The latest battle for the Biden Administration’s firebrand Federal Trade Commissioner, Lina Khan, is playing out in a Northern California court. That’s where the FTC is challenging a deal that envisions Canada’s Constellation Software’s (CA:CSU) Perseus operating unit buying Optimal Blue from Intercontinental Exchange (US:ICE) and Black Knight (US:BKI) for $700 million.

Optimal Blue offers a SaaS marketplace platform connecting mortgage originators and investors.

The simple part of the deal is the price: Perseus will pay $200 million in cash and issue a $500 million 40-year promissory note at 7% interest. However, the acquisition requires a couple of events before Perseus can make the acquisition.

Intercontinental, which owns the New York Stock Exchange, is in the middle of trying to close its $11.7 billion purchase of Black Knight, a large provider of mortgage software. For Black Knight to sell Optimal Blue to Perseus, Black Knight must be a subsidiary of Intercontinental for the sale to proceed.

That’s far from a certainty, given the deal’s regulatory issues. In 2020, ICE acquired Ellie Mae for $11 billion. Ellie Mae was a mortgage automation company. Combining with Black Knight would make it the largest mortgage software provider in the U.S.

FTC’s Regulatory Issues 

With a court ruling on the deal expected by the end of this month, Perseus must wait to learn the outcome of this appeal by the regulator.

“Optimal Blue has been a sticking point in the FTC’s case to block the proposed merger of ICE and Black Knight,” The Globe and Mail reported RBC Capital Markets analyst Paul Treiber’s comments regarding Constellation.

The analyst has a Buy rating and CAD$3,200 price target on Constellation stock, which closed Tuesday just above CAD$2,798 a share.

However, in addition to the Optimal Blue acquisition, Constellation is trying to close its purchase of Empower, a loan origination system also owned by Black Knight. Perseus announced the Empower acquisition in March.

While terms of the Empower sale weren’t disclosed, the agreement did adjust the amount Intercontinental would pay for Black Knight lower by $1.4 billion, from $85 a share down to $75.

The fact Perseus is buying both Empower and Optimal Blue improves Intercontinental’s chances of successfully closing its purchase of Black Knight.

Benefit for CSU Stock Investors

The deal would give Constellation a foothold in a business, mortgage originations, ahead of what looks like an uptrend in home financing. Data from the Mortgage Bankers Association, via Statista, shows that a decline in originations that started in Q4 of 2020 likely troughed in Q1 of this year.

CSU stock garners some impressive scores on Fintel’s quant dashboards. Up 23% in the last six months, the shares scored 74.25 on Momentum. But it’s the Quality score, which is based on a company’s cash generating efficiency, that really stands out, at 91.21

If successful, it would be only the second time in Constellation’s history that it’s paid $700 million for an acquisition. The first was in 2022, when it acquired Altera Digital Health for the same price.

Small Deal History

Until 2022, Constellation was content to make many small acquisitions rather than single, large purchases. According to Globe and Mail reporting, the average price Constellation paid for an acquisition over the past five years has increased 300% to $28 million from $7 million.

Yet, in 2021 and 2022, Constellation spent $1.2 billion and $1.6 billion, respectively, completely shattering its record of $600 million spent on acquisitions in a single year before 2021.

Before this surge in acquisition spending, Constellation had been content to acquire small software companies for its various platforms, including Perseus, and organically grow those businesses.

However, founder Mark Leonard laid the groundwork for larger acquisitions early in 2021 when he realized that the company was missing out on a lot of interesting acquisitions because investment bankers felt Constellation had too high a target for the return on capital for its deals.

Leonard openly admitted that the company would be willing to lower its return on capital to get bigger and better deals. Previously, Constellation sought acquisitions with a 30% return on invested capital. By reducing that hurdle rate to 20%, the company’s generated more than $4.8 billion in acquisitions since the beginning of 2021.

Tech Version of Berkshire

In recent years, Constellation’s organic growth has been minimal, so larger acquisitions can hide the lack of growth until it can use its economies of scale to drive its organic sales.

In many ways, Constellation is the Berkshire Hathaway (US:BRK.B) of the technology industry. As it’s gotten larger, the number and size of niche businesses coming across its desk have greatly increased.

If not for Leonard’s decision to opt for larger deals to generate optimal cash returns on its capital, Constellation still might be doing tiny deals as it always had.

Times are changing. The Optimal Blue deal is indicative of this change. It’s excellent news for CSU stock holders.

This article originally appeared on Fintel

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