Roper Technologies, Inc. (ROP) Earnings Call Transcript & Summary

To those in the line who are listening. That $50 million was hard fought. So thank you for that. So hey, the business is a fantastic business, just running through the criteria, right? It's CRI accretive, which is the first of our M&A criteria for every deal. The management team is spectacular. We view this spectacular in that they're focused on building this business. Amy and her team have been there for 4 or 5 years. And they're building this business the right way, right, with the proper infrastructure, the proper processes to drive sort of long-term and hopefully improved and sustained higher organic growth than what they've had historically. And from a business profile perspective, it's a niche, it's property. It's agency management solution software for property and casualty insurance agents. So it's the core software chassis that the agents use to run their business. It's a -- the competitive forces are known and observable. There's one primary competitor in us in terms of the market sort of dynamic, competitive dynamics. They have very long track record of mid single-digit organic growth rate. And in the last 4 or 5 years, they've added some products, especially on the carrier side, which we think gives us optionality for higher growth rate going forward. And so it just checks all the boxes, like every acquisition we ultimately do does. And then the kicker on this one was that we're able to finance it at just record-breaking levels in terms of rate. So we always assume the same level of capital cost for 15 years in our model. And then when we can do better, it's just incremental good guy for our shareholders. So in this case, all-in financing was just north of 1%.

How about -- take us through at a high level, when you talk about the boxes to be checked. Because you're highly disciplined in terms of how you go about targeting potential acquisitions, and they have to meet some really exact theme criteria, including cultural fit. So when you -- and then make sure you touched on the CRI because I think that's a real differentiator in terms of how you look at M&A, what you consider to be and how you measure returns.

Yes, thanks. So we'll just go through the checklists briefly. So our first screening criteria for every transaction is, is it accretive to our cash returns? And is it accretive to organic growth rate? So the cash return is our North Star, it is our definition of success. And over the arc of 20 years, we've improved our CRI from 30% in 2003 to a little about 500% today, right? So it's been a core element of our strategy, which if you don't -- if you're not a student of cash return, it essentially says, 20 years ago, we generated $0.30 of cash flow for every fixed asset and net working capital dollar in the business, and today, we generate $5 per $1 of assets deployed in the business. So the quality of our cash flow has just improved dramatically over that period of time. So we only acquire businesses that are better than us, and our proxy for that definition is better CRI, higher CRI. So Vertafore checks that box. The second criteria, Roper in Sarasota here there's -- when we are in the office, there's only 60 of us. There's no management teams laying around idle. And so it's super important for us to acquire a management team that aligns with our culture. And the simplest way to describe that is we need a team that is -- just gets up out of bed every day wanting to go beat their competition and grow and build their business. In the private equity world, some management teams are aligned with that philosophy. Others are aligned with sort of what we call transactional philosophy. So they wake up every day pursuing the next transaction. In our view, those management teams don't build businesses the right way for a long period of time. They're sort of building them for the next transaction. So in this case, Amy and her team are 100% aligned with the builder concept. Go ahead, Deane.

No. What was interesting -- so this -- on the cultural fit, maybe an example of everything that lined up in terms of potential returns but at the end, you decided that wasn't the right cultural fit. Maybe it was a founder owner that you didn't think would work well within the Roper organization.

Well, it's hard to...

Yes.

Go ahead, Rob.

Yes. Well, there's a number of assets we see. We looked at this business several years ago. And to us, it wasn't -- we didn't quite sort of have the management team that we thought that were great in our structure. I mean that's the most sort of realignment example.

It's a great example. 2016, when we looked at Vertafore, we passed because of the management team dynamic.

And that's not -- that issue is not there anymore?

With this new team?

Yes.

So that's not there, exactly.

All right. The $1.6 billion acquisition of iPipeline. Insurance also, but it might as well be a different industry. Is that fair?

Correct. iPipeline is life insurance. Vertafore is property and casualty. The carrier overlap, there's only like 5 or 6 carriers that write both lines, if you will. So it's almost a completely different ecosystem. In addition, what iPipeline does is different conceptually than what Vertafore does. As I mentioned, Vertafore is the core system of record for the agents that they run their business with. iPipeline, Internet Pipeline going back to the origins of the company, are the pipes that connect the insurance companies and their distribution engine, right? And so when the insurance companies want to launch a new product, the details are launched through our company's pipes through the distribution channel. When the distribution channel wants to get a quote or write coverage, they push that back through the pipes, right? And so it's more of a network effect at iPipeline -- excuse -- hence why it's in our network business. And Vertafore is more application software, hence in our application software business segment.

All right. Great distinction between those. So Vertafore puts you at pro forma leverage around 4x. So just address your ability to fund M&A. Are you shut out at all over the near-term as you work that leverage down and there's -- how do you view the self-funding aspect of your whole M&A strategy?

Yes. Thank you for that question or questions. So principally, we're going to be out of the market for large-scale M&A for the next 12 months, plus or minus. This is exactly the play that we ran in the second half of 2016 when we bought Deltek and ConstructConnect. We essentially deployed 2016, '17's capital in one shot in Q4 of 2016. Similar dynamic here. It's essentially 2020 and 2021's cash flow being deployed here in the third quarter of 2020. Same exact concept. We're -- from a self-funding point of view, our business model is super simple. We generate -- we have a bunch of super high-quality businesses that generate a tremendous amount of excess cash flow. This is cash flow they cannot invest back in their businesses after they fully funded their channel investments, they fully funded their innovation investments and many times increased the level of innovation in the businesses. And then the cash that's left over comes to the corporate and then we deploy it. The model is such that we deploy that and we stay investment -- we are committed to investment-grade leverage, which allows us to run at plus or minus 3x sort of leverage over a long arc of time. You peak up like we are right now, we'll pay ourselves down. We'll probably peak up again and pay it down. But the policy is to be investment-grade at about 3x. So it is a perfectly self-sustaining model with a little bit of leverage on it, which actually provides enhanced returns to our shareholders, right? It's just you're running the M&A flywheel a little bit faster, which all, by the way, has been part of the self-funding mechanism for 20 years. There's no difference there.

Talk about the funnel. So even if there's not a big acquisition over the near term, you still spend a lot of time cultivating the final relationships and have a long view in terms of what might fit well with Roper.

Yes. So again, I appreciate the opportunity to talk about this question. Every transaction that we've done since 2016, Deltek, ConstructConnect, iPipeline, PowerPlan, Foundry and certainly Vertafore, all of them, we've had a pre-existing relationship with the management team. So this Vertafore management team, we met in Q1 of 2019 for the first time. Obviously, we had exposure to the business in 2016. So we know that we're -- more likely than not where we're going to deploy our capital a year and 2 years from now are going to be from companies that we meet in the next 6 to 12 months. Right? So we will continually build relationships with companies and with sponsors and, if you will, sort of prequalify that pipeline. Yes, so being in the market and sort of understanding and getting to know these management teams and companies is critical for our future capital deployment.

One of the questions I get from investors is, when a business is -- uses growth by M&A as part of their algorithm, eventually, they face a law of large numbers. Like when does an incremental large deal not move the needle, by our math and our experience, we covered Danaher when they did, I mean, visibly hit the law of large numbers where some of their larger deals were not moving the needle. We had a whole thesis they were going to need to do some form of a breakup and that resulted eventually in the spin-off of what was Fortive. But the market cap at that point for Danaher was $85 billion to $90 billion. So 2x of where Roper is today. So I'm very confidently telling people law of large numbers doesn't -- you can double before we're even into that conversation. But I'd love to hear your perspective.

Yes. So for us, as we decompose the growth drivers and our growth algorithm over the last 7, 12 and 17 years, it's been basically 19% TSR. And the organic revenue growth, the organic operating cash flow growth, the M&A layer and then the improvement attributed to better CRI as we look through that model and apply it forward, the next 7 years, that's just the planning horizon that we work on, there is -- we deploy -- have to deploy about $2.5 billion a year right now. At the end of 7 years, it's about $3.5 billion. So there's nothing that says in our model, the way we do it today, that we can't do the capital deployment or manage the breadth of the portfolio that exists 7 years from now, right? So I understand getting too big, to me, it's not about big deals. Our sweet spots are $750 million to $1.5 billion size deals. So we do 3 of those 7 years from now versus 2 now. I don't view that as a scale issue. At some point, we will run into the Danaher problem, but we 100% agree with you that it's not in the next 7 plus or minus years. But we critically evaluate this. As you know, we have a Board meeting coming up this week and it's this strategic long-term things, things like this, we talk about with our Board. So we're constantly vigilant in that.

And I just want to point out one of the things that's really different about Roper. When you talk about an acquisition, rarely do you talk about earnings accretion as much as you're talking about free cash flow accretion. And is that's just something that everyone should expect? And is that still the plan going forward?

We are -- our whole strategy is based on compounding cash flow, right? So that's where we focus, right? And so we will give adjusted DEPS guidance once we -- now that we're closing Vertafore and give a sense of what that looks like for sure. But this -- our strategy is about cash flow because it's tangible, you see it, you can touch it, right, as opposed to earnings from company to company can be defined quite differently where cash flow cannot.

And in terms of earnings visibility, I mean, I really appreciate the work that you did on the resegmentation because it really makes so much more sense than what you had before. You're still a hybrid. It's Roper Technologies and you're covered by predominantly industrial analysts. And my experience has been when you buy a really like unique asset, let's say, Foundry, it's always new for the industrial investors to say, well, wait a second, this is not like a pump company that they're used to looking at. So there's -- I find there's a delay until the deal closes and the cash flow comes in and the comfort level then spikes higher. It's not on the announcement, it's on the, here's the first quarter with all the cash flow. Is that still the experience? Because I certainly feel that way.

It's the experience and our internal expectation. And it's not the first quarter. It's -- we got to get, in this case, Vertafore completely in our trailing, right? So it takes about a year for the value we expect in our models to accrete into our shareholders.

All right. So let me -- I got this question...

We can't tell you why that is. We can just tell you that's what empirically what's been experienced over a long period of time, not just for us, but for many other companies that we said as well.

Absolutely, Zack and I have talked about this at length. And as soon as the deal printed, we said don't expect an immediate stock reaction because for whatever reason, it takes a bit longer until the deal closes and the cash flow is tangible, and you can point to that increase -- incremental increase in the cash flow, that's when the market starts to recognize those deals. So we're very comfortable with that. I'm also comfortable with the ground that we've covered over the last 30 minutes. I appreciate that. Our time is up. And just to make sure investors know that they're not getting gypped on getting to do one-on-ones today, you all have a full day planned, I understand, to do the onboarding of the leadership team from Vertafore. Is that right?

That's correct. It starts in about an hour.

Okay, good. So fully appreciate, your schedule is full, but you did graciously give us this opportunity this morning. Thank you, Neil. Thank you, Rob. Thank you, Zack. Best of luck. And Shannon, who I know is in the background there somewhere. So best of luck to the team. Stay well.

Thank you. And it's always a pleasure to hear you.

Bye, everybody. Thank you.

This concludes the presentation by Roper. Thank you.