Description

CERTAIN STATEMENTS CONTAINED HEREIN REFLECT THE OPINION OF THE AUTHOR AS OF THE DATE WRITTEN. NO INVESTMENT DECISIONS SHOULD BE BASED IN ANY MANNER ON THE INFORMATION AND OPINIONS SET FORTH IN THIS REPORT.  YOU SHOULD VERIFY ALL CLAIMS, DO YOUR OWN DUE DILIGENCE AND/OR SEEK ADVICE FROM YOUR OWN PROFESSIONAL ADVISOR(S) AND CONSIDER THE INVESTMENT OBJECTIVES AND RISKS AND YOUR OWN NEEDS AND GOALS BEFORE INVESTING IN ANY SECURITIES MENTIONED. Please see additional Important Disclaimers at the end of this analysis.

Investment Overview:

• Roper Technologies (“ROP” or the “Company”) is a unique collection of ~45 high quality businesses, run by an owner-operator mentality management team that has a proven track record of creating value through M&A[1]. ROP has consistently acquired market leaders in niche verticals with strong returns on tangible capital, taking a Berkshire-like “forever owner” approach, and then utilized that free cash flow (FCF) generated from its portfolio companies to purchase additional high quality businesses – this is the flywheel that has turned ROP into a compounding machine that’s been one of the best performing stocks over the last 17 years, appreciating ~1500% vs 300% for the S&P 500 from 2003 through 2019. 

• ROP calls Cash Return on Investment (CRI), which essentially represents returns on tangible capital, its “north star” [2] to both acquiring and operating businesses, and describes this guiding framework as its version of “money-ball investing.” ROP has increased its CRI from sub 100% back in 2003 to 400%+ as of 12/31/19, as over that time it’s used its cash flow to consistently acquire additional high quality businesses, and that journey has led to ROP primarily acquiring software businesses in the last decade plus. The software businesses ROP aims to acquire embodies its key criteria for new acquisitions – market leaders in niche verticals, high margins and recurring revenues combined with a capital light model, all leading to strong returns on tangible capital or CRI. In 2019, ~62% of EBITDA was generated from such software assets; though the remaining 38% of EBITDA generated from more product centric businesses in medical, industrial and energy end-markets are still excellent assets with highly desirable economics (per 2019 10K). 

 [1] See Exhibit A on next page for how ROP defines ‘high quality’ businesses.

^[2] Quote by CEO Neil Hunn at 5/21/2019 Investor conference.

• Exhibit A: The Exhibits below outline ROP’s business model & general framework for compounding capital.

* Source of exhibits above – ROP 2/19/2020 Investor Presentation 

• Below is what I believe is an excellent overview from CEO Neil Hunn walking through the ROP business model (from 2/19/2020 Barclays investor conference)

“So Roper is a bit different than most of the companies here. Our strategy for 2 decades now has been singularly focused on how to compound our cash flow, and as a result, the TSR at the highest possible rate that's sort of risk managed and sustainable. And the way that we do that is we operate a portfolio today of 45 different businesses. The end markets are wildly different. Water meters and tolling to half our portfolio now is software, about half products, half software. But the 45 business models are highly similar. All the businesses are in niche markets. We love the niche markets because they protect us from the sort of disruptive competition. These TAMs that all the businesses in are very small. Some TAMs are $100 million. Maybe the largest TAMs are $1 billion, $1.5 billion. So they're very small served markets.

  All the businesses tend to be the leader in what they do. And so in these markets, we tend to compete on what we term as customer intimacy. So being very close to what our customers do. Most of our products or software that they buy is core to what it is our customers do. And so they give us feedback all the time about how to continue to evolve and develop the products and serve the markets.

Then all 45 businesses also tend to have a higher -- a relatively high degree of recurring or reoccurring revenue. And then perhaps the most -- the hallmark staple characteristic of these businesses is they don't require capital to grow. For almost 2 decades, CapEx in this business has been about 1% of revenue. So these are wonderfully asset-light businesses. In fact, our working capital as a percent of revenue now is negative 4%, 5% and our fixed assets in total are somewhere in the 7% or 8% of revenue. So it's a very, very asset-light model.

  
Now the asset selection is just a part of the story, right? We have a very unique operating structure that allows these businesses to thrive. And so we have 45. We operate this very decentralized approach, which we think is a necessity with these types of assets, right? And so we have 45 of everything: 45 executive teams, ERPs, development centers, locations, whatever, 45 of everything. And the reason that we bear the cost of that infrastructure is these businesses have to act extremely nimbly in these small served markets because the competitors are small competitors, family run or private equity owned, for the most part, or small divisions of larger companies. So they're acting nimbly, so we have to act equally, if not more, nimbly. So this org structure enables that, right? There's no better example of that in the real world as how our energy business has reacted here last year. In the fourth quarter, margins -- or full year, the margins were up in the face of headwinds. And so those businesses were able to shed the costs very quickly. Do it and then tell us they did versus ask for permission or ask if they should do it.

 
But there's a difference in the way that we operate. We have this org structure, and -- but -- and just because we're decentralized, we're far from passive owners. So we have a group executive layer. Each group executive, of which there are 5, have a portfolio of 7 to 10 companies each, and their job is to be a thought partner/coach about how to evolve our businesses to be great, really great in the way they actually develop strategy, the way they execute strategy and the way they run a talent offense. And over a long arc of time, we expect to see our businesses improve their cash returns and improve their organic growth rates and improve their margins, which has largely been the case.

 
And then finally, and perhaps the most important part of our org structure, is the way we pay people. We pay the entire organization based on growth. Most companies here, I would suspect, pay people and their teams based on some sort of budget, plan performance. And for us, it's super important culturally because if you pay people based on a plan or budget, you provided your operating teams an incentive to lie to you, and you have a filter not to believe anything they say. So I would submit you can't have a culture of trust or, for that matter, accountability. So all the tough stuff, the problems get elevated in our organization because we're there all to try to solve because those are the barriers to growth typically.

 
And so these businesses and this org structure generate about $1.5 billion of free cash flow. And because they're so asset light, they have no way to deploy it back in their business. And so the third hallmark of our enterprise and our strategy is a very centralized approach to deploying the capital. It's -- we have a very small staff in Sarasota, about 55 or 60 people. The vast majority of that is sort of the administrative overhead of being a public company. And then there's a couple of handfuls of executives, and it's our responsibility to deploy the capital. So we don't outsource this to our operating companies. We don't outsource it to an M&A team. We are the ones doing the capital deployment and it's very process ridden. Does it meet our cash returns? Yes or no? Does it meet our organic growth thresholds? Yes or no? Do we like the management team? Are they builders? And then is it a type of business we like? And those are the characteristics I started with. When you put all that together, we have a -- that strategy, which has been in place for nearly 2 decades, has yielded in the neighborhood of 19% or 20% TSR compounded for 2 decades. And so we -- as we play that forward in our models, basically the same returns are modeled for us. And so a lot of our focus is how do we sustain that strategy and the execution against that strategy.”

[3] Note: “TAMS” is Target Available Markets. “TSR” is Total Shareholder Return.

• It’s also important to point out that this management team eats their own cooking, highlighted by this quote from Neil Hunn at a 2/19/2020 Barclays investor conference “Rob (CFO) and I are very overweight. I mean it's -- we're all in like 95% of our net worth.”

HISTORY

• Brian Jellison joined Roper as CEO in 2001, coming from Ingersoll Rand, and he is the one that implemented and executed the Roper business model discussed until his death in Nov 2018. The exhibits below highlight the improvement in margins, asset intensity and thus returns over the last 15 years, which is about when Jellison started doing his first transformational deals under the new ROP playbook. Under my basic definition of returns on net assets (EBIT/(net working capital + PPE), where net working capital is simply receivables + inventories – payables), ROP’s pre-tax returns have increased from ~50% in 2004 to 200%+ at the end of 2019, and when including deferred revenues in working capital as ROP does in its CRI definition, returns are ~400+% (at 12/31/19).  

* Source of exhibit above – ROP 2019 Annual Report 

(1) Results are presented on an Adjusted (Non-GAAP) basis. See the appendix of the presentation for reconciliations from GAAP to Adjusted non-GAAP results.

(2) Operating Cash Flow and Free Cash Flow for cash taxes from sale of Abel (2016) and the Scientific Imaging businesses (2019) (see appendix of presentation for reconciliation)

(3) Free Cash Flow = Operating Cash Flow less Capital Expenditures and Capitalized Software

* Source of Charts above –2/19/2020 Barclays Investor Conference, Roper Technologies Overview presentation. (http://investors.ropertech.com/Webcasts-and-Presentations)  

• Evolution of the ROP portfolio:

• Per Brian Jellison’s last annual report letter written in early 2017 (source ROP 2016 annual report)

“HOW WE’VE EVOLVED - Our businesses at the time of our IPO, focused on pumps and valves for energy and water markets, remain part of Roper today. During our first decade as a public company, we were known as a diversified industrial company with a primary focus on industrial and oil & gas markets. The ability of our businesses to yield excess cash flow allowed the company to deploy capital for acquisitions that generated cash flow at an even more attractive level.

Roper’s second decade marked a shift toward larger businesses with new technologies. The acquisition of Neptune Technology Group (using radio frequency for remote meter reading) and TransCore (using radio frequency for tolling) began our transformation. In fact, the TransCore acquisition included the acquisition of our freight matching businesses, which were our first entry into software as-a-service (SaaS). These high cash flow, high technology businesses began Roper’s journey to an asset light company, which has been further accelerated by the acquisitions that followed. Over the last five years, our capital deployment has focused even more on high value software and network businesses.

As our transformation has continued, our cash returns have accelerated. In recognition of this dramatic evolution, we renamed our company Roper Technologies in early 2015.”

• Per current CEO, Neil Hunn, on the ROP Q4 2019 earnings call (1/30/2020)

“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, the 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. 

The recent acquisitions that you referenced, certainly the ones really from Deltek, ConstructConnect, Aderant, PowerPlan, Foundry, iPipeline, the larger ones from '16 forward, have met all those criteria, and the businesses are performing at or maybe modestly above our initial expectations.”

• And also on the Q4 2019 earnings call, Neil Hunn (1/30/2020) highlights ROP’s focus on software acquisitions

“So turning to capital deployment. Since 2011, which is when I joined, we've deployed about $10.4 billion, $10.5 billion. As you can see, virtually all of it is in either networked or Application Software, so think almost all software, software-like business models. That's again in the pursuit of improving cash returns.”

Roper Philosophy on New Acquisitions:

• Below is more color on why ROP loves businesses that are dominant players in niche verticals with small TAMs, highlighted by Neil Hunn at 11/5/2019 Baird investor conference:

“But when you go top-down, it's remarkably simple, right? They're all in niche markets. We like small TAMs, right? The smaller the TAM, the smaller the market, the more we like it for 2 reasons. One is, you get to serve a customer very specifically, and when you do that, you solve a problem. You can price based on the value that's created. And also the small TAM insulates you from large competitors because they're uninterested in small TAMs. Almost all of our businesses are either #1 or #2 in the primary thing that they do. So in their little niche, they have the scale advantage, right?  

But they're small, and we compete on intimacy with the customer, not scale. It's not a supply chain scale. It's not a cost to develop 1,000 lines of codes or KLOC scale in the software space. It is about the intimacy we have with our customers. They all tend to have high recurring revenues, very high gross margins and, most importantly, the ability to grow without consuming capital.”

• CRI (returns on tangible capital) is ROP’s north star that drives everything in the organization – it works to improve the CRI of its current portfolio companies and it looks to only invest in businesses that have equal or greater returns than what ROP already owns, which has led to ROP seeking to acquire and own improved business quality (i.e., primarily software) over time. 

CEO Neil Hunn at 5/21/2019 Investor conference - “So as you know, our sort of north star, our guidepost is cash return on investment. This is the definition of success for operators, is to improve this formula. It basically is a return on tangible assets. We've used it since 2001. We're going to use it until the -- until as far as we can see. The reason we use it is it has a very high correlation to how market cap and equity values are determined, north of 90%. So we're not doing this because we think it works. We do it and optimize on it because, empirically, we know it works. 

It's been the core principle behind our capital deployment strategy. It's also been the core principle behind the way we compensate, reward and incent and train our operating teams in terms of improving this. Now it's both the earnings, so you're driving revenue, and margin structure on the numerator but you have to do it in a very thoughtful way as you're deploying assets in the pursuit of that growth on the denominator.”

• Along those lines of searching for the highest quality businesses, it’s worthwhile to note that ROP buys almost all of its businesses from private equity. ROP’s view is that it’s private equity’s job to build these businesses, and then ROP can come in and purchase the best businesses that are already cleaned up, optimized, more mature and clearly established as market leaders and thus de-risked; and ROP fully understands this means paying a higher price vs trying to purchase these companies earlier in their life cycles where there could definitely be more upside in returns from doing this heavy lifting, but that also brings risk and it’s not ROP’s objective – they are not turnaround experts, they have group executives/coaches to work with portfolio companies at a high level, but really they are not adding a lot of hands-on operational time & resources to these businesses. And again, as ROP sees itself as “forever” holders of businesses, they want to be highly confident that what they’re buying is of the highest quality and eliminate risks that portfolio companies turn out to be something different than what they thought at purchase that would make them want to sell those assets.  

CFO Robert Crisci at 5/21/2019 Investor conference - “Yes. I would just add to that. So it's really private equity's business model to build these businesses. So there's dozens of private equity firms that are working to build these great niche market businesses. And so in a way, they're sort of working on our behalf because at some point, they are going to have to sell the business and they're going to sell to another private equity firm or us. And so it's really amazing. I mean sometimes, we won't even know about a company, and 3 or 4 years later, it's $100 million of revenue. And this happens all the time. So there's no concern about having enough targets available to purchase for our strategy. It's really not a concern.”

• The commentary below, from CFO Robert Crisci at 11/5/2019 Baird Investor Conference, highlights that ROP’s preference is to acquire businesses that are already mature and established winners rather than businesses that are earlier stage and that while might have better growth potential, carry more risk of proving themselves. The commentary also highlights some discipline on valuation – while ROP wants to acquire very high-quality assets and is willing to pay mid to high-teen EBITDA multiples for the right assets, it gets very difficult to justify paying north of 20x EBITDA for acquisitions.

“Yes. I would say it's not for the level of investment. It's that math he's just given you. If the business is going to grow 20%, then the LBO model, if you believe the growth, they can -- PE can pay 25x, right? So the question is, what level of risk is there in a super highly growing business and what's the chance they don't hit those growth numbers that you've underwritten, and that's where you run into sort of problems.  

So our model is very much around very consistent growth, high-margin businesses that grow mid- to high single digits. And there's a couple of double-digit growers in there. Those trade at the multiples Neil mentioned. 

The super high-growth business and -- you're right -- a business that's not EBITDA positive yet, super high revenue multiple you mentioned, we don't play in that space. We would wait for a winner in that niche market and then buy that business later because it's much lower risk and it's going to generate cash day 1 versus waiting to day 2 -- or year 2 or year 3 to start generating cash from the business that we bought.”

And CEO Neil Hunn’s follow up from the same conference: “The only thing I'd add to that, Rick, for your next question is there's an opportunity cost that we always filter every acquisition through. And so it's a market -- even if our CRI models would say you could pay 25x EBITDA, we know there's a deal right around the corner where it can pay 17 or 18 or 16 or whatever the number is. And so the opportunity cost of deploying it north of 20 is extraordinarily high. It would take a really extraordinary unimaginable type asset for us to do that. It's the opportunity cost is too high.”

• The commentary below from the 2/19/2020 Barclays Investor conference provides more details on types of software businesses specifically that ROP wants to acquire – those that are already dominant players in niche verticals that have  Mid-single digit (MSD)+)organic growth runways; not businesses so mature that their growth is tapped out, but also not the super high growth and earlier stage SaaS companies that trade at lofty multiples.

CFO Robert Crisci – “We'd love to buy the highest-growth business we possibly can.”

CEO Neil Hunn – “Yes. I mean it's not CRI per se. CRI talks about and describes the asset intensity to the cash flow orientation of a business and do you have a economic relationship with your customers where you get paid at a time and an economic relationship with your vendors or your infrastructure where you don't have to own it, you can rent it. That's sort of what CRI tells you is the nature of the business model. And then all things being equal, businesses that grow faster or better are more valued than ones that grow slower because they compound cash flow faster. That's obvious. 

It thus then becomes, if you're a forever holder and you're in these small niches, vertically oriented application software, it's our belief that if you're growing in the teens, there is some thematic trend that you're playing into or some likely temporal technology advantage, temporary technology advantage that you're availing yourself to sort of the benefits of that, that are accruing to you, both of which have a half-life. 

In our view, the businesses that are these mid-single to high single-digit growth application software businesses, it's our belief that the -- that half a dozen or so growth drivers in these business are durable into the very long term, where -- and it's different by company: a few points of price, a little bit of attrition offsets price, a little bit of cross-sell, the ability to innovate a little new product and monetize that. And you put that together, you get a very sustainable mid- to high single-digit growth rate without a lot, if any, technology risk and no sort of tailwinds, secular changing risk on you. And so it's just a very defensible, compounding way of looking at asset selection versus I want to grow for 5 years and I'll deal with years 6 to 10 later. Our mindset is different.”

CFO Robert Crisci – “Right. And we're also only buying businesses, as you know, that are highly profitable with strong EBITDA margins and strong cash flow performance. So you're not buying the SaaS business that maybe is growing 20% that's not profitable yet that you hope in 4 or 5 years could be this wonderful, great thing. Maybe it is, maybe it isn't, but you're taking on quite a risk by doing that versus selecting the assets that have already proven to be profitable in niche markets, #1, #2 player. Those businesses can continue to compound cash flow, as Neil said, mid to high single digits with much less risk. And then we're not underwriting future growth that could potentially go backwards, right? If you need the business to grow 15%, 20% in order for your model to work, that's great if it does grow 15%, 20%. But if it doesn't, then you just destroyed value. And we take what we would view as a much lower risk approach to M&A.”

Roper Philosophy on Operating businesses

• ROP employs a very decentralized approach, with ~45 completely independent portfolio companies. And ROP points out that it avoids trying to generate synergies between portfolio companies as it believes this would kill the culture. 

CEO Neil Hunn at 5/21/2019 investor conference - “So I'll answer the second half first. And if forget the first one -- hold onto the microphone. If I forget the first one, then repeat it. So on the synergy piece, hey, we fully recognize, we've not done the math, we won't do the math, that there is, I don't know, 100 to 200 basis points of EBITDA margin just laying in Roper if we wanted to do more centralized stuff. If we did that, then we would kill the company. We'd kill the entrepreneurial spirit, we'd kill the ownership model. And so we're very -- we just won't do sort of "synergy" because these companies have to -- when we say these 45 leaders are making their resource allocation decisions, they are making their resource allocation decisions and with no direction or insight from us. In fact, we're very careful not to inadvertently give them direction.”

• The commentary below (CEO Neil Hunn on Q4 2018 ROP earnings call, 2/1/2019) is a good example of how ROP looks to build businesses through both organic & bolt-on investments. ROP talks about “soft solution stacking” and I believe it’s much easier to create organic growth when one already dominates a niche vertical and are very close and critical to their customer.   

“Aderant entered the year with essentially one offering, large law. They exited the year with 3 SaaS recurring revenue offerings in addition to the core large law products. Organically, Aderant developed and launched a mid- and small law SaaS practice management ERP solution. In addition, Aderant onboarded, integrated and started cross-selling 2 small bolt-on acquisitions, one focused on the law firm knowledge management space, and the other focused on billing preparation and management. When combined, these 3 new product offerings are building a meaningful SaaS recurring revenue business within Aderant.

…Maybe start with Aderant. The last 4 -- 3 or 4, 5 years and next several years, the large law market will continue to be a viable growth driver for the business, and all the legacy reasons why we've won, we think, will continue. So as you think about building a recurring revenue business, you build it on top of that larger piece. And so while each individual piece of the recurring revenue piece that we talked about with Aderant earlier by itself is small when you stack it on top of an existing business, it can become pretty meaningful. And importantly, it extends your -- the company is also working in its R&D pipeline to add -- to build bolt-on products that you can sell into large law and the mid- and small law-size practices. So it's just a concept of -- which we talk broadly about with our software business. It's about "soft solution stacking." So you spend a lot of money acquiring a customer and hopefully selling them 1 or 2 products. And then as you -- certainly, once you have the customer, it's much easier to sell them additional products, especially if they're fully integrated in with the -- because if the -- excuse me, the existing products that they have. And so that's strategy specific, not specific to Aderant or Deltek but ConstructConnect or DAT or iTrade. And so we can certainly spend more time off-line about it, but that's the way we think about growing the product strategies of these businesses.”

Risks:

• I’m a bit skeptical of ROP’s ability to add similar outsized value from M&A going forward as it has historically. 

• ROP is bidding for high quality, competitive software assets with rich, and rising multiples. And as we’ve gone through their approach to only buying the what they believe to be the best businesses that have already been professionalized, optimized and are clear winners in their niches, it makes me more skeptical to believe that ROP can generate outsized returns at this point in these companies lifecycles when PE owners already made good returns and sold at competitive fair market multiples, and ROP isn’t bringing much value add to portfolio companies post acquisition – there isn’t much room for margin improvement, there aren’t many synergies and there’s not a Danaher type business model that is adding a lot of hands on value; it’s more just continuation of the same managers running the businesses but with a little extra guidance from ROP coaches telling them how to think about maximizing CRI. 

• Returns on incremental capital have been ~high-single digit (HSDs), or essentially cost of capital, from 2011 through 2019, while organic growth has only averaged ~3.4% cagr over that period. The exhibit below outlines my estimates of ROP’s various returns on capital metrics – returns on tangible capital clearly shows the rising trend of improving business quality, but the ROEs and returns on unlevered total capital to reflect acquisitions have not been quite as impressive over that period of time. For example, ROEs averaged ~18% from 05-12, but have since come down to 15% at the end of 2019 as incremental returns on equity from 2011 to 2019 have only been 12%. That 12% incremental ROE is still not bad and I believe is clearly indicative of adding value, but it comes from leverage, as returns on incremental total capital over that period have only been ~8% - not bad, but not great, and this makes me question a) have returns on new acquisitions been just ok, or b) have there been declines in the legacy base businesses? – both of which would be concerns and need further due diligence.

* Source – All return on invested capital (“ROIC”) and return on equity (“ROE”) calculations above derived from ROP 10K reported financials. All data is at December 31. 

• Scale – as ROP has gotten bigger and bigger, it has needed to do bigger deals, and maybe that’s part of why returns on incremental capital haven’t been exceptional. But regardless of whether ROP is doing a smaller number of bigger deals or a larger number of smaller ones, it seems that at some point it stretches their small team too thin; again, at ROP it’s really just a couple of execs - CEO & CFO - evaluating and executing new deals and they are still very involved with portfolio companies as well. And there’s the question of how much TAM is out there of software companies that really fit their framework – on biz quality, size and multiple. Obviously ROP claims the pipeline is full, but is it full of deals at the right price that will generate respectable returns? 

• One knock on CEO Neil Hunn. I knew the healthcare IT space and MedAssets pretty well back in 2010 when Neil was the CFO and President of revenue cycle management. Medassets was a good business, but had the misfortune that Obamacare enacted in 2010 essentially forced the accelerated adoption of electronic medical records and clinical IT systems by hospitals. MedAssets played on the other side of the house in revenue cycle/financial systems. I spoke with 20+ hospital CIOs back then, and it was clear to me that clinical systems implementation shifted to be the primary focus and revenue cycle management products were put on the back burner, but more importantly many noted they thought that over time once the major clinical systems were fully installed (by Cerner & Epic as the major players) that those vendors would incorporate the financial side for a fully integrated offering. So MedAssets stock got hit hard in 2011 while Cerner and others took off. Anyways, Neil leaves MedAssets to join Roper in 2011, and one of the very first major deals that ROP does is in 2012 with the acquisition of Sunquest Information Systems for $1.4B, which was is a hospital lab software business. Fast forward today, when management is asked whether they’ve had any bad deals, Sunquest is the one that is continuously noted, and has gone through multiple years of MSD revenue declines. Thus, it’s a bit concerning to me that Neil would do a big deal in the healthcare software space that he was an expert in, and that had pretty clear writing on the wall that Epic & Cerner were going to integrate into and disrupt many of these markets. Now it seems that recent deals have performed very well, and maybe this was just his early learning mistake, but it’s note worthy to me. Commentary below from Neil Hunn speaking at 11/5/2019 Baird investor conference: 

 “But all kidding aside, there's been one. We talk about a lot. It's our United States laboratory -- hospital laboratory software business called Sunquest. It has been a challenging mid-single-digit decliner for us for the last several years, will probably decline for the next year or 2 and then stabilize and return to modest low to mid-single-digit growth. And the lesson for us there is, the niches that we're in are all born after the enterprise layer there. 

In the case of Sunquest, the enterprise layer, meaning the electronic medical record came after lab automation. So you just have -- you have the enterprise vendor pulling lab into their ecosystem where every other niche ever known to mankind, the niche spawns after the enterprise vendor. And so it's a unique situation for us that we've learned from that we hope not to repeat that mistake.”

• Valuation – as of 6/15/2020, ROP is trading ~32x price to 2019 earnings. In my view, it’s clearly a set of very high quality, attractive assets, and it has a 20 year track record of adding value through M&A and compounding cash flow at very high rates. But, I believe the multiple is just too high and the sum-of-the-parts (SOTP) valuation of software vs non-sw/product businesses doesn’t add up. ROP’s multiple is materially higher than even the best software assets it’s been purchasing at ~mid-teen EBITDA multiples (> 20x cash flow multiples after tax and minimal capex, vs ROP trading at 30x+) so everything ROP has been buying is immediately accretive even if they’re only delivering cost of capital unlevered returns on those acquisitions, and based on my research, I believe if ROP was split up into two businesses (software and industrial/medical products) that these businesses would trade much lower – the software assets are good, but they’re not the super high growth runway/big TAM bizes that software/SaaS investors really desire. Due to this, there may also be a scarcity value premium put on ROP because it’s viewed in the lens of multi-industrials and it blows those competitors out of the water on these high-quality business metrics (e.g., solid non-cyclical growth, very high margins and returns, good management team that has created value, etc.). Thus, in summary, I believe ROP has: a) a collection of assets one would aspire to own; and b) a management team that has a desirable owner-operator/forever owner mentality and uses the appropriate returns metrics to manage its business. With that, investing in ROP today may provide stability of underlying earnings and cash flows and I think should generate a respectable return in the context of the current market environment, but there’s likely a better entry point for one looking to stack the chips on this coveted asset. 

Important Disclaimers

The provision of this report does not constitute (and should not be construed as) a recommendation, financial promotion, investment advice, encouragement or solicitation to buy, sell, or hold the security of the subject issuer (the “Security”), or any other securities, discussed herein. This report is for informational purposes only. All of the information contained herein is based on publicly available information with respect to the security and the author’s analysis of such information. Past performance is no guarantee, nor is it indicative, of future results.

Certain statements reflect the opinions of the author as of the date written, may be forward-looking and/or based on current expectations, projections, and/or information currently available. The author cannot assure future results and disclaims any obligation to update or alter any statistical data and/or references thereto, as well as any forward-looking statements, whether as a result of new information, future events, or otherwise. Such statements/information may not be accurate over the long-term. The views are those of the author acting in his individual capacity and not as a representative of the firm.  The author’s opinions on this Security may change at any time in the future and the author will not, and disclaims any obligation to, update this report to reflect any change in opinion. The author further disclaims any obligation to respond to any comments or questions posted regarding the Security discussed herein.

NO INVESTMENT DECISIONS SHOULD BE BASED IN ANY MANNER ON THE INFORMATION AND OPINIONS SET FORTH IN THIS REPORT.  YOU SHOULD VERIFY ALL CLAIMS, DO YOUR OWN DUE DILIGENCE AND/OR SEEK ADVICE FROM YOUR OWN PROFESSIONAL ADVISOR(S) AND CONSIDER THE INVESTMENT OBJECTIVES AND RISKS AND YOUR OWN NEEDS AND GOALS BEFORE INVESTING IN ANY SECURITIES MENTIONED. AN INVESTMENT IN THE SECURITY DOES NOT GUARANTEE A POSITIVE RETURN AS STOCKS ARE SUBJECT TO MARKET RISKS, INCLUDING THE POTENTIAL LOSS OF PRINCIPAL.

The author or his or her respective employer or employer’s clients, affiliates, officers, managers and directors, may or may not hold positions in the Security noted in this article. These parties may trade at any time, without notification to this community, and will not disclose this information to this community. The author and his employer disclaims any liability for investment losses that you may incur under any circumstances.

The author does not hold a position with the issuer of the Security such as employment, directorship, or consultancy.

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