George Roper founded Roper Technologies (ROP) in 1890, primarily as a manufacturer of home appliances, pumps, and other industrial products.
It was an old industrial conglomerate. But no longer…the company has sold off its industrial businesses and transformed itself into a software conglomerate.
In June 2022, Roper sold a 51% stake in 16 legacy industrial firms to Clayton, Dubilier & Rice for an upfront payment of $2.6 billion. The deal multiple equated to an enterprise value of just over 10 times the businesses’ earnings before interest, tax, depreciation, and amortization (EBITDA).
The deal also expanded Roper’s war chest for making acquisitions to over $7 billion. Yet investors seemed unconvinced that Roper had made the right move. Its shares quickly fell 17%.
Here’s why they’re wrong, and Roper is a buy right now…
Roper’s Metamorphosis
CEO Neil Hunn didn’t care about the skeptics. His sole focus was on completing the transformation of Roper from a highly cyclical and asset-intense business to a company with a portfolio of high-quality niche software businesses.
The goal behind Roper’s moves soon became quite apparent. The monies in the war chest were to be used for high-quality software businesses that had few physical assets, recurring revenues and strong cash flow.
Fast forward to today and vertical software now makes up three-quarters of the company’s revenue (two-thirds of which is derived from application software and one-third from network software), with the remainder of revenue coming from the medical and water products division.
Roper did not just go out there and buy some random software firms. Over the past two decades, it has been purchasing software companies with very niche businesses. Roper now owns more than 20 high-quality, cash-generative software companies in niche markets. Let me give you a few examples…
One application software business it owns is Aderant, which Roper acquired for $675 million in 2015. It helps law firms with all aspects of running a firm, such as docketing, case management and billing. Aderant is highly successful, with more than 3,000 corporate customers and a retention ratio above 95%.
Network software is software that matches people or companies. In 2004, Roper acquired traffic management company Transcore. In 2014, Transcore spun out DAT (originally known as Dial-a-Truck). This company then became the largest freight-matching software platform in North America. It connects brokers and freight carriers and has more than three times the market share of its closest rival.
Roper also owns MHA, which is the company’s alternate site group purchasing organization (GPO). It is the largest network of independent long-term care pharmacies in the United States and has an 80% market share. According to a study co-authored by former Federal Trade Commission chair Jon Leibowitz, providers (hospitals, etc.) can realize savings of 10% to 18% using GPOs, relative to the costs they would incur had they negotiated prices on their own.
Roper’s Success
The strength of Roper’s software businesses is evident in its latest earnings report. In the second quarter, strong software recurring revenue meant organic sales growth hit 9%, to $1.53 billion. Roper’s operating cash flow was up 20%, to $320 million. Earnings per share rose 20% from the prior period and topped Wall Street expectations. Management once again raised guidance for 2023. The company now expects adjusted earnings per share of $16.36-$16.50, up from its prior outlook for $16.10-$16.30.
Although still in early stages, there are potential revenue benefits stemming from generative artificial intelligence (AI) solutions across Roper’s businesses, as the company explores releasing AI-enhanced industry-specific applications to its portfolio offerings. After all, the company has access to a large amount of data in some of its market niches.
Roper has already incorporated some AI into its products. Aderant has launched a generative AI product called MADDI. This automates time entry, cash receipt matching and docketing for its law firm customers. And Roper management, during the recent earnings conference call, pointed out that DAT is using AI to reduce fraud in the freight industry.
Buy Roper
Roper currently trades at 27 times 2024 consensus earnings forecasts. That’s a premium to its five-year average of 22 times. It deserves a higher valuation because of its switch away cyclical industrial businesses to high-growth, niche software businesses—and, when compared with its software peers, Roper is cheap. Its shares trade at around a 20% discount, according to analysts at Jefferies.
The software firms Roper acquires (often from private equity companies) have, on average, double-digit organic revenue growth, along with a 21% operating cash flow margin. That is worth paying up for.
The stock has beaten the annualized total returns of the Morningstar U.S. Market Index by about 4% over the past 15 years. It is up 12.5% over the past year and 11.6% year-to-date.
Roper is a buy anywhere in the $450 to $500 a share range.
