In the 2017 Constellation Software President’s Letter, Mark Leonard discussed his process for dealing with potential investments that don’t quite meet their hurdle rate. Here’s an excerpt from that letter:
Maintaining Investment Discipline:
I recently worked on a large transaction. With every day that passed, I could feel my commitment to the process growing… not because the news was getting better, just because I was spending more time on the prospect. The investment didn’t quite meet our hurdle rate. We were not able to negotiate a structure that got us an extra couple of points of IRR, and the big one got away. The difference between investing and not, was tiny.
Currently, we have 26 Operating Group and Portfolio Managers who spend >50% of their time on M&A, and another 60 full-time M&A professionals spread across CSI. We are trying to ramp up our M&A capacity from the 40 acquisitions that we did last year, to 100 per annum. It was useful for me to once again experience the temptations that these people face every day. It also reaffirmed for me that when we pursue a very large acquisition, the diligence, structuring, negotiating and integration needs to be led by a single person who is one of our highly-experienced acquirers, and who will shoulder responsibility for the process and the outcome.
Bernie [Bernard Anzarouth] tries to be the last line of defense when our Operating Groups and BU’s [Business Units] propose borderline investments. Some of our Operating Groups have developed or are developing senior M&A people to help Bernie filter out over-optimistic acquisition proposals, but Bernie is still the primary provider of this acquisition control function for some of the Operating Groups.
If a small investment with a borderline hurdle rate is proposed, we sometimes allow it to proceed. Our rationale is that if the investment goes sideways, then it becomes a “lesson” for the Operating Group or BU personnel that proposed it. If the investment goes well, it becomes a “lesson” for Bernie and me.
An investment only becomes a lesson if we diligently track its post-acquisition performance and take the time to analyse the outcome while the investment is still fresh in everyone’s mind. We have a process for this that we call a post-acquisition review, or “PAR”. We try to schedule the PAR’s about a year after the initial investment. The PAR’s originated as a head office led process approximately four years ago. Just over a year ago, we started delegating them down to the Operating Groups.
One of the useful things that head office can do, is pilot new processes and champion new ideas. If the ideas add enough value to the BU’s and Operating Groups, and they choose to maintain them, then I’m delighted.
Nevertheless, I think all processes should be periodically re-examined for their cost and benefit. An ad-hoc analysis done to understand a problem or opportunity is more likely to translate into action than a quarterly report that gets generated because “we’ve always done it that way”. The former requires curiosity and intelligence, the latter bureaucracy and compliance. If the Operating Groups can learn from their acquisitions by some less burdensome method than PAR’s, I’m all for it.
As we teach more people at CSI how to deploy capital, we lean on the accumulated data from our historical acquisitions to help maintain investment discipline. We have base rates for a variety of key operating metrics. Whether it is a neophyte investment champion arguing that a particular acquisition is “special”, or a senior executive being tempted by a large acquisition, we have enough data to make the discussion rational, not emotional. We all know whether the key assumptions are being pushed to the 55th or 95th percentiles of our historical distributions.
My only significant concern regarding investment discipline, is that we’ll be tempted to drop our hurdle rates as our cash balances climb.
You can read the entire CSI 2017 shareholder letter here:
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