Deep Dive Brief: Constellation Software Capital Allocation Outlook - Part #1

Can CSU sustain its legendary returns into the next decade?

Aug 21, 2025

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Welcome back Explorer!

In this eleventh edition of my Deep Dive Briefs series, I’m continuing my research journey on serial acquirers, this time exploring one of the big whales on the space but using a different approach as you will see inside the topics we’ll cover:

The Inevitable Gravity of Scale

By Nikotes, author of Expanse Stocks

I've been thinking a lot about Constellation Software lately, particularly after their latest results and the ongoing discussions about their long-term reinvestment prospects. The company has delivered one of the most impressive capital allocation track records in public markets, but the central question for the next decade is whether this model can withstand the dual pressures of bigger scale and increased competition.

While CSU's decentralized structure and proven playbook provide a formidable defense, I think it's highly probable that the laws of financial gravity will take hold. The math is pretty straightforward: sustaining 25%+ IRRs on an ever-growing pool of capital becomes exceptionally challenging as you scale. The thing is most investors are still underwriting CSU as if the past will simply continue indefinitely.

Topics We’ll Cover

🔹 The Original CSU Playbook
🔹 The Headwinds
🔹 Strategy Evolution
🔹 Strategic Alternatives for Sustained Returns
🔹 The Risks
🔹 Peer Comparison
🔹 Three IRR Scenarios for the Next Decade (including an IRR model)
🔹 How to Think About CSU Going Forward
🔹 The Bottom Line

This Deep Dive Brief kicks off a three-part series on Constellation Software.
This first chapter will be free and open to all readers, and at the end you’ll also find a downloadable IRR model (exclusive to subscribers).

I hope you enjoy it, let’s get into it!

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The Original Playbook: A Masterclass in Capital Allocation

Constellation built one of the most successful reinvestment engines in public markets through its disciplined vertical market software (VMS) acquisition strategy. The model is brilliant in its simplicity: acquire small, cash-generative software companies in fragmented verticals from retiring founders, typically paying 1-3x revenue or 3-5x EBITDA for assets with high recurring revenue and switching costs.

The numbers speak for themselves. Management has consistently achieved unlevered IRRs of 20-30% on acquisitions, while maintaining consolidated ROIC above 20%. This high return on invested capital, combined with aggressive reinvestment rates, created the mathematical formula behind their legendary shareholder returns.

The genius of Mark Leonard's approach was recognizing that decentralized execution at scale could maintain small-company acquisition discipline while deploying increasing amounts of capital. Rather than running everything from corporate headquarters, the six operating groups and their underlying business units are empowered to find and execute their own deals, creating a wide and deep deal sourcing network.

But here's the thing: the environment that enabled this success is changing rapidly.

The Headwinds

Deal Flow Is Getting More Competitive

The global VMS market remains highly fragmented with thousands of potential targets (CSU estimates around 70,000 potential acquisitions), but several factors are constraining attractive deal flow. Private equity firms like Thoma Bravo, Vista, and Francisco Partners now actively target VMS companies. Sellers have become increasingly sophisticated about their strategic value.

I found it particularly telling that on a recent podcast featuring Speedwell Research and a former Volaris executive, it was mentioned that some VMS founders are now attempting to push up acquisition prices by highlighting AI tool integrations within their products, even if the impact is marginal. This is exactly the kind of seller sophistication that erodes buyer advantages.

Average deal multiples have increased from 1-2x revenue in the 2010-2015 period to 2-3x revenue or more today (Sources: 🔗 Parkergale Capital and 🔗 SaaS Rise). While CSU has been able to maintain discipline and scale up, the math could start working against them.

The Mathematics of Large-Scale Capital Deployment

At CSU's current scale (~$70B market cap), maintaining historical returns faces mathematical headwinds that are difficult to ignore. To move the needle, CSU needs to deploy $2-4B annually. But there are fewer deals >$500M available in the VMS space, and managing hundreds of business units creates operational challenges that didn't exist when they were smaller.

This is where the "Constellationization" of software M&A becomes problematic. Multiple public and private acquirers are attempting similar playbooks, creating auction dynamics that drive up prices and reduce returns. There's also increasing scarcity of experienced VMS operators, though CSU has built a deep talent pool over the years.

Strategy Evolution: Adapting to Reality

Mark Leonard is acutely aware of these challenges, and their strategy is already evolving.

Let’s Spin Them Out

The spinning out of entities like Topicus and Lumine serves two purposes: it creates smaller, more agile parent companies that can hunt for smaller deals without being burdened by the parent's enormous capital base, and it provides separate currencies for acquisitions.

This is CSU's most effective tool for combating scale, and I expect to see more of it. However, it solves the problem for the spin-off more than for the parent. CSU still retains large stakes but must find ways to deploy its own massive cash flows.

Using Debt or Raising Prices Paid

The company could use more debt as they’ve demonstrated the last few years (they've historically maintained a pristine balance sheet) or accept paying higher multiples. Both approaches would allow them to do larger or more deals, but they introduce either financial risk or mathematically lower IRRs on new investments. If they pay 8x EBITDA instead of 3-5x, the return profile inherently weakens.

Accepting Lower Returns at Higher Scale

The most realistic outcome? Management may have to implicitly lower its internal hurdle rates from 25% to, say, 15-20% to get deals done. This would allow them to pursue larger, more stable assets that don't offer the same explosive returns but can absorb more capital.

Strategic Alternatives for Sustained Returns

Geographic Expansion

The most obvious opportunity lies in international markets, and some CSU subsidiaries have already proven this works like Topicus. European markets offer a less competitive landscape with similar VMS characteristics to what CSU originally found in North America. The thing is, private equity hasn't saturated these markets yet, and there's still that "retiring baby-boomers founder" dynamic that made CSU's original playbook so successful.

Emerging markets present an even more intriguing opportunity. These are earlier-stage software markets with significant growth potential, but they require local expertise and patience, two things CSU has in abundance. The challenge, of course, is that emerging markets can be unpredictable and may not offer the same stability that CSU's model depends on.

I'm particularly bullish on their sector focus approach. Healthcare, government, and education software markets exist globally, and CSU's operating groups are building deep expertise in these verticals. This isn't just about finding new deals - it's about becoming the natural buyer in specific sectors worldwide.

Enhanced Organic Growth: The Underexplored Lever using The Topicus Playbook

Here's where I think most investors underestimate CSU's potential. The company has historically been acquisition-focused, but there's significant untapped value in post-acquisition improvements across their 1,200+ business units.

Pricing optimization alone could be massive. Many of these VMS businesses have been underpricing their products for years, either due to founder conservatism or simply not having the resources to optimize systematically. CSU has the data and expertise to implement price increases across the portfolio and customers in these niche verticals typically have limited alternatives.

Cross-selling opportunities are equally compelling. When you own the software that manages spa appointments and also own the payment processing system for retail businesses, there are natural synergies waiting to be exploited. The challenge is doing this without destroying the entrepreneurial culture that makes these businesses valuable in the first place.

Selective R&D investment could also generate attractive returns. Rather than trying to be everything to everyone, CSU could identify high-return areas where modest investments in product development could significantly expand addressable markets or improve pricing power.

Capital Structure Evolution: Using Financial Engineering Wisely

CSU has historically maintained a pristine balance sheet, but that conservative approach might need to evolve. Using 2-3x debt could enhance equity returns without introducing excessive risk - particularly given the stability of their cash flows.

The debt utilization strategy makes sense for larger platform acquisitions where the target's cash flows can service the debt. This would allow CSU to pursue deals that might otherwise be too large for their equity base while maintaining discipline on pricing.

I’m also curious about CSU’s share buyback policy going forward. As reinvestment opportunities naturally become scarcer, balancing growth investments with direct shareholder returns becomes more relevant. While share buybacks during periods of market volatility could be attractive, Mark Leonard has been quite clear that he’s not particularly keen on this route.

Adjacent Opportunities: Expanding the Playbook with a ‘Style Drift’

This is where things get interesting (and risky). CSU has traditionally avoided services businesses, but high-margin professional services attached to their software businesses could make sense. The key would be maintaining the recurring, predictable nature of their cash flows.

Platform plays with embedded payments represent a natural evolution. Building integrated solutions across portfolio companies could increase switching costs and generate additional revenue streams. The challenge is execution complexity. This isn't as straightforward as their traditional acquisition model.

Technology infrastructure investments in data analytics and AI capabilities could also pay dividends. Rather than trying to build everything from scratch, CSU could selectively invest in capabilities that enhance their entire portfolio's value proposition.

The Elephant Hunting Dilemma

A highly discussed alternative is what they've long avoided: large platform acquisitions. The math is simple, a multi-billion-dollar acquisition would move the needle on capital deployment. But it would also come at higher multiples, lower IRRs, and carry integration risk.

Lumine's WideOrbit acquisition was essentially a test case for this approach. The early results have been mixed. The deal got done, but it's clearly a different risk profile than their classic tuck-in model. The question is whether CSU can develop the capabilities to manage these larger, more complex integrations while maintaining their return standards.

I suspect they'll do more of these deals out of necessity, but they'll need to be extremely selective. The downside of a major integration failure at CSU's scale could be significant.

The Reality Check

About all these strategic alternatives: they're mostly incremental improvements rather than game-changers. Geographic expansion can extend the runway, organic growth initiatives can boost returns, and capital structure optimization can enhance equity returns. But none of these fundamentally changes the mathematics of deploying ever-larger amounts of capital at attractive returns.

The most realistic outcome is that CSU successfully executes several of these strategies simultaneously, which collectively help moderate the inevitable decline in returns. Instead of dropping from 25% IRRs to 12%, maybe they manage to gradually land in the 15-20% range.

That's still an excellent outcome for shareholders; it just requires adjusting expectations. The company's track record suggests management will be thoughtful about this evolution, but investors need to model it realistically rather than hoping the past simply continues indefinitely.

The key insight is that CSU's future success depends less on finding a silver bullet and more on executing multiple strategic initiatives competently while maintaining their cultural advantages. Given their track record, that seems achievable - even if the absolute returns won't match their historical performance.

The Risks

Beyond the competition and scale issues, CSU faces several other headwinds:

AI displacement could threaten niche software functionality (though this is likely overstated in the near term). Large tech companies might build competitive solutions in some verticals. This has been a hot topic recently which I’ll address in more detail in the upcoming second part of this three-part series on Constellation Software.
There's always the risk of cultural dilution when maintaining entrepreneurial culture across 1,200+ business units.

Technology disruption is real but probably manageable. The bigger concern is operational risk: key talent leaving for competing platforms, integration fatigue, and the simple mathematics of managing an increasingly complex organization.

Peer Comparison

Roper Technologies (ROP): Roper is what CSU might look like if it focused on larger, higher-quality "best of breed" businesses. Roper's reinvestment rate is lower, but its asset quality is arguably higher. It's a more mature, less frenetic version of the model.

Topicus (TOI.V): Is the "CSU of 10-15 years ago," but in Europe. It shows the playbook is replicable and offers a higher-growth alternative for investors who believe in the model but want an earlier-stage vehicle.

PE Software Aggregators: Thoma Bravo's model is fundamentally different: use leverage, drive operational efficiencies, and sell within 3-7 years. CSU's model is permanent ownership, focused on cash flow discipline, not a sale multiple.

Three Scenarios for the Next Decade

Scenario A: Maintain >20%+ IRRs

This requires successful international expansion into less competitive markets, operating groups achieving true autonomy and local market expertise, and continued disciplined capital allocation with willingness to return cash rather than overpay.

The requirements are steep: leverage the Topicus model for geographic expansion, develop sector-specific expertise, and maintain decentralized decision-making. It's possible, but the headwinds are significant.

Scenario B: Gradual Return Compression

This is my base case. Likely outcome: 15-20% IRRs by 2030 as the company accepts moderately lower returns to maintain growth, focuses on larger platforms with greater operational leverage, and increases internal reinvestment in R&D, pricing optimization, and cross-selling and up-selling to spur organic growth.

Strategic adaptations would include shifting toward "buy and build" strategies within verticals, developing organic growth capabilities post-acquisition, and utilizing debt financing to enhance equity returns.

Scenario C: Significant Deceleration

Returns drop to 10-15% IRRs as market saturation forces acceptance of lower-quality deals, increased competition eliminates pricing discipline, and scale diseconomies overwhelm operational benefits.

How did I come up with these numbers?

I built an IRR model with projections over the next 5–10 years, inspired by Mark Leonard’s preferred method for estimating shareholder returns, which combines profitability and growth:

Shareholder IRR = ROIC + Organic Growth
(Source: Q1 2008 Conference Call & 📎 M. Leonard’s Letters Collection)

In this analysis, I’ve taken Leonard’s approach one step further by introducing a third variable — the valuation effect — to account for the impact of today’s FCF multiple versus the expected exit multiple. This addition bridges operational performance with potential market re-rating (positive or negative).

The complete IRR formula, along with scenario outcomes, is detailed below.

You can access this IRR model and download it in Excel format directly from the Portfolio Corner (exclusive to paid subscribers). I’ve also be adding more practical examples with CSU spin-offs (TOI and LMN) and will be adding more serial acquirers to this IRR model, covering both current holdings and watchlist names.

For just $0.39/day ($12/month) or $0.27/day ($100/year), you’ll get full access to the Portfolio Corner and everything that comes with a paid Expanse Stocks membership.

🔗 Portfolio Corner

How to Think About CSU Going Forward

The key investment question is whether CSU can successfully evolve its strategy to maintain attractive returns at scale. Given management's track record and cultural commitment to disciplined capital allocation, I think they'll adapt successfully, but investors should temper expectations.

Here's how I'd approach modeling CSU:

Don't extrapolate the past. Building a model that assumes 20%+ IRR on all future free cash flow is a recipe for disappointment. Instead, model a declining marginal IRR where your base case assumes returns on newly invested capital trend down from ~20-25% toward ~15-20% over the next 5-10 years.

Focus on free cash flow per share as the ultimate driver of value. Model the amount of FCF they can deploy and the return they're likely to get on it. Value the spin-offs and recognize that significant future value creation may come from spinning out more entities like Topicus and Lumine.

Most importantly, acknowledge the quality. Even with moderating returns, CSU remains a best-in-class compounding machine run by one of the world's best capital allocation teams. It deserves a premium valuation, but that premium should be based on a realistic assessment of its future, not a mirror of its past.

On the upcoming third part of this CSU trilogy, we will dive into valuation.
I’ll walk through how to build a DCF model tailored for a serial acquirer like CSU, one that’s driven primarily by ROIC and reinvestment rates, rather than the usual revenue growth and margin assumptions.

The Bottom Line

Constellation Software's reinvestment engine faces inevitable pressure from scale and competition, but the company's structural advantages and strategic adaptability position it well for continued value creation. My realistic expectations center on 15-20% IRRs over the next decade. Still attractive relative to broader markets, though below historical performance.

The company will likely succeed in this transition, but investors need to adjust their mental models. CSU tomorrow won't look exactly like CSU yesterday, and that's probably okay. The question isn't whether returns will moderate (they will), but whether management can execute the evolution successfully while maintaining their cultural advantages.

Sometimes the best compliment you can pay a management team is trusting them to navigate difficult transitions and CSU's track record suggests they're up to the challenge.

I’m currently working on the second installment of the CSU trilogy and it’s a hot one: Deconstructing the AI Threat and Opportunity for Constellation Software.
We’ll cut through the noise, separate hype from reality, and evaluate whether AI is a true game changer, for better or worse.

Thanks for following along.

—Nikotes