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

Yes, absolutely welcome to Nashville. Well, let's maybe just start off with some background on Roper Technologies for those who might be not familiar what is the history of the company? What does the business look like today?

Sure. Thanks for having us. It's the first time I think we've been in Nashville. So that's great. So Roper is a free cash flow compounder, if you think about Roper, we've compounded free cash flow in the mid-teens over the last 20 years. And our roots are really a diversified industrial company. And now we're -- today, we're a diversified technology company. And so over -- really since 2008, we've been acquiring vertical market software businesses. So we sort of have industrial open air, but a lot of software underneath it and then our GI code change in 2022 when we had divested our industrial businesses. And so -- but the through line for Roper over the last 20 years is we like being leaders in niche vertical markets, so small markets, typical TAM size for us. The largest TAM that we're in is maybe $4 billion, right? So we're leaders, so we can extend our leadership when you have market leadership, you can still continue to grow. Cross-sell, get new logos. It's a good place for us to be. So you get a low range of outcomes as a result of that. And we take our free cash flow, we reinvest that to the next great vertical software business. Today, we're about $9 billion of revenue, 40% EBITDA margins, 30% plus free cash flow margins. We have 29 businesses, 21 of them are vertical market software. 8 of them are call it, product tech vertical tech businesses with a lot of recurring revenue. And so think of us as like mission-critical across the industries that we play in. system or application software or critical network software businesses are primarily what we own in terms of software.

Perfect. And maybe we could just briefly talk about some of those key sentence or key end markets, just to give a flavor of what those TAMs look like?

Sure. And just to set the context. So we certainly are we love end markets that are protected. But at the end of the day, we really are thinking about the type businesses we want to own the business models. The high gross retention, the high recurring revenue, the ability to cross-sell all those things I've mentioned, good working capital efficiency and low CapEx. So those are the characteristics from a fundamental standpoint. But if you think about -- as we've acquired over the years, we've just sort of naturally fallen into really good kind of protective fits. So we're in health care. We are in GovTec. We're in like kind of education institutional tech, Insurtech, and then a variety of sort of I'd call them just broadly industrial tech type spaces. .

Okay. So given that, and I think 1 of the questions I get from investors is just how I think a lot of investors are familiar with strategic acquirers of software where there's some iteration of the code, whether implicit or explicit around vertical a strategic strategy. But like maybe talk about differentiating how a purely private equity approach would be versus how you approach M&A of software assets, that would be a great.

Sure. And I'd say just from the outside, if you talk to sponsors, you talk to bankers, they think of us more as a public -- private equity, sorry, private equity versus a sponsor or versus a strategic. And that can be true, but I think the way we differentiate is we have sort of -- we think about owning a business over decades, not over 5 years, so we can think about a business that, like in 10 years, it's going to be better than it was in 5 years and the like because we're just continually reinvesting in that business. We're adding new capabilities, new leadership. So I think that's a huge differentiation. The other is if we're going to buy a business and this is part of a change in strategy to buy a little bit earlier in their life cycle, we're doing bolt-ons to increase the organic growth of that platform. And I'd say private equity does the same thing, but they also know that they can potentially buy down a multiple by doing bolt-ons. So we'll do bolt-ons really to make the platform stronger, again, just thinking over a very long arc of time. So that's -- I'd say it's a key differentiator between us and private equity.

I'm just thinking of the metaphor of how perpetual rental versus a home that's owned by the owner and just what kind of investments do you make to make sure that, that asset is that the highest quality possible you defer things. You never invest in it because it's always within the horizon sell.

Sure. And part of that is we know that when we acquire a business, but we know also the kit of tools that it takes to sort of get the business where we need it to be. And maybe it's not the first year or the second year, but the third -- and we're trying to move that forward. Obviously, we're always trying to get better. But there are always really good businesses in good markets. that have primarily -- they started in Venture, had good product market fit. They got it in private equity. They had that iteration of a strategy, which is kind of shorter term. And then it's like, well, now we have a strategy where we can build on that forever. So that's sort of -- that's the life cycle, and we like that space. .

Yes. Well, we'll definitely get to I'd say the work that you do with ongoing assets in the portfolio, but I'd love to talk about at least the boarding funnel of new assets via M&A -- it's been a little bit tighter of late in terms of M&A activity. Obviously, you mentioned the bolt-ons. And going back to the prior year, there was about, I think, 1/3 of the M&A activity dedicated to bolt-ons. But -- so what's your expectation right now for the M&A environment? What are the things that might unlock it in the coming quarters? And what's maybe the immediate strategy for when that might unlock will go after.

Well, I'll just start. It's been a crazy couple of years in terms of capital markets and specifically in private equity. What you've seen is businesses that were acquired in the '21, '22 cohort with lower cost of capital. So there's sort of that dynamic of exiting at a potential lower multiple because of just the cost of capital alone -- and then obviously, we've seen what's had in the public markets with SaaS apocalypse. That sort of gummed up the system as well because the sponsors are to figure out like what can I -- when can I actually exit at a more reasonable multiple -- there's been a bit pressure, though, for several years now on -- for DPI, right? So LPs are pressuring to get return on capital. So we think those -- we think -- so all those things kind of swizzle and private equity has to continue to return capital, and that's how they fundraise. So that, coupled with -- you also have a pending private credit cliffs in '28, '29, and they're going to have to work backwards a year kind of minus 1 on that. So they're not faced with that cliff because we think that close going to be pretty substantial. It's going to be hard to put more debt on a business, they're going to have to put more -- they have to equitize as well. So I say all these things to say, like all the ingredients are there to have a much more robust market. We think it's probably going to be somewhere closer to 27% than the end of this year. But we're encouraged by that because all those factors mean reasonable prices. But it's just hard, right? It's the kind of stages of coping with buying something for really high and then having all these external factors sort of force the hand to sell it at a more reasonable multiple, but we're going to be a buyer of choice. We're having a lot of constructive conversations. So I talked about all the macro at the micro, having really good conversations with a variety of sponsors proprietary looks, management meetings, those sorts of things prior to any process. And so we're hopeful that, that will provide some unique opportunities.

Yes. Well, I think a very hot topic for how investors try to view these software markets is really what's the impact of AI. And I guess -- what I think is the presumption is that if shipping software has become less of a scarcity in the market, the full stack of software becomes a more open for new competition. But -- from your vantage point, like a company that's getting your hand set with companies with TAMs less than $4 billion. Has anything changed on the recent climate with AI in terms of business formation or new competition as an acquirer of those potential assets must have, I guess, some view of what's happening on the ground anything you'd say on how AI has changed the climate within the 4 billion TAM company.

And I would just say, we've been at this for 2.5 years. We've really pivoted to on our M&A team primarily work with private equity sponsors, but we increasingly had a lot of [indiscernible] with venture part of it is to see what's in their portfolio and more so just like what are they doing and where are they going after? And I would say broadly, like they're not going after vertical market software. They may go after some new part of labor that needs to be automated. And that part might not even be attached to the system of record. It could be like front desk type software, right, at a company. But we're not seeing anything sort of -- there's a couple of things that have emerged in a couple of markets, but nothing that's wedged in. We've actually had an example in 1 of our businesses where someone had a little wedge product, got about 10 of our customers on it. But the customers were -- they were frustrated because the integration was sort of wonky and they had to do a lot of manual. So it came to decades or Central reach business came to Centriach and said, "Can you create this wedge product? And within 8 weeks, we did and those customers are all -- that competitor is now gone. So not that, that wants to be a primary strategy, but the ability to innovate much faster with AI allow us to kind of, again, -- our customers trust us. They want -- they'd rather consolidate with us. And so we do get a lot of feedback from them on things that they want or any sort of fringe startup that might be out there. And again, most start-ups are not going after kind of where we play. They're kind of going after other parts of labor, which we're going after a lot of that, too, but more so the things that are connected to the current workflow or things that could sort of change the workflow that we're in and then how that attaches back to the system of record. So kind of rethinking how processes work. That's part of what we've been focused on.

Yes. And then last part on the sort of the funnel of onboarding assets, you have had a strategy that shifted to early life cycle companies. Maybe you can give us some background on what prompted that change and even if you are in a position of acquiring earlier life cycle companies, are you still able to do a medium-term target of cash flow outcomes for those businesses. How do you have to adjust expectations of those kind of assets?

So yes, we kind of -- we pivoted the strategy a little bit in 2023. And so we deployed about $10 billion of capital against that. Part of that is also doing more bolt-ons, as you mentioned. So used to be 10% of our capital. It's been more like 1/3. And again, that's all to increase the organic growth for the platform that we're attaching it to -- and so I think for us, there's a couple of reasons why we want to do it, obviously, higher organic growth in general, which equals higher year 5 and further cash flow -- and so we have to underwrite a little bit higher growth. But the businesses we're looking at are the same businesses we own in our portfolio. It's just the Think of it as like the TAM has not been digitized yet. So there's still more adoption. There's still a lot more white space in those markets. So we understand the markets. It's just we're underwriting it to a little earlier part of their life cycle. And this isn't venture, right? This is first term private equity typically not third turn, which is where we -- second or third is where we used to play. So we like that. We like to be ability to capture more growth for shareholders. And then also, as I mentioned, to be able to do bolt-ons. These businesses haven't been hadn't had a Frankenstein bolt-on sort of scenario that we can kind of put our print on that business and have our own platform to grow from there.

Yes. Well, let's shift gears to maybe the strategy around commercializing AI. And I think it's a rotation are of companies that are acquisition-minded as some of the functionalities for AI can maybe supercharge integration. It can be productized across the portfolio and the sort of individual businesses may not they can share how earnings -- so maybe we can talk about the big pillars on how to commercialize some sort of the agentic products that have been released and maybe any it have the fastest traction for.