Roper Technologies : The quality is undeniable, the question is "How much to pay?"
It's been added to the wish list.
Roper Technologies ROP 0.00%↑ , a business that came on my radar after reading “Lessons from the Titans” will suit most quality investors. This business fits all my criteria when looking to add quality into my portfolio. In this article we will look into its past, its evolution to being a low asset base, high margin business it is today and my valuation and expected returns going forward.
History Under Brian Jellison
Ropers transformation began in 2001 when they hired CEO Brian Jellison. Before his appointment, Roper was a highly cyclical oil and gas supplier who designed and manufactured pumps and test equipment. Under Jellison’s tenure, between 2001 through to 2018, Roper acquired small niche businesses “mostly software within the last decade” that produced high margins with strong cash conversion that where inherently less cyclical than Ropers core business.
During this time Ropers stock price increased an impressive 1300%, the S&P returned just over 1/10th of this return during the same time frame. Jellison was the architect that created the Roper we know today, a high margin, asset light, low cyclical business with a decentralised operating structure.
Jellison, a former executive at General Electric and Ingersoll-Rand witnessed first hand the flaws in capital heavy industrial businesses. Although barriers to entry where high with this model, so where Capex requirements and working capital which tied up cash and limited cash flow.
Due to the high cyclicality inherent in Ropers core business, Jellison knew Roper needed a stronger foundation. Less cyclicality, high margins and excellent cash generators where high on his wish list. He realised that smaller, asset light businesses in niche industries produced higher margins and cash. The acquisition market for small niche companies was large, as bigger firms where more interested in larger flashy M&A deals. Most businesses Jellison wanted flew under the radar as their TAMs where considered too small or that their growth wasn’t attractive enough. After Introducing Kaizen events throughout the organisation, Roper was able to buy these “slow growers” achieving operational improvement and in turn creating higher profits and cash flows.
He had three requirements and wouldn’t pursue a deal if a business didn’t possess all three.
Low asset intensity
Good businesses in niche industries
Excellent management
I would have also assumed low cyclicality here and maybe it was a factor with the businesses he acquired?
During his tenure Jellison managed to acquire 25 businesses, his first being “Neptune” in 2003 a water meter technology company and his last “PowerPlan” in 2018, a data management software business for asset intensive organizations. From sub - $600M in revenues in 2001, Roper managed to achieve $6775M in the LTM.
Brian Jellison retired on 22 August 2018 due to medical reasons and died shortly after in November 2018. His visionary legacy lives on within Roper to this day and was passed on to Neil Hunn who took over the CEO role. Neil Hunn who joined Roper in 2011 was trained under Jellison and was group vice president in its medical division.
Roper today.
A. The Business
Today, Roper is still a diversified vertical software and products business serving multiple defensive industries such as Insurance, Food, Education, Construction, Laboratory, Finance and Transportation. Currently there are 28 businesses under the Roper umbrella and are all leaders in their industries. They have a decentralised structure with an owner-operator mentality for each individual business. Management have the autonomy to select the best strategy for their respective markets and their incentive structure is aimed to grow their businesses, not to achieve budget targets annually. This owner operator structure encourages management at the local levels to offer customers excellent service with a deep sense of intimacy which is shown by their high gross margins. Due to the closeness of their relationships with customers, feedback is constantly transferred to evolve and develop their services towards their customers needs.
Ropers Portfolio of businesses.
B. M&A strategy
Current CEO Neil Hunn (2020) on their M&A strategy
So the criteria for capital deployment really has not changed that much. It's always been rooted in finding businesses that have better cash returns than our existing. Over the arc of 20 years, that's gone from industrial products to medical products, then more software. The second criteria is always having a management team that is fundamentally focused on building the business versus transacting. And then finally, businesses that share the characteristics that all 45 of our businesses do, right, niche, leadership position, ability to invest in themselves to grow, high recurring revenues, high gross margins, et cetera. So those criteria have not changed at all and it won't change going forward.
This simple, disciplined and targeted M&A strategy has allowed Roper to achieve 70% of its revenues that are recurring and now gets more than half its EBITDA from software-related businesses. This highlights the excellent work they have managed to pull off over the years from being highly cyclical to highly predictable. The reason for the predictability is that most of the software they provide are mission-critical to their customers and are not considered discretionary expense but rather essential to their workflow. Due to Ropers low capital reinvestment needs, the majority of their cash flow “over 2B in free cash flow over the past twelve months” and after paying dividends, is free to allocate towards further value creating acquisitions. This flywheel has a long way to go. Their acquisition of TransCore (2004) “Their first entry into software SaaS” ignited their focus on asset light companies with high margins and cash flows.
However, don’t expect Roper to be pulling off any major deals in the future, that’s not their game. High growth businesses that are young in their business lifecycle and have high expectations are the ones Roper generally don’t gravitate towards. Businesses of this nature tend to invite competing bids by other businesses and therefore create demand resulting in lofty valuations which poses certain risks of overpaying and also impairment risks in future periods. Roper targets businesses with the financial characteristics I’ve mentioned above but focuses on small TAMs, the smaller the better. They want businesses that are number 1# or 2# in their industry and ones that have deep connections with their customers. There are two huge positives for this.
Disruptive competition risk is small (Who wants to enter a small TAM?).
Being 1# or 2# in their industry and being so close to what their customer needs, customer retention remains high.
This M&A strategy has proven highly successful and I believe they will stick to this disciplined approach for the foreseeable future.
