Subordination

Constellation Software - One Ring to rule them all, One Ring to find them, One Ring to bring them all, and in the darkness bind them.

A little over a year ago I was introduced to Sygnity SA by a guy named CJ. If you’re not familiar with Constellation Software (that would be shocking), that company is sort of like a nesting doll of a melting pot of software companies, often private and very specialized to their tasks. This is why it’s called vertical market software. These vertical market software companies are then taken over and then either bled off, restructured or built up. Whatever makes the most cheese fall out in the long run is pretty much all that they try to do for themselves. Then they take the cheese and redeploy it. I’ve definitely made the mistake of buying VMS over VMS aggregators and unless the stock is really, really, really cheap— that’s probably not a good idea. The consistency of the cash flows or some regularity to the stream is usually not what you want out of owning these types of companies. What you want if you own these types of companies is someone with their hands on the capital to redeploy it into further acquisitions. It’s as close to a wrote formula as you can even get, and Constellation does it quite well.

Occasionally within the nesting doll another doll will shoot itself out or in the case of Sygnity, they just took over a majority stake of a publicly traded company and left it to remain public. The fan boys call the big nesting doll the mothership. Now something interesting recently happened where one of these spins (Topicus) issued a special dividend to mothership Zeta and this made a lot of people’s heads turn with the quickness.

The going precept at the time, more or less, was that issuing a dividend for these companies is antithetical to the entire structure of the model that CSU operating groups are supposed to operate by. They’re supposed to take the cash and redeploy it rah rah rah. People were not happy, especially Topicus shareholders. There was a lot of noise about it at the time.

But the lesson that I took away from the whole experience was that within these relationships there are tiers to the hierarchy… and the dominant entity in the relation will do as they see fit to their subordinate. There’s probably a big lesson in that to be taken away when you’re in search of companies like this. Ideally you pretty much only ever want to ever own a well-run monopoly where there’s alignment with management in maximizing the long run share price. Then you ride the length of that return stream if you can actually manage to stay on the thing (almost no one can). That’s basically the only thing you ever really need to do to make it out alright. Do that one time over 10+ years and that’s how anyone that’s not self-made from starting a business ever makes a fortune. That’s definitely not the only way to go about this, but for the most part the people with insane long run outcomes do just that and the bulk of their historical returns concentrates itself. A 20 at 5 portfolio is either being actively managed by weights or it’s a new portfolio, there’s not a lot of inbetween. While it’s not exactly a science, there are ingredients to the mix and these ingredients usually have some form of common aphorism attached to them. Older and mature investors, if they ever even talk at all will usually just say these aphorisms or short stories... Those people stop talking stocks (in general) because they implicitly appreciate what solitude offers them wherever they’re roaming... And if you study and take heed of what their aphorisms mean and seriously practice the aggregation of their sage wisdom, well, you’ll usually end up being better off for it.

That’s part of why indexing works so well for so many people— you simply just own most of the good monopolies with very, very well learned subordinates and proper incentive structures in place to drive a good long term shareholder return. There’s a common suspicion that it’s something else by active investors (e.g., too much money in the system or something). While it’s true and there’s a bunch of cheese obsessed savages out there pricing these securities who routinely gain some type of alpha off of information asymmetry— the return series of the index is simply a residual and it’s a good one. Now our planet has turned itself into a capitalist paradise where the consumer is lorded over like a holy dairy cow and I have to be honest whenever and wherever I see people talking about how benchmarks are on this unsustainable tear, I think about how much more ridiculously wealthy and expansive society has gotten in just the last 20 years. You may be wondering how we got here from Sygnity and Constellation Software and I’m not quite so sure myself but what I’ll say is that there’s usually a reason certain stocks end up going up for a long time, and those management teams have it down to an artful science.

Sygnity’s the newest of the lot and its operations mostly live in Poland from what I gather and if they run the rollup well, it will do well. But one day the mothership will come for it too. Because Sygnity is still a subordinate to the one ring of power.