There are no sure things in the stock market, but Constellation Software Inc. CSU-T was as close as you get. “Was” being the operative word.
The stock has gone into freefall over the past five months or so, its losses now sitting at 33 per cent.
The selloff is all the more striking for the fact that the Canadian stock market is up by nearly 20 per cent over that time. Or that North American tech stocks have gained, on average, 30 per cent to 40 per cent.
Constellation is a crash unto itself, felled by the sudden suspicion that artificial intelligence is going to kill this company.
Is this really the end of one of the greatest – if not the greatest – runs in TSX history?
From the time of its initial public offering in 2006 up to its peak this year, the company’s shares gained roughly 30,000 per cent, which equates to a 35-per-cent return annually.
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Over the past two decades, any investor with a decent stake in Constellation practically guaranteed themselves a good year.
It was also an incredibly consistent stock. It has had just one negative calendar year, posting a 9.9-per-cent decline in 2022, when the tech sector was engulfed in an industry-wide selloff.
This one feels different. A crisis of confidence has crept into the outlook for this company. The market seems convinced of the full transformative power of AI and has begun to sort the winners and losers with incredible speed.
Celestica Inc. CLS-T, for example, has been declared a winner. Few investors wanted anything to do with the company in the 20 years or so between the dot-com bubble and the AI boom.
Now it’s the hottest tech play on the TSX. Its shares are up by 250 per cent year to date, and more than 1,400 per cent over the past two years. Celestica makes network switches used in data centres that power AI models.
Constellation, on the other hand, has been deemed to be on the wrong side of AI.
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We can think of Constellation as a private equity firm of sorts. It has spent the past 30 years accumulating a roster of 1,000-plus small software companies serving niche businesses. Things like library software. Transit scheduling.
It takes the cash flows from those businesses and plows it into new acquisitions, only committing to deals if strict financial conditions are met. Repeat forever. The ultimate investor darling. Dips in share price were seen as nothing more than a chance to get the stock on sale.
But then this year, AI hype took hold of investor attitudes in a much more pronounced way. Its ability to change the world seemed to be fast-tracked. Suddenly, AI was going to render whole swaths of the economy obsolete, including the traditional software firms that are Constellation’s bread and butter.
The risk is that a marina manager or a hospital administrator or a fitness club decides to replace their specialized software with a DIY alternative using AI tools like ChatGPT.
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“I just think things move slower than that,” said Richard Liley, an analyst at Leith Wheeler Investment Counsel, which has held shares of Constellation since the initial public offering.
“These are fairly small customers and niche industries that don’t have a lot of internal AI talent. I don’t think AI comes in and replaces these things overnight.”
In September, Constellation held a question-and-answer session with its shareholders to address AI concerns. It failed to provide investors with much relief. Days later, Constellation’s founder and chief executive officer Mark Leonard announced his resignation for health reasons. The stock kept tumbling.
And yet, nothing has fundamentally changed for the company.
“The acquisition machine is running just fine,” said Jason Del Vicario, a portfolio manager at Hillside Wealth Management in Vancouver. “The nuts and bolts of this company and the cogs turning this machine are running just fine.”
Is the market just getting way ahead of itself? It wouldn’t be the first time.
Lots of analysts are drawing a parallel to the dot-com boom, when the tech industry vastly overspent on building the infrastructure for the internet. The great disruptive potential of the information age was real, but it unfolded more gradually than many initially thought.
If you think history is repeating itself with AI, Constellation looks like a pretty good bargain.