Roper Technologies: Still Not Appealing (NYSE:ROP)

In August, I believed that Roper Technologies, Inc. (NYSE:ROP) was nearing the completion of its transformation efforts. I believed that after the latest divestment, Roper was close to complete its transformation, as these steps prepared a better positioned Roper for the next phase of growth.

The Business

Roper is a software and engineered product business which operates leading positions in niche segments. With local management teams given the freedom to operate and thrive, and Roper being active in businesses which require limited capital spending, making them great assets to own in their portfolio, with a greater focus on software with the passage of time.

The company made a huge move when it acquired Vertafore in a $5.4 billion deal in the summer of 2020, causing shares to rise to $450 per share. With a $51 billion enterprise valuation, Roper was trading at around 10 times sales and 25 times EBITDA, huge multiples on all accounts.

After posting adjusted earnings at less than $13 per share in 2020, earnings were set to rise towards $15 per share in 2021. In the meantime, the company addressed the leverage position with some divestments. This includes a CIVCO radiotherapy divestment in a $120 million deal, the sale of Zetec in a $350 million deal, and a larger $2.7 billion sale of TransCore. Following these moves, leverage would come down a lot, although I believed that earnings would fall to $14 per share if we account for these sales.

With shares trading near the $500 mark in 2021, valuations were very high, yet the long-term capital allocation track record of the business was good. For that I am an admirer of the business, yet the valuations were simply too demanding for me to get involved.

Valuation Thoughts

After shares hit the $500 mark in 2021, shares fell back to $430 in June of this year. After 2021 revenues rose 19% to $5.79 billion, earnings came in at $14.18 per share. The 2022 guidance was comforting, as the company issued an earnings guidance, calling for earnings between $15.25 and $15.55 per share, despite the impact of some divestments.

The company actually hiked the midpoint of the earnings guidance from $15.40 per share alongside the release of the 2021 results, to $15.625 per share alongside the first quarter earnings report. With net debt down to $4.2 billion, leverage ratio fell to 2 times. Needless to say, valuation were still demanding at 27 times earnings based on the situation in June.

Net debt was set to fall further, as the company sold a majority stake in its distribution business in June. Still retaining a 49% stake in the business, Roper saw $940 million in sales and $260 million in EBITDA leave the door. Valuations looked quite reasonable, with Roper obtaining a $2.6 billion cash component in exchange for essentially selling half the business.

Following the deal, earnings power would fall to $13.50 per share, yet net debt would fall to just $2 billion, for a leverage ratio around 1 times. Despite the elimination of the debt overhang, valuations remained too demanding for me to get involved.

Appeal Lures

Since June, shares have fallen from $430 to $370 per share following a further retreat in the markets at large and concerns of the effect of a cooling economy on all companies, including Roper.

In July, Roper announced its second quarter results as the company announced pro forma earnings power around $13.50 per share. The performance looked resilient, albeit that there were many moving parts with Roper, of course. Despite so many divestments as of late, Roper actually announced a buy-side transaction as well by the end of August.

At the time, Roper had reached a deal to acquire Frontline Education in a $3.725 billion cash deal, with the net present value of tax benefits reducing the net purchase price to $3.375 billion. The company offers software which is a connected platform for administrative solutions, built for K-12 education institutions. With a $370 million revenue contribution and $175 million EBITDA guidance, the acquired activities look extremely compelling, yet Roper is paying a full price for these activities.

With net debt posted at $4.5 billion by the second quarter, ahead of the divestment of its 49% stake in the industrial business, I peg pro forma net debt load around $5.5 billion – still manageable. The company guided for 2022 earnings around $13.50 per share alongside the second quarter, and while the recent deal looks to be accretive, that is likely very limited given the financing costs and smaller size of the business.

With earnings power impacted a bit following some divestments earlier this year, earnings multiples continue to come in around 27 times, still elevated. This is certainly the case given the higher interest rate environment and increased doubts on the economic environment.

Still Holding Off

The recent buy surprises me a bit, as the deal comes a bit early in the transformation story of Roper. Moreover, the recent deal looks fair but is not necessarily a cheap purchase, and Roper feels a bit too eager in its attempt to optimize the portfolio, but that is just my impression.

Additionally, current earnings multiples remain a bit too demanding, as valuation multiples have not really come down over time, even as shares have come down a bit. This is concerning, as now we find ourselves in a higher interest rate environment. These higher interest rates and slower growth makes investors cautious, and while Roper is still a solid long-term value creator, the company still has something to prove here. Thus, I am still not happy to start buying into Roper at these levels just yet.