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Covered by Stratosphere

Acquiring VMS for Vertical Growth

Following in the footsteps of Constellation Software Inc ("Constellation" or "CSI"), ("Topicus") is a successful vertical market software ("VMS") aggregator. Topicus acquires, manages, and builds European VMS companies to provide "mission critical solutions" to customers that seek specific software for granular processes and business needs. The company owns and manages about 85 of these independently run companies. 

Topicus empowers business unit managers to leverage their niche expertise of these VMS businesses to scale organically, locate new targets within the vertical market of a particular business, and generate vast amounts of cash flow in the process. The aid of CSI, and Topicus's decentralized management and acquisition strategy allow Topicus to execute on its strategy repeatedly with Constellation-like consistency.

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Balance Sheet

Adrian Iwanicki


Adrian Iwanicki

Equity Analyst

Investment Thesis

  1. Topicus focuses on acquiring, managing, and building niche VMS businesses that have outstanding management, profitability and cash flow, and ample organic growth opportunities. These businesses generate strong returns on invested capital, avoiding the need for Topicus to issue debt to finance growth or investment into new acquisitions.

  2. Like CSI, Topicus's decentralized management strategy is among the world’s best - these foster a culture that promotes strong customer relationships and deep market knowledge and is agile when it comes to responding to new market trends, customer needs, and other changes.

  3. Topicus will make sure that each acquired company will thrive in its ecosystem. It offers and shares financial security, strategic guidance, and best practices with these companies while they are operated independently by managers who know the businesses best.

  4. CSI has substantial "skin in the game" when it comes to the performance of Topicus. CSI banks on its experience in VMS and conducting bigger acquisitions to steer Topicus towards prosperity.

  5. The global VMS market is highly fragmented, opening up a plethora of acquisition targets that Topicus can acquire and build. As the Topicus ecosystem of VMS businesses grows, independent business unit managers can cross-sell software products, integrate offerings, and leverage other business units' knowledge to add value to their current customer accounts.

Key Company Metrics

A set of metrics we constantly keep updated to monitor the investment thesis.

Competitive Advantages

Sticky Software Services

Customers of Topicus's business units face high switching costs - they are contractually bound for years to these services and would waste lots of time and money by seeking other niche alternatives.

Software license revenues are charged for the use of Topicus software products, which are typically licensed under contractual provisions of multi-year or indefinite terms. Customers could face substantial break fees to get out of such contracts that would not justify switching to a competing software provider to save a few bucks.

Niche VMS offerings often do not have a viable alternative, especially when the software serves to modernize an obscure process in a "boring" industry, like government, education, or healthcare. In a fragmented market like vertical software, small nuances between software products may make a world of difference to a customer who is looking to fill an extremely specific need.

Even if there are alternatives available for a particular field, these vertical software products generally represent an insignificant portion of customers' expenses. All in all, customers face major disincentives to switch vertical software providers.

Decentralized Operations and Capital Allocation

In a similar fashion to CSI, Topicus places decision-making responsibilities for its business units on levels of management that are closer to each business unit. 

The autonomous, decentralized structure allows higher levels of management to focus on the big picture - effective capital allocation - while lower levels of management focus on managing business units and customers, executing on their long-term goals, growing organically, and identifying acquisition targets within their verticals.

Network Effects

The buy-and-build strategy at Topicus creates network effects within its ecosystem of business units. With each new bolted-on business, Topicus gains opportunities to expand current customer accounts by creating new links between software products and cross-selling.

Customers who are satisfied with their current suite of products from Topicus-owned businesses and are looking to obtain additional services for their expanding operations can leverage this growing network of well-managed VMS offerings to add on more to their account. Rest assured, these customers would know what to expect as each business unit is managed with the utmost diligence and with a long-term focus that places the customer first.

Prudent Capital Allocation

In most respects, Topicus operates like a "mini-CSI". On the capital allocation front, Topicus is essentially identical to CSI, the only difference being its European focus.

Topicus targets VMS businesses with growth potential that can be managed and built under the Topicus umbrella. Particularly, the business is always looking for ways to learn more about emerging and obscure VMS products by seeking targets with attractive historical and expected returns that can add to Topicus's sustainable competitive advantages and ability to mobilize capital on new deals and other expansionary efforts.

Like CSI, Topicus's focus is on small, niche players that are generally purchased at or below the $20 million mark. These small acquisitions allow for lean integration, quick payback periods, and higher likelihood of success in the Topicus ecosystem.

For many investors and serial acquirers today, price does not matter. For Topicus, valuation matters – it seeks an internal rate of return above a certain minimum hurdle rate to ensure that each target will create value for shareholders. Under this approach, Topicus investors get first-hand access to having their money “managed” by some of the best capital allocators on the planet.

Unlike competitors, Topicus does not use debt to fuel its acquisitions, nor does it engage in private-equity-like practices - buying a company only to flip it for a profit about 5 years later. Topicus invests in target companies on a perpetual basis with the aim to allow each business unit to flourish under its wing.

Constellation's Younger Brother

Topicus may have been spun off from Constellation, but it was certainly not left to fend for itself. Its "Big Brother", CSI, has got its back.

On a fully-diluted basis, CSI owns just over 30% of Topicus shares and 50.1% of votes via CSI's one super voting share. Additionally, CSI will maintain the right to nominate six of ten directors for the Topicus board of directors as long as CSI holds 15% of fully-diluted Topicus shares.

Topicus Organizational StructureSource: Prospectus

CSI has significant voting rights and skin in the game when it comes to Topicus and its performance. If history is any indicator of how any of CSI's investments would be treated, Topicus will likely be held by CSI forever with the aim to create as much shareholder value as humanly possible. Topicus winning means CSI wins too, and CSI's management is making sure of that by holding majority voting shares to guide it using the "Constellation way".

This close brotherhood between CSI and Topicus also means Topicus will benefit from managerial advice, strategic direction, and financial help (especially for larger deals) from CSI. Not to mention, CSI's track record and experience with bigger deals within the VMS space are knowledge "databases" into which Topicus has exclusive access.

Directors of CSI’s board of directors also have a heavy presence on Topicus's board – Robin van Poelje, Stephen Scotchmer, Donna Parr, John Billowits, and most notably, Mark Leonard. 

This internal connection to CSI should steer Topicus in the right direction. In fact, we believe Topicus is in great hands. If Topicus were to fall to its knees, we would expect CSI to swoop in to get it back on its feet.

To close out our discussion on Topicus's competitive advantages, we will leave you with an excerpt from Mark Leonard's April 2018 President’s Letter to CSI shareholders:

"Our current policy is to invest all of our retained investor's capital (and then some) when we think we can achieve our targeted hurdle rates. When we can't find enough attractive investments, we plan to maintain our hurdle rates and build cash for as long as our shareholders and board will allow. We believe that long-term shareholders and boards should set those policies, which segues nicely into discussing shareholder democracy and the role of boards."

Opportunities Ahead

  • The vertical software market is highly fragmented with thousands of market players with valuations at sub-$20 million levels. The kicker here is that big tech is not really interested in scooping up these companies, either. Vertical software companies are too small, focused on a narrow set of customers, and would consume vast amounts of resources to scale to any meaningful level. The European vertical software market hosts thousands of companies that can offer even greater return potential. The European market is more fragmented than the North American market due to the nuances in the regulatory, cultural, and business environments found in a higher number of smaller countries. 

  • Stemming from our point earlier about network effects, Topicus expands its vertical-adjacent opportunities with every bolt-on acquisition. Management seeks opportunities to learn about new industries and verticals through organic expansion and new acquisitions, which is catalyzed by every incremental acquisition. The market continually expands for Topicus.

  • Although Topicus operates solely in Europe today across 14 nations, that does not preclude the company from expanding to other markets in the future. Topicus has spoken of "selected internationalization", a concept that starts and moves with the customer. For instance, if Topicus acquires a software company that operates only for Dutch companies in the Netherlands, that software company will typically only expand to other regional markets if one or more of these Dutch companies expand to say, Germany or Denmark. Therefore, Topicus goes where its customers go. This also implies Topicus is likely open to expanding outside continental Europe.


Shrinking Target Base

As with any serial acquirer, the biggest risk posed is a shrinking target company base. Companies that generate or can generate superior returns are few and far between. Although there are almost 40,000 target vertical software companies in the world, only a small fraction of these would meet Topicus's strict criteria.

Poor Ability to Scale

Some niche industries can be so narrow that serve such a small base of customers that would make it difficult to scale beyond what acquired targets already capture. It may be difficult to scale businesses within these niche areas and limit the future growth potential and return profile of them, harming Topicus as a whole. Organic growth tends to be slow for many of these software services.

Misidentified Market Opportunities

Management at Topicus is constantly targeting new vertical markets and niche software businesses that, prior to integrating the business into Topicus, may be beyond their circle of competence. Topicus has had a lot of success integrating a myriad of different businesses across many industries, but there is still a risk that as the digital world gets complicated, growth opportunities are misidentified (i.e., overstated) or integration is more time consuming and resource-heavy than expected.

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