Bull List Report – Topicus – CVE:TOI

Topicus – TOI.V

Topicus com Inc is a provider of vertical market software and vertical market platforms to clients in the public and private sector. It is engaged in development, installation and customization of software and the provision of related professional services and support for customers across different markets predominantly in Europe. Substantial revenue is derived from maintenance and professional services offered by the firm.

Focus area	Score
Valuation	28
Profitability	75
Risk	70
Returns	21
Dividend	–
Outlook	100
Debt	49
Growth	87
Overall	63

Click the KPI images to expand them if needed!

Pros

Backed by Constellation Software – effectively considered its European arm
Deep understanding of the underlying European market
Impressive growth rates (20%+)
Provides strong international exposure
Although organic growth rates are slowing coming out of the pandemic, they’re still at a similar pace to Constellation
The company has a 19% CAGR on its free cash flow available to shareholders
The company is trading at substantially lower valuations than just 3-6 months ago

Cons

Despite it being larger than many TSX-listed companies, it trades on the TSX Venture – the company gets lumped in with other speculative small caps
Higher interest rates could impact growth due to more expensive acquisitions
The company’s exposure to the Euro
The company is known to go through sharp corrections, often with 15%+ swings in share price
Artificial intelligence fears is putting a lot of pressure on the stock price

I have focused on Topicus since it was spun out of Constellation Software (CSU). It is no secret that I view Constellation’s management as best-in-class. Topicus marked the first time in the company’s history that it spun out one of its acquisitions. This notable event created a mini-CSU as they have similar business models. In short, the company identifies, acquires, manages, and builds attractive VMS (Vertical Market Software) businesses. While the spin-off was done for several reasons, I want to focus on two.

First, Constellation trusts the Topicus team to execute and build the company using the same principles as Constellation. It says a lot when a company with the management ilk of Constellation speaks highly of another team. While it is a separate company, it is still majority-owned by CSU. Topicus benefits from the CSU talent, infrastructure, etc.

Secondly, Topicus is laser-focused on the European market. CSU felt that having a talented team that knew the ins and outs of the European market was a better means of entering that market than trying to make acquisitions themselves. With that in mind, CSU can concentrate on other global operations, while Topicus can grow and build the European base.

The company is growing at a 20%+ clip with healthy, mid-single-digit organic growth, and the market is finally started to reward this growth.

Despite the recent surge, I still view this as an opportunity to grab an under-appreciated company backed by one of the best management teams in the sector. It is also a way to get international exposure in your portfolio, as the company’s operations are primarily outside of North America.

Beta	0.1
Best monthly return	NA
Worst monthly return	NA
Max drawdown	NA

Of note, the risk data above mostly shows N/A. This is because our data utilizes 5-year averages in terms of drawdowns and monthly returns. Because Topicus hasn’t been trading for that long, it doesn’t have the data to complete it.

Another note, the beta seems low at 0.5, however, this is when we compare it to the index it trades on. In this case, it would be the TSX Venture, which contains many volatile stocks. So, although the beta is lower, it can still have large swings in price relative to blue-chip stocks on the major TSX index.

Much like any “growth through acquisition” company, Topicus’s ability to maintain its growth rate depends on its ability to identify and complete suitable acquisitions. From there, they also need to integrate these acquisitions effectively. Failure to do so can result in higher-than-expected costs and write-offs.

There is considerable competition from other serial acquirers in the software solutions industry. This can lead to high purchase multiples, as we saw when the tech industry got ahead of itself during the pandemic.

That said, the company can mitigate this by ensuring it sticks to its acquisition principles, which CSU’s management team is well-known for. Those principles should carry through to Topicus.

Speaking of CSU, since Topicus is dependent on the relationship with its parent company, any deterioration of the relationship with CSU management could have adverse long-term effects. In addition to this, any struggles with CSU management might impact the trust of Topicus.

A newer risk would be the potential for AI to disrupt the business. If clients of Topicus feel they can utilize AI to code their own platforms, this could result in a loss of clients. I feel this is a very small risk for a company like Topicus, but is one of the main reasons the company has drawn down as much as it has in recent times.

Finally, higher interest rates and currency risk are two risks that are current headwinds for the company. Higher rates make acquisitions more expensive, especially if debt is required and the company reports in Euros while its businesses have operations worldwide. It also can impact valuation metrics as information sites like Ycharts are in CAD, so the company’s reporting needs to be converted from the Euro.

	TTM	Historical average	Forward numbers
P/E	109.9	–	44.6
EV/EBITDA	20.4	22.0	–
Free cash flow yield	3.0%	–	–
P/FCF	33.8	–	–
PEG ratio	0.2	–	–

Because Topicus trades on the Venture, there are not too many analysts covering the company. This is why you don’t see forward P/E and PEG ratios in the chart above. In addition to this, historical averages are yet again blank, because the company just hasn’t been trading long enough to develop any data.

However, Topicus isn’t really a company we should be looking at in regards to earnings per share as a valuation metric anyway. I prefer to use EV/EBITDA and Price-to-Free Cash Flow. Why? Because the company will have a lot of depreciation and amortization on the balance sheet due to its acquisition-heavy strategy. As a result, there will be a lot of non-cash items impacting earnings per share but not impacting the profitability of the company.

An example of this would be a company spending $1B on an acquisition and amortizing it over 10 years. That acquisition costs them $1B in year one, however the impact will be felt on the income statement throughout the next 10 years.

For this reason, it is best to utilize the price-to-free cash flow ratio, which adds back any non-cash expenses to get the true cash flow generation of the company. At this point in time, Topicus is trading at 26x free cash flows, a premium valuation ratio to Constellation Software. Considering the fact that Topicus has been growing FCF by 19% annually since 2020, this is a valuation we can come to expect from a company like this.

And the most alarming part? Just last quarter, Topicus was trading at 40x free cash flows. This is how substantial the drawdown has been because the potential AI headwinds.

At 26x free cash flows, large technology firms in the United States often exceed these multiples yet grow free cash flow at slower rates. Yes, they are more well-known, trade on a major exchange, and have significantly larger economic moats. However, Topicus is a high-quality corporation that is growing free cash flow at a market-beating pace. As such, we can expect to pay a premium for the company. However, that premium just got much smaller.

Topicus operates in the vertical market software (VMS) industry. Since it operates within many different verticals, competition varies quite a bit. Likewise, the company is a European pure-play, and only those in operation in Europe can be considered as competition. The company lists the following as their main competitors: EG, Intapp, USoft, Prospa, and Linxo, SAP, and WoltersKluwer.

As you might guess, none of these are listed on the TSX. Few are publicly traded in North America save for SAP and WoltersKluwer (which trade on the over-the-counter market).

However, it is difficult to project direct competition for both Topicus and Constellation due to the niche businesses they focus on. One thing I will say, however, is that the areas they operate in require exceptional management teams in terms of execution, which is far more important in my eyes than comparing competitors.

I’ve left the dividend analysis section up for Topicus but it will be relatively short. You cannot expect the company to pay out any sort of consistent dividend. Yes, it has a dividend yield, but that is primarily due to a special dividend paid out in 2024. Once that dividend goes beyond TTM dividends paid, the yield will go back to 0.

Will there be continued special dividends? It is hard to say. I believe the 2024 special dividend was likely given to investors due to excess cash flows generated that potentially couldn’t be utilized at that time toward an acquisition. With acquisition activity picking up, I wouldn’t expect any special dividends in the near future, but treat them as a nice bonus if they do come.

Topicus continues to prove that it can scale within the European market, and thus far, we are seeing zero impacts from artificial intelligence in the company’s results. In fact, the company is accelerating growth. The one concerning element is that despite this rock-solid quarter, the company did not move in price much at all post-earnings. Pre AI-disruption fears, results like this would have sent the company up by anywhere from 7-10%. Now we have a situation where growth is higher than its ever been and the market is rewarding it with a 2%~ increase after a 50% drawdown.

What does this tell you? Well, it tells you valuation multiples will need more than a single quarters worth of strong results before the market rewards the company with a higher multiple. On a higher level? It means you’re going to need to be extremely patient with software stocks, and watch their results like a hawk. Don’t expect short-term rewards from these companies, is what I will say. Let’s get to the results.

Total revenue jumped 20%, and while the 4% organic growth rate might look a bit low to some, it is exactly what we should expect from Topicus. It’s right inline with historical averages in terms of organic growth. This is one of the elements that was supposed to face pressure in regards to AI. In theory, companies can threaten to build their own in-house solutions and as such, can use this as leverage on renewals for upcoming contracts.

Earnings were all over the map, but this is primarily due to acquisitions. This is pretty typical of a company like Topicus, and most all acquisition-heavy companies. If you want to know how the business is actually doing, you have to look at cash flow. In this regard, the numbers were outstanding. Free cash flow available to shareholders grew 23% for the year, and the fourth quarter alone saw a 40% jump in that same metric.

Management remains aggressive on the acquisition front, deploying nearly 400 million euros into new businesses plus the massive commitment to Asseco. They ended the year with over 320 million euros in cash on the balance sheet, which is a significant increase from last year and tells me they aren’t planning on slowing down the deal flow anytime soon. What it does tell me is the company is likely stocking up cash, anticipating some deals in the future due to the substantial valuation re-rating we’ve witnessed across the entire sector.

For those who were worried that the high interest rate environment in Europe plus AI fears would hurt their ability to find and close deals, these results show that this is not occuring. It is the same old story here as it is with their parent company, focus on the cash flow and the capital allocation, and ignore the noise in the GAAP earnings figures.

Of note, there was a lot of misinformation out there about Topicus coming out and specifically commenting on AI. In reality, what this was was a boilerplate AI risk piece that was added into their annual report. Companies are legally require to disclose the largest potential risks they see and put them in their annual reports. This will not be unique to Topicus. In fact, I would not be surprised if this type of AI commentary in the risk section of annual reports isn’t in 70%+ of companies reports moving forward with all the potential disruption.

Ignore the noise with Topicus and focus on the results. But also, don’t expect any sort of quick turnaround here.

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