ROP - Roper Technologies: I Stay Bullish

2023-11-02 07:39:18 ET

Summary

• Roper Technologies has strong Q3 results, with steady organic sales growth and strong free cash flow.
• The acquisition of Syntellis Performance Solutions adds value to Roper's portfolio, offering potential upselling and cross-selling opportunities.
• Roper's tech-enabled products division is expected to experience accelerated growth, particularly in the medical and water-related sectors.

Thesis

Earlier in May, I authored a report on Roper Technologies, Inc. (ROP), where I covered the company's strong market positioning and financial outlook. Today, in this article, I will take a look at the company's recent results and the acquisition of Syntellis and provide my updated outlook on the company going forward. I continue to believe that Roper has the potential to continue on its strong momentum due to its substantial software portfolio, an under-leveraged balance sheet, a disciplined history of mergers and acquisitions, and the completion of divestitures. I anticipate continued robust growth in organic revenue and free cash flow, particularly driven by the company's niche industrial and software sectors. Hence, I remain positive about the company and reiterate my buy rating on the stock.

Q3 Review and Outlook

Roper reported strong Q3 results. One of the standout aspects of the quarter was the strong FCF, surpassing street expectations at $625 million, driven by the promised seasonality from the Frontline segment. Roper demonstrated steady organic sales growth in the third quarter, showcasing the resilience of its business model in comparison to other software companies. The company's approach of acquiring niche, market-leading software firms to its consistent organic sales growth, even in challenging economic conditions, contributes long term gains expected to be in the range of 8-10%. Roper's focus on high free-cash-flow yield is likely to support its M&A activities. The company's various segments performed well during the quarter, but there was a slowdown in the software businesses. Notably, the Network Software segment showed an exceptionally high margin, but it's expected to decrease in the fourth quarter as the segment's growth slows down to low-single-digit levels.

Overall, despite potential macroeconomic challenges, I expect Roper's software business to maintain moderate organic growth. The company's emphasis on the M&A compounding model could become more appealing to investors as organic growth in the Industrials sector diminishes in 2024, despite high interest rates. Roper mentioned some signs of improvement in the M&A market, as sellers who have been waiting for lower interest rates may reconsider their positions. Roper has over $4 billion in available funds for deployment, which could result in meaningful EPS accretion even in a high-interest-rate environment.

Syntellis Acquisition is a Valuable Addition

Syntellis Performance Solutions is an American enterprise performance management software company that specializes in providing data and analytics solutions for healthcare, higher education, and financial institutions. The company offers key software solutions such as Axiom, Connected Analytics, and Stratasan and serves more than 2,800 client organizations with 450,000 software users. Syntellis is headquartered in Chicago, Illinois, and has a workforce of over 460 employees.

Roper acquired Syntellis from private equity firms Thoma Bravo and Madison Dearborn Partners, who had previously supported the company's spinoff from Kaufman Hall, a provider of financial and performance consulting services, in 2020. Initially valued at approximately $500 million during its spinoff, Syntellis has since made investments in enhancing its products and platform, primarily within the Axiom Suite, and acquired Stratasan, a leader in advanced healthcare market intelligence and data analytics, in 2022.

Looking at the broader picture, the combination of Roper and Syntellis makes sense as they were previously competitors in the niche healthcare IT market, offering potential opportunities for upselling and cross-selling. The headline multiple of approximately 15 times 2024 EBITDA is attractive, but when factoring in synergies and tax benefits, it's closer to around 21 times. The management believes that the cost synergies are relatively low-risk, primarily related to reducing duplicative expenses in personnel. It's worth noting that the cost of capital has increased significantly, and when considering interest expenses, partially offset by a cash tax benefit, the net cash addition amounts to $25-30 million, equivalent to 2% of the FY23 base.

Tech Portfolio Supporting Growth

Roper's Tech-Enabled Products division is poised for accelerated growth, with anticipated growth rates of approximately 11-13% in the coming year, surpassing its historical average organic growth of 8% over the past two years. This segment primarily focuses on medical and water-related products, capitalizing on prevailing trends such as the increasing aging population in the United States and the growing demand for water conservation solutions. The product portfolio includes items like single-use hospital devices and water measurement tools. The recent surge in demand for these products, driven by supply chain challenges, is expected to normalize in the current year. Additionally, Roper's Application and Network Software segments are projected to achieve mid- to high-single-digit organic sales growth. These units have played a pivotal role in the company's transition to a recurring revenue model in recent years, specializing in specialized enterprise resource planning and marketplace software.

Valuation and Financial Outlook

Roper's software portfolio consists of 27 companies that provide a consistent revenue stream regardless of economic conditions. While the software industry as a whole has been growing at an annual rate of around 10%, I believe Roper's collection of mature software assets will achieve organic sales growth in the mid- to high-single digits over the next 3-5 years. With a revenue base of nearly $6 billion and a free cash-flow margin of around 30%, Roper has the capacity to fund ongoing acquisitions. In the short term, management aims to allocate $3-$4 billion annually to acquisitions, considering the company's leverage. While profitability has significantly improved over the past 5-6 years, I anticipate a more gradual margin increase in the next 2-3 years due to the high percentage of software assets. Given the rising cost of capital and elevated acquisition multiples, I expect management to focus on smaller bolt-on acquisitions rather than larger deals. The stock is trading at a forward PE of 27x, as per Capital IQ estimates, at a discount to its average historical P/E. I believe the company's strong growth metrics and strong balance sheet, coupled with substantial FCF make it deserving of a premium multiple. My buy thesis around the company has not changed, and I remain bullish on the stock and reiterate my buy rating on the stock.

Conclusion

Roper is in the process of shifting its focus from being a diversified industrial conglomerate to becoming a more technology-oriented business. The company's emphasis on software, which requires minimal physical assets, enables it to consistently generate free cash flow. ROP is effectively shifting its portfolio towards asset-light businesses with higher returns on invested capital. Hence, I remain positive about the company and reiterate my buy rating on the stock.

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