Mark Leonard, the founder of Constellation Software Inc. (CSI), is one of my favorite capital allocators and business leaders, notonly because of his exceptional track record but also because of the principles he upholds in running the company. Leonard’s disciplined approach to capital allocation and his frugality stand out as key factors that have driven CSI’s impressive growth over the years. His 2007 shareholder letter offers a perfect example of his commitment to spending shareholders’ money judiciously, which sets him apart from many of his peers in the business world.
In the letter, Leonard shared a personal anecdote about flying economy class to the UK, despite his 6’5” frame and 280-pound build. He candidly noted, “I can personally afford to fly business class, and I could probably justify having Constellation buy me a business class ticket, but I nearly always fly economy.” Leonard emphasized that he holds himself to a high standard because Constellation employees are expected to fly economy when traveling for business, and he wouldn’t expect them to do anything he wouldn’t do himself. He added, “The implication that I hope you are drawing is that the standard we use when we spend our shareholders’ money is even more stringent than that which we use when we are spending our own.”
This anecdote perfectly encapsulates Leonard’s philosophy of stewardship and discipline in capital allocation. His leadership by example, combined with his keen ability to generate long-term value for shareholders, makes him not just an effective leader but also an ethical one. These principles—leading with integrity, maintaining a long-term focus, and avoiding unnecessary costs—are why Mark Leonard is one of my favorite business leaders.
In his February 2021 shareholder letter, Leonard outlines several key aspects of his philosophy that are worth exploring. He begins by acknowledging that one of CSI’s directors has criticized him for not reinvesting all of the company’s cash flow into acquisitions, given that CSI is more adept at capital allocation than most shareholders. Historically, Leonard resisted this idea, maintaining high hurdle rates for acquisitions, which resulted in excess cash that couldn’t always be effectively deployed. This cash was then returned to shareholders through dividends. However, in this letter, Leonard admits that he’s “converted” to the idea of reinvesting a larger portion of the company’s free cash flow available to shareholders (FCFA2S).
Key Takeaways from Leonard’s Philosophy h
1. Capital Discipline: Leonard’s philosophy centers on maintaining high hurdle rates for acquisitions. His caution against lowering these rates simply to deploy capital reflects a commitment to long-term value creation, rather than short-term gains. The idea that reducing hurdle rates would drag down overall portfolio returns is a fundamental part of his approach. This disciplined mindset is what has allowed CSI to grow steadily without falling into the trap of reckless acquisitions.
2. Focus on Acquisitions: Leonard underscores CSI’s focus on acquiring small and mid-sized VMS companies, which have proven to be resilient businesses with loyal customers and significant moats. Leonard’s respect for autonomy within these acquired businesses is another standout aspect of his strategy. The Operating Groups in CSI are given significant freedom to run their operations, fostering an environment of collaboration and long-term thinking. This decentralized model is unique compared to many other companies, which often enforce heavy centralization and bureaucracy post-acquisition.
3. Shift in Approach: The 2021 letter marks a significant shift in Leonard’s approach. He acknowledges that the company will pursue larger acquisitions and expand its circle of competence beyond VMS. This represents a bold move, as it requires stepping outside of CSI’s proven strategy to seek opportunities in new sectors, where the returns might initially be less certain. Leonard understands that this will lower the overall return on invested capital but views it as a necessary evolution to continue deploying capital efficiently as CSI grows.
4. Long-Term Ownership: Another notable aspect of Leonard’s philosophy is his focus on being a “perpetual owner” of the businesses CSI acquires. Unlike many private equity firms that look for short-term profits and often flip acquisitions within a few years, Leonard takes pride in being a permanent, supportive stakeholder. This long-term perspective aligns the interests of CSI with the managers of the companies they acquire, fostering a more sustainable business environment.
5. Contrarian Thinking: Leonard’s willingness to venture into sectors outside of VMS reflects his contrarian approach to investing. He’s not afraid to go against the grain and explore underappreciated industries where others might not see value. This philosophy requires patience, as it takes time to develop a deep understanding and build competence in new sectors, but Leonard’s track record suggests that he’s more than capable of making this transition successfully.
Conclusion
Mark Leonard’s 2021 shareholder letter is a reflection of his evolving approach to capital allocation. While he remains disciplined and cautious about acquisitions, he’s also open to growth and change, particularly as CSI scales. His emphasis on long-term value creation, autonomy for acquired businesses, and a patient approach to investing are what set him apart as one of the most effective capital allocators today. As CSI moves into larger acquisitions and new sectors, it will be fascinating to see how Leonard continues to balance risk and reward, while staying true to his core principles.
This letter serves as a reminder that successful capital allocation requires a blend of discipline, flexibility, and foresight, all of which Mark Leonard embodies.
