholders. Higher ROIC firms deliver significantly better returns for investors than lower ROIC companies, so I think management’s focus on these metrics is valid and worth keeping an eye to track the investment thesis as well.

Free Cash Flow

Free cash flows are linked to acquisitive and organic growth models as well - more acquisitions, more free cash flow. Higher organic growth, more free cash flow. It also serves as ammunition for continued acquisitions into the future, and so is pretty central to the success of Topicus moving forward and a good metric to follow. FCF can be choppy and fluctuates over small periods, so it may not always be up and to the right, but keeping an eye on longer term growth or reduction in free cash flows is important for potential investors.

Defense & Offense

Keep on Keeping On - Offense

Topicus has a set strategy in place. They have a development and R&D focus from the Topicus OG, and a playbook for successful acquisitive growth and monopoly building in the TSS OGs. They don’t have to do anything crazy here to continue growing, they just have to execute on exactly what they’ve been doing.

Maintain Culture - Offense & Defense

I’ve already gone on at length about the importance of culture for Topicus, so I won’t harp on it too much longer, but truly culture is everything in this business model. Maintaining that strong sense of culture will be key to attracting acquisition targets, retaining the sort of entrepreneurial spirit and product loyalty that Topicus looks for, and providing a competitive edge as/if more competitors look to become serial acquirers in this space. In these ways culture helps Topicus to grow and maintain current market share in the industry - unfortunately, culture is a hard value to quantify and therefore track as investors, but management certainly seems aware of this aspect as it was part of the reason the spin-off was done in the first place.

Organic Growth Rates - Offense & Defense

Maintaining high organic growth rates, similar to culture, will allow Topicus to continue attracting willing sellers into their acquisition funnel (offense) and set them apart from other competitors that may not offer the same organic growth rates as Topicus does (defense).

Fundamentals Grade: A-

The Investment

Valuation

Based on TTM figures:

P/E: 84.3x
P/S: 4.9x
EV/S: 5.3x
EV/EBITDA: 30.6x
FCF Yield: 3.9%
EV/FCF: 25.5x

Topicus does not come cheap. Investors are hoping for a change to get in on Constellation when it sat at a similar market cap, and the stock is priced according to that optimism. The growth potential, if Topicus can fill those shoes, is massive, and would entirely justify today’s valuation. As it is, though, 84x earnings and 5x sales on 22% YoY growth (Q3 ‘23) may be hard for some investors to stomach.

However, my thesis concerning the valuation is that the growth potential and playbook outweighs the valuation risk. It may result in volatility, as evidenced by the nearly 54% drop from peak to trough it suffered through 2022, but this story very much revolves around the ability to be patient, ride the occasional fluctuation quarter, and allow this company to compound at a rate (hopefully) similar to that of Constellation.

In addition to that, I would point towards the valuation of Constellation, which has always been incredibly high and probably kept a lot of investors (who are now very sad) from buying shares at various points. In 2014, when Constellation was roughly the same size as Topicus, it was trading over 60x earnings, and investors that bought in then are still sitting on a 10-bagger. So if Topicus is able to follow even at all in Constellation’s footsteps, the potential returns are pretty fantastic despite the current valuation.

Further, and encouragingly for investors, Topicus is actually trading at a discount to the valuation of Constellation on a forward looking basis:

This isn’t necessarily surprising, given Constellation’s higher returns on capital metrics, dividend, and more mature business overall. But I would expect that the extended growth runway that Topicus has would place it at a slight premium, at the very least on sales metrics. TTM revenue growth was actually slightly higher for Constellation, which may help to explain that a bit, though Topicus’ revenues edges Constellation out on a 3-yr CAGR basis.

With the combination of Constellation’s valuation history (and concurrent returns), the slight discount investors get with Topicus, and the growth runway ahead, I’m actually very comfortable with the current valuation on Topicus for my own risk appetites.

Forward Valuation

Time for my customary, rudimentary, and back of the napkin math on the future potential on Topicus based on the current valuation.

Bear Case

For a full 5-yr holding period:

I assume a 25% CAGR in revenues through to 2028, which would put Topicus at $3.3bn in revenues.
Net income margins hover around the 5-yr average for Constellation at 8%.
P/E follows in the footsteps of Constellation and consistently stays above 30x. I’ll stay conservative here and assume an exit multiple of exactly 30x, though Constellation’s P/E has historically hovered far above this.
Total shares outstanding increase by 5%.
Based off $3.3bn in revenues and a net profit margin at 8%, Topicus makes $263m in net income by 2028, with EPS of $3.06.
- At a P/E of 30x and EPS of $3.06, the price per share would be $91.8. At the current price of $93.3/share, this would actually result in a decline over the coming years.

Bull Case

Let’s say Topicus follows more along the trajectory of Constellation relative to multiples. I’ll keep my revenue and margin estimates the same here, as I don’t think any higher would be very realistic.

I assume a 25% CAGR in revenues through to 2028, which would put Topicus at $3.3bn in revenues.
Net income margins hover around the 5-yr average for Constellation at 8%.
P/E follows in the footsteps of Constellation and consistently stays above 30x. I’ll be more optimistic here and assume an exit multiple of 40x, though this is still well below the historical valuation of Topicus and Constellation’s average P/E over the last 5 years (82.5x).
Total shares outstanding remain unchanged, following Constellation’s model of 0 growth in shares outstanding over the last 5 years.
Based off $3.3bn in revenues and a net profit margin at 8%, Topicus makes $263m in net income by 2028, with EPS of $3.06.
- At a P/E of 40x and EPS of $3.21, the price per share would be $128.4. At the current price of $93.3/share, this would offer a 38% upside (6.6% CAGR). This would underperform my personal benchmarks and the annualized 30-yr returns on the S&P 500 (~10%).

Even in a fairly optimistic model, I can’t quite justify the current share price on Topicus. Even if it’s able to follow in Constellation’s footsteps and maintains a very high P/E ratio of 40x, the upside over a 5-yr basis is still somewhat limited. I don’t feel comfortable projecting higher growth in EPS or revenues, nor estimating an even higher exit multiple than 40x. Though still below Constellation’s average, this would involve writing a perfect growth story into the model, which I’m hesitant to do - any hiccups along the way would throw the model entirely if I were to do so.

However, this is an incredibly simplistic model that I’m only including to give a very rough ballpark on forward valuations. I don’t offer buy recommendations and have been hesitant thus far to provide more detailed price targets, as that strays a little close to the sun for what I’m hoping my research provides to investors. This model also doesn’t factor in ROIC metrics that will likely grow nor organic growth figures that may actually be higher than Constellation’s given the increased focus on this metric from the Topicus OG and the potential effect of that on the rest of the business.

I 100% encourage you, if you’re interested in Topicus, to make a more advanced model that factors in these metrics and to entirely disregard my model here as anything more than just a very shoddy ballpark.

Risks to Share Performance

Heightened valuations present a lot of risk. Topicus is valued richly because investors maintain hope of repeating Constellation’s returns. If that’s possible, today’s prices may still look incredibly cheap. If it isn’t, or there are major hiccups along the way, the rich valuation will result in more volatile downswings and possibly mediocre returns on what is nonetheless a fantastic business.
Repeatability of Constellation’s model may draw more competition from PE or other serial acquirers - this would increase competition on acquisitions, heighten valuations, and diminish the pool of available acquisition targets that meet hurdle rates.
It seems simple to grab a model from one place, plug it into another location, and hope for the same results. Sometimes, though, it just doesn’t work the way it was intended. There are countless examples of companies experiencing just such a problem when expanding into new geographies. Constellation’s model may not be as easy to replicate in Europe as investors think, which would diminish growth and increase valuation risks.
- However, the growth in Constellation’s European segment alongside the decentralized management structure and the long history of TSS and Topicus succeeding in Europe helps allay this risk.

Red Flags

Expensive valuation
Not a long proven history in market
Investors are making a bet on a plug-and-play of Constellation’s model for growth, which isn’t guaranteed

Green Flags

Award-winning culture
Strong growth since IPO
Aligned management and compensation structure incentivizes Topicus to create value for shareholders
Growth in revs from Constellation’s European segment has been higher than North American growth
High quality business mitigates (to a degree) the long-term risk from valuation

Investment Grade: B-

The Short Story

Topicus is a fantastic business following Constellation Software’s tried and true model for acquisitive and organic growth in the niche VMS space. The spin-off offers a very unique opportunity for investors to wind it back and start over again with Constellation. If it’s capable of filling in these (very large) shoes, than shareholders who are comfortable taking on some (pretty notable) valuation risk and remaining patient with the name may be in for an absolute treat.

However, it should be noted that, in a direct comparison scenario with Constellation, Topicus will likely be focused exclusively on Europe, whereas Constellation’s growth has also been focused in global geographies. This will limit their potential growth relative to the current size of Constellation, but there is still lots of potential upside being offered.

The team & culture, decentralized management model & alignment structures, balance sheet, and the upside offered by its backing from an industry legend are all bright spots in an investment thesis in Topicus. That thesis revolves around the ability of Topicus to take advantage of a fast-growing industry in a very fragmented region by using the organic growth focus of the Topicus OGs alongside the high-return M&A processes of Constellation and TSS.

The quality of Topicus overall is fantastic, and is one of the more unique opportunities I’ve ever studied, especially with the opportunity to avoid the mistakes made by Constellation and follow a more linear growth model. However, the secret on Topicus is out (if it was ever a secret) - the valuation multiple adds a layer of difficulty in projecting potential upside for investors. Because of this risk, I believe a DCA approach with a very long investment horizon (10+ years) would be the safest bet for investors that are interested in the name and want to take advantage of the opportunity that Topicus offers.

VMS will only continue to grow with the prevalence of technology in our global society, and as such I believe the runway for this name and business model is incredible. Not financial advice as always, and please do note again that I am a shareholder in Topicus, so I am likely quite biased towards it. But there’s also a lot of good reasons for me to be optimistic as a shareholder, and I’ll be clinging onto Topicus for dear life.

Now, let’s add up the tally and give Topicus its final report card.

Report Card

Final Grade: A

That’s all for Topicus folks, I hope you enjoyed! It was a difficult business to study in detail, and definitely made for a long article.

I have a fun early Christmas surprise for subscribers coming out next week and then another research article will get released on December 21st diving into Global-e, an ecommerce platform with a very interesting value proposition.

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Happy investing folks.