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

All right. This is the best story that we're learning more about, and it's probably the most beautiful stock chart of the day, maybe the whole entire conference. So congrats on that. Neil is here, CEO and President; and Rob, EVP and CFO. And thanks, Zack, on the front row. We go back to the Microsoft days. So he's a phenomenal resource, so get to know him as well. But thanks so much for joining.

Thanks for having us.

To kick off, maybe just give everyone a quick intro on the story and then we've got -- so what's driving this phenomenal stock chart?

Appreciate that. So it's great to be here. We can use the slides or not. I can just give you 5 minutes of Roper for those who don't know us. So Roper today, we just learned this ourselves a couple of weeks ago, we're the fourth largest application software company in the S&P 500 by revenue, cash flow and enterprise value. So we're excited to have worked to get to that point. What Roper is in a sentence is we compound cash flow. That's our focus is how do we compound the cash flow for our shareholders over a long arc of time by buying great businesses and then making them even better. So that's what the ethos is of Roper. When you deconstruct the -- Zack's trying to get the chart up there. For 20 years, we've been able to compound the cash flow or our shareholders TSR at [ 18% ] a year. And when you deconstruct that, about 60% of that is organic, about 30% or 35% of that is acquired cash flow [ growth ] and then the balance is, is the quality of our enterprise has improved [ where we ] earn a little bit higher [ multiple ]. And so Zack, if you go to like the next page, that would be great. So this is the portfolio. Yesterday, we made an announcement where we're divesting really the legacy industrial cyclical businesses that are in the portfolio. We announced that we're divesting 16 businesses in a transaction with Clayton, Dubilier & Rice, and what you see on this page is what Roper looks like excluding those business. So at the midpoint of our guidance range, which we updated last quarter, $5.2 billion of revenue, 40% EBITDA margins. We're 75% vertical software, and you can see it on the right-hand side; and still 25% highly engineered, very technical products in health care and water end market. So that's the -- and that's what both organic and inorganic growth profile looks like from I think it's 2018 or '19 [ to this year. If ] you go to the next page, Zack. Go ahead.

I was just going to say this compounding cash flow is a really interesting perspective because every one of these companies at this conference is about growth, not about the bottom line or cash flow. So good to hear a contrasting story from what we've been hearing.

We'll be delighted to unpack that. So if you think this -- and then if you think about the type of companies that are in the portfolio, all those companies, they're in small markets. We love small markets. We like them because it is a competitive moat. We also like it because the basis for competition in the small markets are one of customer intimacy, right? So if you think about we're market leaders in small markets but they're growing markets, we have a portfolio of 26 businesses. This is sort of how we think about Roper, right? So you have those businesses on the right-hand side. The way we govern those businesses is highly decentralized, super, hyperly decentralized. These companies are in these small markets. They're super intimate with their customers, so they don't need a center organization or a headquarters organization telling them what to do every day. They make strategic choices, they make resource allocation choices at the local business. We have 26 businesses and 26 of everything: Presidents, CFOs, ERP system, development centers, you name it. It's 26 of everything for that local autonomy. And so it helps customize and tune what we do to all 26 of our companies. But also, there is nowhere to hide in our organization. There's no syndication of operating risk through a matrix in our organization, so the purity of our organizational structure is key. But we're not passive owners. Sometimes, we get compared to other sort of public/private equity firms or other large public companies that are more passive in their ownership. We, at the center, have a series of business coaches that work with our companies to make them better around their strategy, how they execute strategy, how they run a team and talent offense, how they think about cybersecurity, how they think about ESG principles, diversity, equity, inclusion, all in the pursuit of improving the organic growth rate of the business. We then take all the -- so as we have these businesses that are great in their markets, they're getting better over time. They're growing a little bit faster over time. They're wildly cash generative. As we mentioned, we have 40% EBITDA margins, and that's a very clean EBITDA. We expense all stock comp through that number. We convert north of 80% of that number into free cash flow every year, year in, year out, a very clean EBITDA number. We take all of that cash flow, pay a small dividend. It's grown for 29 years in a row, by the way. And then the balance is we buy the next great company, and then we keep the flywheel going. So like I said at the beginning, you deconstruct it. It's partially organic, partially inorganic and a little bit as the quality enterprise improves, we get a little bit of [ a multiple ].

I will just add to that. So the one thing we do centralize very importantly is that capital deployment. So it's a big part of our jobs at Roper, with Neil certainly leading us, is about finding the great next business that fits all the criteria Neil laid out for Roper. And that's really an important part of the value-creation model, which we'll talk about in the cash flow compounding. It is -- we believe organic growth is very, very important. We have good organic growth, always working to improve that. But we're also deploying capital, and that's what gets you to the double-digit consistent cash flow compounding, which leads to the high teens TSR that we've been able to compound in 20 years.

[ On cue to the next page ], and that's the stock chart, right? So it's just been a nice up and to the right [indiscernible] time.

Gorgeous. Nothing looks like that.

So we can get to your questions. We're proud of that. I mean that's engineered over 20 years, right? That's not a fluke. It's about all the process we have around the M&A flywheel. It's all the process we have about how do we help the businesses get better, about the asset selection. By the way, that growth -- that stock chart is -- the average organic growth, that was probably 4%, and the organic growth profile going forward is much better than that.

When you see a chart like that, like the natural question is what's the next [ mode of any factor ] to keep going, which is this is incredible, but what's the gas in the tank that has got you guys going that's enabled this to continue?

Well, we're -- that's -- we're entirely piqued up by this concept, right? So we're hyper analytical, and it's all about -- like it's -- Rob and I have been here about 10 years. So we've been there for only a chunk of that chart and -- but that is in a way that maybe comes off the wrong way, you don't mean for it to be. I mean it's -- we view that as close to elite level performance. And you don't get to be part of that except in a very short burst of time. And so what motivates us is how do we continue to extend this elite level of performance, have an extremely high performance bar inside the company to work at Roper and the expectations we have for performance, and that's what keeps...

Can you give us an example of the niche vertical businesses? Just maybe [ roll in ] a few of them that you're really excited about?

Maybe if you go back to -- Zack. So I'll give you an example. So what do we mean by these small businesses that are niche or -- I'll give you -- there are 2 buckets. They're either application software. So true application, like companies are running their business on our software or software that is network-oriented. So I'll give you an example of both. So on the application side, it's not our biggest company but it's easiest to understand. Roughly 1 in 2 -- 50% of the largest law firms around the globe run on our software, right? So we are the ERP for law. It's a company called Aderant. It's deeply verticalized the way a law firm thinks about matter versus project, the way they assign resources, the way you have to go find the right skills to deliver into a particular project, the fact that their business model is changing to be less time and materials and more [ fixed fee ]. Like we just tune the software to deal with the challenges of lawyers. Also, by the way, when we implement it, it comes out of the box ready to go for a law firm. You're not taking a generic ERP and then customizing it with service packages [ over the top ]. So a medium-sized law firm could take the software with like no tuning. It's just ready to go out of the box. An example on the network side is we own a business called Foundry. It's in the media and entertainment space. The core application itself is the software the entire industry uses were ubiquitous, that takes a live-action shot and computer-generated and merges them into one scene in a process called compositing. So think Game of Thrones. Basically, every scene in Game of Thrones is comped, or composited, using Nuke, which is the product of Foundry. And so it has an application specificity to it. It also has this wonderful network effect. The kids are trained in college on how to comp using Nuke. There's -- on your profile in that industry, you're a Nuke level 1, 2, 3, 4, 5 engineer, and it is ubiquitous in that regard for that...

You mentioned you're not like others. Some will say like [indiscernible] consolidation. What makes your approach [indiscernible] some of these other models like -- and I don't know if there's one that you would say you're closest to or compare yourself to?

Yes. Well, there's not -- there's parts of companies that you can draw some similarity to, but we really have sort of carved our own pathway. At our core, we are business pickers. We're not market [ pickers ], right? So we are able to find analytically the very best software business models that are in the world. We can analytically identify those very early in the screening process. We then find leadership teams that are authentically just [ peaked up ] to build their business, put the blinders on and build their business the right way. So everything we buy is from private equity. They have to go through the buy-sell cycle every 3 to 5 years. They have these monthly Board meetings, these 100-page PowerPoint presentation they have to give every month. So all that noise goes away, distraction goes away and they can just build their business authentically. And then is it, like I said before, is it in a small market? Is it a leader? Is the market growing? Do they have the right to sort of grow into [ mixed or ] adjacencies? Those are the characteristics that we look for. And everything in our M&A process and everything in our operating governance process is tuned to that type of asset. That's sort of what makes us special is the consistency. I mean you could pick any name off that chart and I could give you like why they're -- they meet those [ criteria ].

And then the current environment we're in, does this make you look at more assets given what's going on with valuations? How do you think about the current environment and...

Yes. I mean, so it's -- so we definitely don't -- we don't attempt to be market timers, right? When you have a compounder's lens, we think in 7-year increments. If you run any analytical model that -- if you could predict when the market was going to bottom and you deployed all of your capital at that moment, it's -- and that's a couple of years out, the compounding effect of buying on the way down and buying on the way up 7 years from now always overwhelms the time, right? So being in the market is important. And so -- but that said, in this market, valuations are coming down. Private valuations where we buy from lag public. And so we're very much in this process of just understanding the drift down. And so we're being very patient trying to find these companies at the valuations wherever they're going to get to. And in our case, we don't have that much money we have to deploy in any given year. We take our cash flow. We run a leverage model. We have to deploy $2 billion to $3 billion a year. Right now, we have about $7 billion to deploy because of the divestiture activity. We've got some money to deploy, but it's not that much in the grand scheme of things, and we'll be super patient.

I will just add, we're making those decisions with the eye to own these businesses forever. So really, it's about long term, is this a great business, will continue to be a great business. And while we certainly care a lot about valuations, at the end of the day, we're going to buy the best business for the best price we can possibly get it versus sort of trying to make a value acquisition on something that might not actually be a great business. So that's what we're always trying to balance. And again, getting back to why we do the M&A at corporate, we can see everything and sort of make the decision that's best for our shareholders, taking into account the opportunity costs of sort of buying the wrong business versus having the businesses themselves run an M&A strategy. We do, do bolt-ons for our businesses as part of our growth, but we don't compensate our businesses to do M&A. It's a big part of what we [indiscernible].

$7 billion seems like a lot.

But it's -- in the grand scheme, it's -- it'll -- it's some money we have to deploy. I mean it's a fair chunk at this moment, but we'll get it done. And then it's the $2 billion or $3 billion in any given year is not that much relative to what...

Yes. Our largest acquisition ever was Vertafore 2 years ago, which was $5.5 billion or so. So there's plenty of targets within our pipeline to deploy much more than that.

And when you think about the common [indiscernible] is there a certain revenue [indiscernible] cash flow? Is there -- what would you say like are kind of the common [indiscernible] out of looking at all these -- what would be the...

Well, I think the way to think -- so the question around valuation and sort of what's the sweet spot of where we play, a little bit longer answer to that is we are always -- most of the time, 90-plus percent of time, we're competing on the buy side against private equity. So there's a cohort of private equity firms that are really good at structurally improving the margin profile of the company. We will not -- and they'll underwrite to that. So we will not compete very effectively with a company that, say, has 10% margins and a private equity firm's going to work to take it to 30%, because they're going to underwrite to that. We'll lose there. There's another cohort of private equity firms that are really great at extending growth rates of companies. So they'll underwrite to 20% to 30% growth rates or 15% to 25% growth rates for their holding period and invest to make that happen. We won't -- and they'll underwrite to that. We won't compete very well -- but in the profile of the businesses that we happen to like, ones that are $200 million businesses, like 40% or 50% EBITDA margins, that are mid-single, maybe high single-digit organic growth businesses, the sponsors don't really have a growth play. They don't have a cost vector, so it's just straight up LBO math at that moment, right, against us. And so we tend to compete very effectively in that profile company, of which there are scores and scores of those profiles of companies held in private equity portfolios at this moment. And we tend to have -- it doesn't just come down to this, but we also have a cost of capital advantage [ over ] private equity. The deal that Rob just talked about, we [ financed 1.1% ], right? So our cost of capital is structurally lower than that.

That's because we're primarily taking our excess free cash flow that we've generated and then augmenting that at our discretion with a little bit of investment-grade leverage. So that's very different than how private equity funding...

In the use of debt, how do you...

Yes. This is -- I think for a conference like this and software companies, it's one of the things that is one of the great mysteries to us why software companies don't use debt more frequently. In our case, you have one of the -- software generally is the best business model the world's ever seen: high levels of recurring revenue, high structural margins to the extent you have a mature software business. Seems like it is a perfect place to use low-cost leverage to the extent you have a use of those proceeds. And we do absolutely have a use of the cash flow and the balance sheet to buy the 27th, 28th to the 30th to 40th [ great ] company because we have a use. We have this balanced teeter-totter of value creation between organic and [ inorganic ]. So we run an investment-grade model, sort of target 3, maybe a little bit more, 3.5x financial leverage over a long arc of time, but just continue the M&A flywheel spending.

When you get the companies in underneath your umbrella, what's the steps to improve? What's the secret sauce that you guys spread?

Well, it's interesting. It's -- what we're about to describe, there's nothing that is proprietary or unique or secret, but what we do is we consistently and rigorously apply it, right? And so that's what makes this special. And so these businesses -- again, think of what the profile of the businesses on the screen are. A median revenue is $200 million, right? So these are smaller businesses. They're growing mid-single to high single digits. They're already structurally very profitable. And so we're asking them to, say, if you're growing -- if you're a 6% growth -- or mid-single-digit growth business, how can you become structurally a high single-digit growth [ business ]? That's the ask. And so you do that, we found in these smaller businesses is you need to be able to think about what the right next strategic move is. So how do you get the strategy right? These small businesses didn't get there because there were a bunch of Bain and McKinsey strategists they got there because they had a great product market. So what's the next evolution? What's the next adjacency? What's the next channel expansion opportunity? So we have a strategic development review process that we work with [ all the companies ], number one. Number two, how do you execute strategy? It's easy to say. Let's say there's a strategy execution mode that says you want to increase the velocity of your R&D engine to have a bunch of new -- 2 new products a year versus a new product every 5 years or whatever it may be. Well, it's one thing to say you're going to go hire 20 engineers or 100 engineers, whatever the number is. It's a whole different thing about how do you sustainably run an R&D engine. How do you ideate ideas? How do you funnel the ideas? How do you progress them through the funnel? How do you release them? How do you do quality control? How do you hire? How do you promote? How do you train? It's all the underlying hows we spend a lot of time on what we call strategy [ deployment ]. Third thing is how do you run a team -- sort of a team and talent or talent offense? Everybody wants -- says they want to do talent. Everybody says they do talent, great. But the reality is that nobody really does because it's just hard. It's hard because you have to do it every day. It's not just like every third Friday. And so it's the consistent and rigorous application of those principles on a, literally, a daily basis where we get these businesses and go from low singles to low teens growth or mid-singles to high single digits as we work through [ them ].

And then really, I mean, if there is a secret sauce, like what underpins all of that is what we said earlier, which is having independent management teams whose whole job and really whole career is growing that business. So like I always bring my binder as something to look at. But there's one page on here for every business: full P&L, full balance sheet, full cash flow. Everyone is held accountable within their business. As companies get larger, you tend to centralize things. You tend to have groups and not really have visibility, tend to have allocations. There's none of that. So all the things Neil talks about, people are able to make those asset allocation decisions within their businesses knowing that they're judged on their ability within their business to grow organically not just top line but EBITDA and cash flow. And having that balance is really kind of the secret sauce for Rover. It's why we can continue to compound double digits really for as long as the eye can see because we're just adding a couple of new great businesses per year and having all the operational capability that Neil mentioned.

Favorite success story?

Favorite success story?

We love all of our businesses equally.

Yes. We do love them all.

Is there one you like better?

No, honestly, I mean, it's -- we'll never answer that question. I mean it's -- yes. I was about to, but Rob cut me off. Not on a webcast anyway.

[ But I mean ] historic, like it could be like 3 years ago that -- so not current, but...

So hey, I think -- so I'll tell you. Internally, one of the -- there's a couple of companies that we do a lot of peer-to-peer sharing. One of the great parts of Rob and Zack and I's job is we have -- there's tremendous amount of pattern recognition. We have a portfolio like -- at the end of the day, business is not that hard. You got to make something. You got to sell something. And so we see the patterns and the challenges and the mistakes. And so there's 2 companies that we hold out, one software, one product: Deltek and Verathon, where they're just remarkably great at executing sort of [ their strategy ]. The Verathon case, it's a medical product business. It was a low single-digit growth business. Now it's a low double-digit [ growth ] business because of the elements that we just talked through. Deltek is a business that has scaled super nicely with us and been able to sustain sort of a low double-digit cash flow growth since we've owned them since June 2015-ish [ time frame ]. So -- but we could pick really any of those companies and we could say similar [ things ]. It's not wide dispersion of performance inside the [ portfolio ]. It's not like there's 3 companies that make that up. It's remarkably homogenous in terms of...

Yes, I think that's a good point to make. Certainly, if you're new to the story, I mean, every one of our businesses is highly profitable, and that's part of our selection criteria. It's important when you're a multi-industry company that there aren't businesses that are losing money that you're having to fund with your other operations. I mean everyone is highly profitable, high margin and therefore has a lot of room to invest within their business and R&D, go-to-market, et cetera, to drive [ organic ]...

Florida?

We love Florida.

I know you do.

No state income tax.

That's it? Is that -- that's it? Not the Miami Heat? Not...

Yes, so we're a small -- we're only 70 -- we have a pro forma for a transaction. We're 14,000 people, plus or minus, and there's only 70 of us in the corporate center, right? It's a very skinny, intentionally, corporate center. So we just do the small number of things that we have to do really well, so we don't interfere. But yes, we're in Sarasota.

Question?

[Audio Gap]

Every day. So yes, there's been -- that question is, have we made a mistake on capital deployment? So yes, we've had one, a meaningful one. It was a company that was in laboratory software called Sunquest.

2012 acquisition.

2012 acquisition. And the mistake we made is they sold, and still do, software to run hospital laboratories. And at the moment, as it turned out, hospital laboratories were the first part of the hospital to automate 40 years ago. 15 years ago, the whole hospital automated [ with the ] HITECH Act, with Obama and EMRs. Epic and Cerner sort of won. As they won the top space, Epic and Cerner, what the CEOs of hospitals then, they did what all software companies do and start adding modules and one of the modules is the lab space. And the decision -- the mistake we made is the decision [ rights, left ] the laboratory and went to the C-suite of the hospital. And so it was -- as a business, it's still a great business, still profitable, just smaller. And so the key learning there is we now understand where the niches were born because almost all niche software -- vertical softwares are born in the nooks and crannies of the [ enterprise ]. In this case, it was the other way around. It's the niche automated first. The [ enterprise ] came second.

[Audio Gap]

Not in any -- the question is, is Constellation a competitor. Not in any capacity. Not on the acquisition side and certainly not in any of the companies that we own. The reason is we fish in different ponds, right? We're a little bit bigger than what they typically have looked at. We're -- more growth even than what they've looked at in the past. And so yes, as far as I'm aware, we've not competed with Constellation [ once in a decade ].

The name of the company, where did it come from?

George Roper in the 19-o-whatever invented the gas range. And so the long history of Roper was appliances that were sold in the '80s, so GE and Whirlpool. And then we were reborn with a small number of industrial companies and then turned into...

There are white goods out there, old-school ranges, that have the Roper name on it. That is not us. But every once in a while, there will be a call [ to us ] asking like to fix their white goods. So...

So glad you guys came. It's great to learn more and appreciate you supporting the conference and being here.

Thanks for inviting us. Thank you so much. Thank you, everybody.

Thanks for having us.