Lumine Stock Deep Dive w/ Clay Finck | Constellation Software + Topicus

(00:00) there has been a lot of discussion that because lumine only operates in one vertical the runway for growth is lower this couldn't be further from the truth the vertical they operate in is enormous the CEO David Nyland has described the pipeline as in the low thousands of potential acquisition targets and they are in conversations with hundreds of them they currently own 30 there is a lot of runway

for growth here well into the future on today's video I'll be outlining a recent addition to my portfolio luming group otherwise known (00:35) as lumine lumine is an interesting business and was brought about as a spin-off from one of the greatest Compounders within

the stock market constellation software since 2006 shares of consolation have compounded at north of 34% perom and has increased its shares by over 200 times since the IPO before we dive into lumine I'll provide a full disclosure that as of the time of recording I do own shairs in constellation software topic. (01:02) com and luming group and as always

this video is for informational purposes only and should not be interpreted as investment advice in this video I'll walk through a business overview of luming group what the investment case is for the company what makes the incentive structure in management team attractive for Quality shareholders and how I think about determining the valuation I'd also like to give a big shout out to my friend Cochran from the seeking wnter substack for helping me better understand

this business he was extremely helpful in (01:29) helping me sift through the the accounting jargon and the complexities of the spin-off transaction and he also put together a wonderful free writeup that I'll be sure to get Linked In the description below for those interested with that let's Dive Right into today's video covering lumine all right so starting with

the business overview here what does lumine do I think to understand lumine we first need to understand the company they were spun out of in 2023 which was constellation software in short constellation software is a Serial (01:58) acquirer that buys vertical Market software companies and holds them forever you can think of a vertical Market software product

as something that caters to a very specific Niche or vertical this might be something like software that caters to a golf course and managing reservations or maybe even managing a golf tournament for example customers might pay a monthly subscription fee to use that software that just suits their business really well on the other hand a horizontal software product can apply to really any (02:26) business you know you can think of

something like Microsoft Excel Microsoft oft Excel is a type of software that isn't necessarily you know built for just one very specific Niche it can apply to many different types of businesses constellation is led by in my opinion one of the greatest capital allocators on the planet Mark Leonard the company's based in Toronto it trades under the ticker CSU on the Toronto Stock Exchange

and as of the time of recording constellations market cap is over 70 billion US Leonard started (02:57) constellation software in 1995 and since then they've completed over 700 Acquisitions their typical deal size is around $5 million but as they've scaled up they've occasionally done some larger deals as well some as large as $700 million now these VMS companies were

attractive till Leonard for a number of reasons they provide Mission critical services to their customers they have high recurring Revenue they represented a very small amount of overall expenses for these customers so there's very little incentive for these customers to (03:28) switch they tend to dominate their niche which tends to be very small so there's little competition and Leonard was also able to buy these VMS companies at very attractive prices

and provide a forever home for them this has generated a return of around 25 to 30% typically on these purchases with that said there are a lot of companies in the market buying these businesses today so constellation is also very disciplined in the types of companies they're going to buy and what they're going to pay in my opinion their (03:57) discipline and ensuring they're going

to earn a high return on capital is one of the most valuable parts of this business they aren't going to take unnecessary risks and they aren't likely to lower their hurdle rates just for the sake of deploying Capital Leonard implemented this strategy successfully for a number of years the stock went public in 2006 and it's essentially been just a straight ride up as

they've continued to reinvest essentially 100% of their cash flows along the way at high rates of return excluding some dividends that (04:26) they paid out along the way to learn more about consolation software I would recommend the the podcast I put together on we study billionaires that's episode 531 which I'll be sure to get Linked In the description

below now in recent years constellation has done a couple of spin-offs in 2021 they span off topicus topicus is a carbon copy of constellation except it's run by its own management team and they make these Acquisitions primarily in Europe so they can really go into any vertical but they're generally contained to just (04:55) Europe this company trades under

the ticker toi on the Canadian venture exchange and then in 2023 constellation performed their second spin-off which was Lumen Group which trades under the ticker LMN on the Canadian Venture exchange now these stocks aren't available on many Brokers that people use I personally use interactive brokers which I'm personally a huge fan of and we can get Linked

In the show notes below for those interested now instead of going into any vertical lumine purchases companies in one vertical (05:26) specifically which is the media and Communications vertical so they aren't constrained by geography like topicus is but they are looking for companies in this one specific vertical globally in one of the

statements related to the lumine spin-off Mark Leonard stated I quote I look forward to having csi's long-term shareholders become long-term shareholders of luming group I hope my grandkids are still holding lumine shares 50 years from now end quote now talk about someone who thinks longterm you don't hear public statements like (05:59) that from from a lot of managers at least

the managers I read about in my interview with Chris Mayer a few months back I asked him about his thoughts on lumine so I'll share this clip here for you this was from episode 608 of the podcast lumine um is another one that you know you got the shares and presum presumably added to them

so uh I'd like for you to talk about this one as well yeah I mean when I first looked at Luma and I I remember talking to you know David Nyon the CEO and he you know kind of trying to sus out (06:36) what the differences would be how Luman would be different maybe than constellation and one of the things that appealed to me about it was this idea that Luman would do would we have

a heavier weight or tilt towards carve outs I know that's not the technical definition of a carv out what they're doing but that's the kind of the language they use is when they buy a a subsidiary you know kind of an orphan from a much larger company like they did with Nokia uh and that was the deal that really put rocket fuel in the share price at the

(07:05) end of the year there um last year so I like that and I like that because there's a lot less competition to do that there's a lot more technical skills and things involved and doing those kinds of deals so there's not as much competition and so I thought that that

uh would also yield lead to high returns and David and his team have done this so they've you know they know what to do so actually the way it's played out is kind of the way I thought it might which is you would you wouldn't see deals for a little while and then all of a sudden (07:38) they would they would do something kind of sizable and interesting uh and I think that's

that's kind of what we should expect from lumine so it's it's really interesting because it's again it's constellation uh you know it has the same incentives and you know the reporting is same so it's very similar it feels familiar but then they have this different tilt or bent you know they

have the specific vertical larger deals carve outs uh I think that's very attractive and they have a lot of uh room you know one one of the things I've (08:15) heard sometimes when I talk to people about lumine earlier they like yeah well you know it seems like it's confined to

one vertical and not as attractive but it's an enormous vertical and when you talk to them David about what kind of pipe L they have I mean they talk we're talking about low thousands is their Pipeline and they're in touch with companies in the low hundreds so again this is a lumine

owns what less than 30 businesses today so a lot of room a lot of space to grow and so um I thought it was a really appealing setup and (08:52) worth having us its own real estate so there were some interesting comments there from Chris so I'll get into a little bit more detail on lumine for you here from a high level lumine is a strategic acquirer and developer

of vertical Market software businesses with within the Global Communications and media industry their core Mission lies in identifying and acquiring high potential VMS companies with a focus on the specific needs of customers in various Communications and media segments the company's led by CEO (10:45) David Nyland he joined valeris

in 2014 which is an operating group within constellation software to help build their Communications vertical as of the time of recording lumine owns around 30 companies acquiring around two to five companies per year and the average price paid per acquisition is around $1.7 million that was at least before the wide orbit acquisition that was recent what I also

like to see is that the businesses that lumine owns are mission critical in the in markets are also essential so think about things like the (11:16) internet mobile phone connectivity these are markets that are not going anywhere they look for companies that are typically number one or number two in their niche market they also tend to look for a diversified customer base to ensure that they aren't dependent on a small number of customers

to deliver those strong financial results each business unit maintains independent management and financial reporting enabling them to make focused decisions tailored to their market and their customer base and with being under the (11:45) lumine umbrella they're potentially able to share best practices with the other business units which can also be potentially

beneficial for the group as a whole lumine looks for a range of profiles in terms of size Revenue number of employees and profitability following each acquisition lumine strategically invests in these businesses bolstering their core functionalities and unlocking opportunities for international expansion by taking advantage of a Playbook of over 250 plus best practices

that leads to organic growth now the (12:18) investment case for lumine is as follows first they acquire VMS businesses in the media and Communications verticals while achieving a high return on invested capital on these acquisitions typically they're aiming for around 20 to 25% return on Capital based on net operating profit after taxes next here

over time they want to generate consistent low singled digigit organic growth rates with limited wasted spend on research and development in sales and marketing they want to use free cash flow generated from their existing (12:50) businesses and redeploy as much as possible back into Acquisitions they want to continue to take advantage of carve out deals

as Chris Mayer mentioned in that clip these can be really attractive to lumine because of the low valuations they're able to get and the technical expertise that is needed which means limited competition from other buyers and then they want to take advantage of the slowing Communication in media industry to acquire cheap companies and use best practices to improve organic growth rates and margin (13:19) profiles of these acquired companies

since lumine specializes in this vertical they may be able to recognize these unique opportunities that exist in making these acquisitions that you know other buyers might Overlook or they might undervalue additionally if many businesses in the space are lower growth or even declining that might mean that there really isn't a lot of competition from private equity and other

buyers now part of the attractiveness of lumine for me is simply their focus on compounding long-term growth in the intrinsic value (13:50) of the business Mark Leonard and his shareholders letters outlined that shareholders can estimate the per share growth and intrinsic value as the return on Ed Capital plus the organic growth rate this rule

obviously isn't going to apply for every business but it largely applies to lumine for a couple of reasons first they look to reinvest all of their cash flows at a return on invested capital of around 20 to 25% and second their organic growth does not require too much reinvestment since much of it might come simply due to price (14:22) increases cross- selling or increased

operational efficiencies prior to the spin-off transaction where wide orbit was acquired the seeking winers blog it laid out how the return on invested capital for the 2 years preceding that transaction was 27% which shows you know just how effective lumine has been at generating profits relative to the amount of capital that's invested in the company additionally

during that same 2-year time period the average organic growth rate was 2% so if we add the 27% return on invested capital and the 2% organic (14:56) growth rate we get a 29% average growth in the intrinsic value per share so if they're able to continue to grow their intrinsic value at 25% Plus for the years that lie ahead I think that shareholders are going to be quite happy with that

result as very very few companies are able to do that for long periods of time the seeking winners blog also shared some analysis on wide orbit since they make up a sizable portion of the overall Lum portfolio after they were acquired in that spin-off transaction So based on the 2021 numbers

(15:28) wide orbit had revenues of 166 million and then lumine had 228 million before bringing white Orbit on board white orbit is a software company founded in 1999 by Eric Matthews white orbit specializes in helping businesses manage their advertising operations their software handles

tasks like sales scheduling Digital Media Radio Automation and optimizing promotions 94% of wide Orbit's revenue is recurring with a nearly 100% renewal rate and they have gross profit margins of around 70% and operating margins of 26% in the (16:05) seeking winners report it shares that

before wide orbit was acquired it's estimated that the return on invested Capital was 53% and the increase in the intrinsic value of the business in 2021 was 25% they were doing some reinvestment in 2021 which is really great to see as it illustrates that the business sees some opportunities to deploy Capital internally at a pretty high rate of return

lumine paid around 10 times IA for this business which is typically higher than what the constellation family would pay for a (16:35) software company so if white orbit turns out to be as good of a business as it appears to be then this should be a really valuable asset to shareholders of lumine and we should also keep in mind that lumine used a sizable amount

of debt in making this purchase which really helps boost the returns that they ultimately end up getting in the transaction now one of my favorite things about the companies discussed in this video is the skin in the game in the aligned incentives constellation will continue to play a vital role in (17:05) influencing the direction of lumine as they selected six out of the seven board members in consolation is oftentimes

referred to as the gold standard when it comes to incentives one thing they do is when cash bonuses are paid out key managers are required to invest anywhere between 50 to 75% of that into shares on the open market which are locked up for 3 to 5 years this incentivizes them to think like owners and share in the company's long-term success the same goes for the board members

they have to invest at least 50% of their bonus (17:38) directly into shares of the company now this template from consolation carries right over into both topicus and lumine we've seen how well this incentive structure has played out for constellation over the past 20 plus years so I'm excited to see how well it it ends up playing out for both topicus and

Lumi another piece that's interesting is that bonuses are calcul ated based on the company's performance more specifically the difference between the return on invested capital and the cost of capital so in other words this (18:07) means that there's no bonus payout unless the company is creating shareholder value and while many tech companies issue quite a bit

of stock-based compensation consolation in lumine don't issue any new shares so rest assured that existing shareholders won't see any dilution at all perhaps in the future they will issue shares if they think it's really attractive to do so but that isn't something we've seen so far or something that I would personally expect before we get to the valuation I wanted to touch a bit on the (18:36) pace of Acquisitions that lumine has

done here in the chart you'll see on the screen you'll see that lumine tends to do anywhere from three to five Acquisitions per year it's not quite up to date for 2024 as I believe they've completed two Acquisitions this year as of the time of recording today they're up to 31 companies and as Chris Mayer mentioned in the video earlier lumine is in touch with

hundreds of companies they could po acquire while this isn't nearly as fast of an acquisition Pace as constellation in their earlier years (19:05) what I do like to see is that constellation still has a significant ownership stake in lumine as they own 60% of the overall shares this tells me that Mark Leonard and the managers running the show at constellation

see a lot of potential for growth in lumine going forward perhaps I'm a bit too naive and optimistic but that's the way I see it I should also mention that lumine typically makes larger Acquisitions than cons ation did in their early days so that would mean their acquisition pace is going to be naturally a bit slower due to that as (19:35) well and then the piece here from the

seeking winners write up with regards to their reinvestment Runway was really interesting I'll just read that directly here trying to forecast out Lum min's future reinvestment rates based on the capital they will Deploy on Acquisitions can be tricky because their acquisition strategy is different from that of topicus and CSI they have a heavier tilt towards deals known as carv outs

or another words buying orphan companies from larger companies the good news here is there is a lot less competition to do (20:05) that due to the technical skills required to achieve hurdle rates with these types of Acquisitions for shareholders who only own topicus CSI and don't yet own lumine I think this is the toughest hurdle for them to get

over there has been a lot of discussion that because lumine only operates in one vertical the runway for growth is lower this couldn't be further from the truth the vertical they oper in is enormous the CEO David Nyland has described the pipeline as in the low thousands of potential acquisition targets and they (20:36) are in conversations with hundreds

of them they currently own 30 there is a lot of runway for growth here well into the future end quote so that really lays out the bull case for lumine there seems to be a lot of opportunity and room to expand and we shall see how well they're able to do that in the years that lie ahead now this brings us to valuation here on the screen you'll see a discounted cash

flow model for lumine for the next 10 years so I'm going to briefly walk through this and my methodology the base year here is what I (21:05) came up with for 2024 we don't yet have the numbers yet for Q4 so I took the year-to-date numbers through Q3 and then I assumed $190 million in revenue for Q4 giving them around $671 million in revenue for all of

2024 and all numbers you see on the screen here are going to be in US Dollars their earnings before interest in taxes or operating margin is roughly 29 % so this gives us $194 million in operating income and as you can see here at the bottom of the screen the current price divided by the operating income or ebit is around 45 so (21:41) the company trades added a significant

premium to the overall Market the S&P 500 as of the time of recording trades at around 25 times earnings but I'm of the opinion that lumine is also a significantly higher quality business than the average company in the S&P 500 as the company earns a really high return on invested capital and it has a lot of room to reinvest and grow here at the time of recording Lum M's market

cap is 10.8 billion Canadian dollars or $7. (22:09) 5 billion US now for me the key assumptions in the valuation model are Revenue growth reinvestment rates return on invested Capital the terminal multiple and your discount rate so for Revenue growth I modeled out 30% growth for 5 years and then that tapers down as their reinvestment rates decline it's up to each

individual investor to determine what sort of growth is appropriate and makes the most sense to them in predicting what this business is going to look like there's really no right or wrong answer though because the future (22:39) is just fundamentally uncertainty for margins I projected a margin of 30% which is similar to their current margin of 29% and uh as you can see on the reinvestment rate line the reinvestment rate is high for the

first 5 years and then gradually declines over time as they grow their earnings and presumably have fewer opportunities to deploy that much capital the section at the bottom summarizes the output their earnings before interest in taxes in year 10 is $1.

(23:07) 1 billion this averages out to around a 24% compounded annual growth rate for 10 years this definitely won't be easy but also keep in mind uh at the current time they're growing revenues at around 35% year-over-year and it's certainly an ambitious Target given that very few companies are able to achieve this level of growth as an investor in this company I'll

be watching their growth rates really closely and also keeping an eye on their ability to continue to deploy Capital but I also expect their growth to be a little bit lumpier than that of (23:36) constellation and topicus they may go you know for some period say a quarter or two of building up cash before they announce a major acquisition that really catches the

market by surprise so I think it's also key as an investor in this company to just be patient and uh when looking at the terminal multiple I put a multiple of 25 on their operating earnings in year 10 and then I applied a discount rate of 10% and I also added in the present value of the free cash flows that aren't reinvested so that gives us (24:05) an intrinsic value estimate of 14.3

billion US and keep in mind if you look up Blue Mine stock you might get quoted a market cap or Enterprise Value in Canadian dollars and that's around $0.7 us so you have to do the currency conversion the market cap at the time of recording is $7.5 billion and that gives

us an estimated discount to the intrinsic value of around 47% now the odds are very high that this intrinsic value estimate is just completely off the mark when we look back uh 10 years from now in 2034 when valuing a really (24:41) high quality company it's better to just be directionally right than precisely wrong the main thing here is that lumine we want them

to be able to reinvest a lot of cash into new acquisitions at a high rate of return if they're able to do that for the next 5 to 10 years then I expect the intrinsic value of this business to really compound at a good clip but if they aren't able to grow at the rate I project and the terminal value ends up being much lower than 25 then the shares might turn out to be

just totally overpriced today so you can (25:10) take this model and plug in some of your own assumptions or take a similar approach and uh plug in your own assumptions that you think are reasonable to some viewers 30% growth for 5 years is probably ridiculous to others who maybe have worked with constellation or maybe they're really familiar with lumine they might deem that to be quite reasonable given Management's talent and expertise their pipeline for

reinvestment and their relatively small starting base remember that they only have 30 companies today and they may only need to buy a few (25:40) companies a year to achieve that level of growth so again feel free to plug in your own assumptions and see what sort of results you come up with all right that wraps up today's video on lumine before I let you

go I wanted to let you know that I help run a private investment Community for the investors podcast Network specifically tailored for private investors portfolio managers and high net worth individuals this is referred to as our tip Mastermind community in the tip Mastermind Community my co-host s brers Kyle (26:09) grievin myself we host weekly live

Zoom calls we host a few Live Events each year in New York City London and Omaha and we talk stocks with our community of over 100 highly vetted members some of the zoom events we have coming up include a Q&A with Alex Morris from the science of hitting substack a stock presentation by one of our community members a portfolio review with one of our members based

in India and another stock presentation on boid we have a lot of great calls set up and we also record each call so we have a library of over (26:39) 70 to 80 videos that members can all tune into we have so many amazing members and I'm really proud to be a part of this network of high quality people so if this sounds interesting to you I'd encourage you not to wait

to check it out as we're capping the group at 150 members you can join the wait list for the tip Mastermind community at thein podcast. (27:02) com Mastermind or you can also shoot me an email for more information at claythe investors podcast.com and if there are any other highquality companies you'd like us to cover on the show feel free to leave a comment

below to let us know so we can take a look at it also if you like this video please like And subscribe below it really means the RO to us and really helps support the Channel with that thank you so much for tuning in to today's video and I hope to see you again next week but in the general I think the source of (27:31) outperformance comes from an

Investor's willingness to let something become a bigger part of their portfolio let them really ride those winners the ideal would be you get something that sort of takes over and you look at it and it's 20 25% of your portfolio and it's just kind of gone up 20x and you're delighted you know