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

And to kick off the presentation by Roper Technologies, we're delighted to have the senior management team here. We have Neil Hunn, CEO; Rob Crisci, CFO; and Zack Moxcey, Head of Investor Relations. So thanks for joining us, each one of you.

Thanks for having us. Great to see you.

Happy to be here.

Hey, if we start off on what has changed the most for Roper has been the positive pleasant surprise from our perspective, a faster debt paydown following the Vertafore acquisition, getting you darn close to that mid-3x goal in terms of leverage. So it brings up the question, when and how does Roper pivot back to playing offense in M&A once again? That's an important part of your growth algorithm. But Neil, take us through that, where you stand today and the accompanying questions about funnel and so forth, but the floor is yours.

Happy to do it. Thanks for the opportunity, and good morning and afternoon, everybody. Yes. So we're delighted with the pace of the deleveraging following the Vertafore acquisition. We closed it just a year ago last week, this past weekend. The cash flow in the Q4, Q1, Q2 has been better than we had hoped. We've also remained super disciplined relative to capital deployment, doing virtually nothing. 3 very, very, very small tuck-ins over the course of the last year, I believe. And we are definitely pivoting to be offensive. We've signaled on the end of our last call or 2, quarterly call or 2, that we could see being -- dipping our toe back into the water and sort of heading into Q4, but certainly heading into next year, being back in our normal way, M&A posture, cadence, rhythm, and get that flywheel spinning. We've been super active throughout this whole period of time, by the way, in terms of maintaining relationships, meeting companies early on, so that we're positioned to be successful when we do get offensive, which is basically happening as we speak.

And how about funnel size? You've actually given a couple of different angles of the way you've sized it.

Yes. So I think it was April or May, I threw out a number of $150 billion. I think that the purpose of me saying that was to say in our normal runway -- normal way of M&A, we need to deploy $2.5 billion, $2 billion to $3 billion a year. And we have scores of opportunity that are above and beyond that. So we don't view the opportunity set of the targets to be in any way a limiting factor for us now or anywhere in the medium-term future. Probably won't -- it's not relevant if it's $160 billion or $140 billion. It's just -- it's always big. It's always been big for the 10 years I've been here. And it's -- and I don't -- just trying to take that issue, a question off the table for investors. And it's very active. It's high quality. And that number, by the way, wasn't the totality of the things we look at. They were like the A and A- candidates that we're looking at, right? So the funnel is actually bigger. And there are certainly things that we don't know about that we're not tracking. So lots of opportunities, and it allows us to continue to be selective in our acquisition targeting process.

Good. How about valuations? And then what are you doing in terms of are there COVID adjustments? I mean if the company has had a dip, it kind of skews your trailing 12 months. I know the forward looks more important, but talk about valuations.

Yes. So valuations are for the assets that we're looking at, right? So our asset profile, the ones that we're looking at, are all software companies. They have all -- have very high levels of recurring revenue. They're all either cloud, SaaS native or in the midst of the journey to become cloud SaaS native. They're very profitable, and they have mid- to high-single, if not low double-digit sort of growth outlooks for the medium term. Those are not cheap assets to acquire, right? And so valuations are high. I would say they're not -- they don't appear to be going up as much as they have in the past period of time. So maybe we've hit a plateau, who knows if that -- if we'll be able to answer that question a year from now if we've sort of stabilized pricing, but they're still high. But the assets deserve that price because of the quality of the cash flows.

Yes, let me add the -- yes, to answer the last part of your question, similar to our software businesses, these type of companies really don't -- didn't see much of a COVID dip, right? I mean the -- because they've got such high levels of recurring revenue. I mean, there could be a little bit of license or service revenue that was delayed. But for the most part, you don't have to worry about an adjustment because these businesses grew through COVID, and they'll continue to grow moving forward.

Hey, Rob, since I have you right here, can you follow up on -- because we get this question a lot. When your higher valuations don't necessarily reflect low returns, how do you look at the CRI looking at higher valuations? And how does that translate into the way you look at deals today? Or you always have them in your business model?

Yes. It's the same approach we've always had. So we have to react to the environment that we're in. And so if interest rates are very low and assets trade at higher valuations to private equity, right, which is who we compete with, then we're going to have to be able to pay $1 more or maybe a little less in private equity if the management team is on our side. But essentially, we're following the markets and the private markets largely run off of interest rates and availability of debt and rates of loan availability of debt is high. Just in terms of CRI, I know it's a bit of a confusion. CRI, cash return on investment, is really a business model quality calculation, right? It's cash return on tangible assets. So it's about the amount of cash the company generates against the physical assets, the working capital. It's really a business model. And so we want to buy businesses with great business models, and most software companies have that. And then we certainly use CRI as one of our tools in terms of valuing the companies. We also use all the traditional metrics that everyone else uses. We use DCF models and LBO models. And we've always seen a high level of arbitrage and we continue to see that when we buy these assets that Neil mentioned the type of assets we like to buy and we buy them in the private markets. We become their permanent owner. We make them better. We work hard to accelerate their growth. They've already proven they could grow over a long period of time, and they have -- and these assets are very, very low risk. So we take all that into account and feel great about the strategy, which is that buying these high-quality businesses that will grow forever with us being a permanent owner. And we try to pay as little as possible for those assets, trust me. And so we feel that we end up getting IRRs. If you compare to a private equity firm, which also has a terminal value in their math, they're getting IRRs in mid- to high teens, 20% plus, and we believe we get the same from the companies we buy.

Plus you have the advantage of you not looking to sell in 5 years.

Absolutely. Critical, right? We're investing for the next 5, 10, 15 years. We're not trying to invest for a year or 2 and then go on sell mode.

Rob, you said something really important. Embedded in there is about maybe not having to pay $1 more because if the targeted management team is on your side. Maybe elaborate on that point because that's a competitive advantage for you.

Yes. Rob, you want me to take that one?

Yes.

Okay. So as we are selecting or meeting companies, as you know, we care deeply about the management team conveying to us. In very simple terms, as we meet teams, we can bucket them in one or 2 buckets. They are either into what we'll call transact the business, call them transactors. So they're there to do the quick turns, the private equity model. And then the other bucket of leaders are we call builders. So they are fundamentally and intrinsically motivated to build their business the right way over the long term. The transactors, by the way, can make a lot of money in both sides. And there's -- that's not a value statement about either one, right? The whole private equity -- most of the private equity model is built on the transactor model. But we look for the builder management teams. When we find a builder management team, they love us because the things they don't like are the distractions of selling their business, the distraction of focusing most of their attention on the short term versus the long term. And most of -- essentially, every business that we buy has a builder mindset in the management team. And as a result, they are -- they do incrementally advantage us in the process to the best of their ability.

That's great to hear. Look, success attracts competition. And we're now hearing almost every day within the multi-industry land management saying, we're going to build out our SaaS business. Are you seeing more of the strategics showing up, the likes of Fortive or Honeywell, at any of these businesses that -- and how do you think that plays out?

So we certainly -- I mean, obviously, Fortive has bought a couple of companies that were historically of interest. We've looked at the one that Honeywell just recently bought for years. That's been on our radar screen. So yes, the answer is yes. But in a meaningful way, is that impacting us? No. And it hasn't over the 10 years that I've been here. As we've said many times, there's always an occasional strategic buyer for an asset that we're looking at. It's a very small minority of the opportunities that we look at, where a strategic comes in and pays what we'll call a strategic multiple and -- because they're going to win that every time. Maybe if we look at, in a meaningful way, 40 or 50 transactions in a year, 2 to 3, maybe 4 fall into that category. So -- but -- and the strategics that are buying those are always different. It was Fortive a couple of years, maybe Honeywell this year, maybe it was Hearst 5 years ago. And so who it is changes but the number of deals is always a small amount. They get sort of swept away by a strategic.

I also find it interesting, the approach in some of these strategics is they like to build around adjacencies, which probably narrows down very quickly the number of assets. I've never -- it's rare that you ever look -- I hear about Roper trying to build out adjacencies on its own, but maybe you can address that.

Well, it's a yes and a yes, I would say. So certainly, our orientation, right, the core of our acquisition model in all the capability we've built over 20 years from the CRI, from the management interview process, from the diligence that we do, our internal vetting is all around picking the very best business that we can find, right? We're business pickers in our M&A approach. So that enables us to look across essentially any end market, right? Who would have thought 3 years ago, we would have bought a company that sells software into media and entertainment? It wouldn't have been Rob, Zack or I, but we found an amazing business in Foundry, did all of our work and said this sort of checks every single one of the boxes around what a great business looks like for us. So it opens up many opportunities for us. And that's why I think you have a very small percentage of strategics that might dip into -- there's somebody who's focused on insurance. They might buy something insurance. Well, if it gets taken away, fine. We'll go buy something in education. It sort of doesn't really matter from an end market point of view with the capital we have to deploy. That said, we have around our larger software platforms, Deltek, for sure, I would expect with Vertafore to do bolt-ons and build-outs, right? And a great example of that is with Deltek. When we bought the business, obviously, it was super strong in government contracting and -- with architects and engineers. But they needed to build out a construction part of the AEC market. So we bought a small construction ERP company and bolted that into what Deltek does, and it's been great ever since, build-out. And we've done, I don't know, 1 to 1.5 bolt-on deals a year since 2016 in the Deltek sort of chassis. And so I expect that we'll do more of that going forward as the number of platforms we have to do bolt-ons increases as we broaden our portfolio.

Now let's -- the question now is on how do you think about sequencing acquisitions and size? So we just had an outlier event where Vertafore was the largest deal you've ever done. Then the playbook became -- and we've seen this before, where the playbook is, it's debt pay-down, and it was done, I think, and it's just faster than expected, but very transparent that then -- that we've had this discussion about that playing an offense. What's your appetite today to go down that road again on a larger deal? Would you rather do smaller like Foundry-like deals that then don't use up the whole warchest at one time?

Yes. The overarching at the top of the pyramid that we serve with our capital deployment approach is we want to find the very best business we can find at the very best price that we could all clear in the marketplace. So with -- if all things being equal under that sort of set of parameters, I think we -- our sweet spot deal sizes, just in terms of, again, small markets, the type of companies we look at, if you sort of profile the funnel, probably $750 million to $1.5 billion is like the sweet spot of the targets, right? There's not -- there's just not a lot of Vertafore-type deals in the software market space, like a small market leader that's like jumbo shrimp, right? You're going to sort of be generally buying smaller businesses. So yes, I mean -- and so that's the sort of the sweet spot and candidly, our preference as well. I mean -- but we wouldn't shy away. If it was -- if the trade-off for us was 5 $1 billion businesses that were inferior to a 1 $5 billion business, we would buy the better $5 billion business.

Okay. Then...

The converse is also the case. We would not buy a $5 billion business that was inferior to 5 smaller businesses, right? So...

How about growth rates, top line? There's always this grumbling that people say, "Well, hey, Roper doesn't grow as fast as like a salesforce.com on a blended basis." And I would say that you're not looking to get the next salesforce.com in the portfolio. But just how do you think about top line? And how is that different?

So we think about top line in the context of its contribution to our flywheel around TSR compounding, right? And so for 20 years, for 10 years, for the last 5 years, it's all about the same math. We've compounded our share price at about 20% a year on the back of 4-ish-percent organic revenue growth. There's been a bit of margin expansion. There's been a lot -- there's been a fair amount of that contribution from the cash flow that we've acquired and a little bit because the quality of our businesses improved and the shareholders have attributed a higher multiple to it. So when I became CEO almost 3 years ago, it became important for us to improve the organic growth rate of our business. And you do it fundamentally by making the core -- the current portfolio, you get it to grow faster. And we're well on our way to do that to where, I think, we can get -- I've said, hey, it'd be great if -- mathematically, you want to find a couple of hundred basis points of growth. So if we were 4%, we'd like to be 6%. I think we're well on our way to doing that. This is not like an overnight thing. It's still got a few years to play out because we're doing it structurally to where it's not just a 1-year thing, and it goes away. It's how can we sustain the capability across these businesses. And then you can also supplement it by buying businesses that grow a little bit faster. And so the first business that we bought that we've ever told Wall Street and the investors that we thought would grow high single digits was iPipeline. We committed mid-singles for Vertafore. I'll tell you, if it delivers mid-singles out of a long arc of time, I will personally be disappointed because there's more opportunity inside that business in mid-singles. But that was the course and speed when we bought it. And Amy and her team are very focused on structurally improving that one as well.

And then maybe, Deane, in terms of the -- just to finish that out, in terms of the type of software companies we buy, right, the type of acquisitions we target, it's the vertical software companies that are proven to be high margin, high recurring revenue. Each individual company would have a smaller TAM than a salesforce.com, but they will already have proven that within their market, they can consistently grow mid- to high single-digit organic with great margins, great cash flow performance at very, very low risk, right, versus the high flyer that you buy that's grown 20% that's not profitable yet. Yes, that might be a home run, but there's also a good chance that company doesn't end up winning in the end. And you just paid a big price for something that's never going to give you any cash or, God forbid, eats cash. And so that's -- so the type of software companies we compare ourselves to are more of the vertical software companies that have very similar characteristics to what we buy. And those companies trade at incredibly high multiples because the cash flow is so stable, the revenue is very recurring. And so it's just a different type of software company that we target.

And if I could piggyback in...

And that sort of...

Go ahead, Deane. I'm sorry, please.

The idea that, hey, there's a -- I'm not saying it's a disconnect, but people question the growth rate, and that was a really good explanation on the top line. But that begs also the question of some of the underlying misunderstandings or misperceptions about Roper. Zack, you probably get a lot of this, I know. But just how would you characterize the -- like either the disconnect or biggest misunderstandings with the company and the business model today?

Yes, I think we've been talking about it. I would highlight a couple, right? The first one is that -- we're not just a holding company that does acquisitions and puts them and looks at them once a year and hope they do well. I mean, we are very much an operating company. We have -- and with a structure and a capability and resources, executive resources, that make these businesses better, that we acquire, right? So if you had to summarize Roper in a compound sentence is we buy great businesses and make them better over a long arc of time. There's no quick fixes, right, because we're already buying a great business, right? We're already buying a business that's growing 5% to 7%, that's got 40% EBITDA margins, that is well run. But the way that we can make that business better, about getting them better and more focused strategically, how they build the strategic capabilities they need, so they endure over a long arc of time, and then how do you get the team and the talent at peak performance, sort of peak team performance is what we have -- we've built that capability over the last 7 to 10 years, and that's what our group executives and Rob and myself, that's a big part of our day job is making these businesses better. So I think that is largely misunderstood. I think the -- and part of that is also investing to grow and all that. I think people think that somehow we have these amazing cash flow is because we don't invest in the businesses. That cannot be further from wrong. We just -- we have amazing cash flows because we buy amazing businesses. And we absolutely invest in the businesses to grow based on the strategic work and the opportunity set in front of them. The second thing I would say is it's one around risk, right? I think people view M&A-led strategies as risky, completely understand it analytically. 75% of acquisition-led strategies tend to deliver sub -- below sort of market returns. We're one of -- one out of 4 that do much better. And it goes to what Rob and you were just talking about, which is the type of assets we buy. These are low-risk assets that we buy, right? I mean small, small -- big TAM, if you have a huge TAM, that organic growth is risky. One, competitors are coming in left, right and center. That's one risk. Another risk is you've got to make sure that company can actually capture the growth and then build a business model to turn it into cash flow at some point down the road. So there's a lot of risk in those higher-flying, high-TAM, high-growth rate businesses. Hey, there's -- at the end of the day, there's going to be a Salesforce or a ServiceNow that pops out of these hundreds of smaller software companies. But it's going to be a small number because there's so much risk. In our case, our risks are boxed and managed around buying great businesses with great teams that are in small markets that are stable but still grow. So it's -- we're not nearly as risky as people would think based on sort of a very quick outside-in look.

That's real helpful. Let's pivot over to what Roper is. You're an outlier within the business model -- outlier has a negative connotation, a leader in building out software. And software-as-a-service is now 2/3 of earnings. What you're not exposed to as much and we've had a parade of industrial companies at this conference talking about supply chain issues, inflation, labor issues, the whole gamut. Just what percent of the portfolio today is that impacting Roper? You talked about it in the second quarter. But just so people have a frame for where that in the portfolio is exposed.

Appreciate it. Just I want to clarify one point in your lead-in. 2/3 of our EBITDA is software, not just SaaS, right? So it's the software orientation. And then if you look at the cyclical part of Roper, which is a small part of our MAS segment, the industrial piece, and then all of process, add that up, it's about 15%, 15% of Roper. There's -- and then inside of that MAS segment, you have Neptune and the medical products businesses. So they have some level of -- they assemble things and ship a physical product that would be subject to some of the supply chain challenges that the world is facing. But that's -- to size it up, that's what it looks like.

Good. We covered a number of companies that are in the same business as Neptune. So we're familiar with what the supply chain issues are. They're manageable. And how about COVID overall? Rob, you made a terrific point that it really -- COVID was not as disruptive to the software side of the world. But just overall for Roper, where is COVID in terms of a disruption versus an opportunity and -- as you see it?

Yes. I mean it's COVID. I mean it's -- it was a -- it impacted us less than most. But still, it impacted us, right? And so if we sort of just start at the top of this, quickly go through the segments. Application software. For a while, people stopped buying software to -- new customers said, "Hey, I don't think now is the best time to implement an ERP." That activity is back. We've talked about that in Q1 and Q2. We're able to -- the retention rates remained super high across the application segment. So people didn't leave, they just said, let's -- with all the uncertainty, let's slow down sort of buying new. Largely, the same thing can be said for the software businesses and our network segment. But there certainly have been -- like, for instance, the media entertainment business, the production of movies and -- they've stopped for a while. So there's a little bit of an air pocket. The air pocket is fully gone, right? Production is full steam ahead across the globe. Same thing could be said. So it's little pockets, fits and starts. Probably the single biggest impact was the Neptune business and the cyclical part of our portfolio with Neptune. We just couldn't, in the Northeastern Canada, get in to do meter replacements. And then you have the normal sort of whipping effect of the supply chain and the demand flows on the industrial businesses and PT businesses that the companies are working with.

Yes, which you've sized overall, about 15%. All right. A 2-part question. We've got 5 minutes left. Compounders -- and Rob had this like 4 or 5 years ago, and I've coined it over and over again. Compounders don't typically divest assets because it's really hard after tax to reinvest to get the same kind of growth rates, I get that. But you've had a couple of divestitures. And Gatan actually goes back to Brian Jellison, who said, "Hey, at some point, for the right price, that would be a business we divest." So I wasn't surprised. Zetec has now gone as well. Is there more openness to divestitures or pruning, if you're not the natural owner? And it begs the question about -- on the cyclical side of it, that 15%, is there ever a notion, an idea that there might be a separation?

So Deane, I've been -- this month -- like this month will mark my tenth anniversary at Roper. I think I've been in every Board meeting save one over that period of time. And I can tell you, Brian, this Board, myself, Rob, we are always at the Board level, talking about how can we create, improve our -- the position and value for our shareholders. It's an ongoing conversation. And it's everything from organic growth rate to the acquisition flywheel. And is there value that can be created by selling or divesting or spending or splitting sort of the whole set of running the gamut of what it looks like. That's not a new thought. These thoughts have been around the whole time that I've been here. And it's just been at what point in time does the math makes the most sense, if it makes sense to do something. And so that's -- we're always committed to that. I mean the great thing about -- it's a great thing about the job I have about we're not trying to build the biggest blank because it liberates us, right? So all -- I mean, we like Zetec, but it's okay if somebody else owns it, right? We're not emotionally connected to our businesses, so it gives us the degrees of freedom to do what we think is in the best interest of our shareholders.

Great to hear. How about the law of large numbers? Companies at a certain point that grow by acquisition reach a size, and we saw that with Danaher in 2016 when they eventually spun off Fortive. If I use comparisons, you could double your market cap before you got to where Danaher was at that stage, and you can increase revenues by 4x before you got to a Danaher stage. Just to use that as a benchmark. But how do you think about the law of large numbers within Roper's model?

It's one of those things we talk about at the board level. We plan out on a 7-year horizon. We go through it with the Board every year. And a big part of that planning horizon is where do the bottlenecks show up? Where do the law of large numbers affect -- hit, right? So essentially, it can hit in 2 places. One is the volume of acquisitions you need to do. So as I mentioned, I don't think there's going to be an availability of targets issue. But right now, we have to do $2 billion or $3 billion of acquisitions. 7 years from now, it's like $4-ish billion. But 15 years from now, it's like $10-ish billion. So if -- could we do $10 billion? Probably, but we have to do something different than the way we organize ourselves to do it today. On the other side, it's how do you then govern and manage that amount of deal flow that comes in. Right now at $2 billion to $3 billion going to $4 billion in 7 years, that's one or 2 platform companies a year. So we think that's imminently scalable. Our group executives can carry about 10 companies as the right sort of -- 8 to 10 is the right load for a group executive to deploy our governance system. And so you're talking about going from $5 billion to $6 billion over the course of the next, call it, 5 to 7 years. So we think that's imminently scalable. So long story short, the next 7 years, as we look at all the flywheels in the company and the law of large numbers, the returns that come with it are not meaningfully affected in the next 7 years. The 7 years after that could be. And then we got to figure out what we need to do. But as you said, we'll be tripled in value and we invite the shareholders to come for that ride.

Yes. That's a fabulous point. That 7-year itch is a long runway of acquisitions and free cash flow, and that math also makes sense to us because we've looked at it a number of different ways. So look, this was a different kind of fireside chat versus what we've done with the other companies. There was no real compelling reason to go deep into price cost or labor shortages and things like that. You've reached such a pivotal point in the debt paydown that you're coming back into playing offense. And some further color on the business model, I find, is always exceptionally helpful for people that need to hear what makes Roper unique, what makes it tick and why it's sustainable. So thanks for indulging me on going deep into the business model.

Well, thank you for the opportunity. It was great.

Great. Enjoyed it.

Great. All right. So we're out of time. Thank you, again, Neil, Rob, Zack, for your time today. Thanks for participating in the RBC conference. I appreciate that. And this concludes the Roper presentation. Thank you, everyone, for participating. You can sign off now.

Thanks, everyone.

Thank you.