Roper Technologies: Transformation Near Completion (NYSE:ROP)

Towards the end of last year, I concluded that Roper Technologies (NYSE:ROP) continued to work on its repositioning, shedding some activities to address leverage while repositioning the business. In the first half of this year, Roper has seen solid momentum from an operational point of view, further divesting some assets, as the repositioning is near completion with much freed up capacity to embark on growth again.

Former Take

Roper is a software and engineered product business which holds leading positions in niche segments. Local management teams are given the freedom to operate and thrive, active in businesses which typically require low capital spending requirements, making them great businesses to operate, to invest in, and to own.

The company has been investing quite aggressively into software, including a huge $5.4 billion deal for Vertafore in August 2020, prompting shares to rise to a high of $450 per share at the time. At this valuation, Roper was awarded a $51 billion enterprise valuation, a huge valuation for a business which was trading at 10 times sales and 25 times EBITDA, all ahead of the Vertafore deal. Pegging earnings multiples close to 30 times earnings following the Vertafore acquisition, I was quite cautious.

Shares kept trading towards the near $500 mark late in 2021 as the company has seen good traction during 2021. After all, the company guided for adjusted earnings around $15 per share, up from less than $13 per share in 2020. The company furthermore divested some assets during 2021, including the sale of its Zetec business in a $350 million deal, its CIVCO radiotherapy business in a $120 million deal and the divestment of its TransCore business in a $2.7 billion deal, going a long way in addressing leverage, albeit that earnings would fall towards the $14 mark if we account of their earnings contribution.

With some divestments looking a big cheap (at least relative to the valuation of Roper), I was a bit cautious, yet Roper has a great long term capital allocation track record. Being a great admirer of the company, I would be willing to enter at around 25 times earnings, which makes that I would be getting attracted if shares would fall to the $400 mark, or high $300s.

Stagnation, In The Numbers

With shares trading around the $500 mark in December of last year, expectations have come down a bit. Still a $480 stock in April, shares actually fell to a low of $370 in June, now trading back at $430 per share again.

In February, Roper posted its 2021 results with revenues up 19% to $5.79 billion, as roughly half of that growth was driven by organic growth, a decent result albeit that 2021 has been a strong year from an economic point of view. Adjusted earnings came in at $14.18 per share, as the company guided for modest earnings growth in 2022, seeing earnings between $15.25 and $15.55 per share, as 2022 is a challenging year given the fact that some divestments have been announced of course.

Net debt had fallen to $7.5 billion by year-end as EBITDA for the year was reported at $2.2 billion, lowering leverage ratios to 3.4 times. Needless to say, these remain elevated valuations at 30 times earnings while leverage was full, not creating imminent appeal at the start of the year.

In April, first quarter results were quite decent as the company hiked the midpoint of the earnings guidance from $15.40 per share to $15.625 per share as net debt fell to just $4.2 billion with many announced deals late in 2021 have closed during the quarter, reducing leverage to less than 2 times.

On the first day of June, Roper announced its next divestment, selling a majority stake in its industrial business to Clayton, Dubilier & Rice. Roper will obtain a $2.6 billion payment, while retaining a 49% stake in the business which includes a collection of businesses which combined generate $940 million in sales and $260 million in EBITDA. This values the business at roughly 5 times sales and 20 times EBITDA, which looks quite reasonable.

In July, Roper posted second quarter results as the company cut the earnings guidance to roughly $13.50 per share, reflective of this divestment which will cut net debt to just $2.0 billion, as the results are pretty solid and are actually up a bit on a comparable basis. With 107 million shares now back to $430, the pro forma enterprise valuation stands at $48 billion, at roughly 9 times sales and 24 times EBITDA, indicating that the latest divestment comes a bit cheaper, all part of the big strategic plan.

And Now?

Right now the continued transition from lower margin activities to more predictable and higher margins software activities is to be applauded, yet it looks and is near term dilutive, which is a shame of course. On the other hand, Roper has been able to transform the business largely since 2020, as the company has done this transition, while keeping earnings intact at around $13-$14 per share, while net debt has been largely eliminated.

The issue is that valuations were high from the start, as the company is ready to make acquisitions again, to further fortify the business. This could increase the earnings power of the business, yet my conclusion from late 2021 still stands. I would be happy to initiate in the high $300s, levels which we actually saw in recent weeks during the period of market turmoil, but did not commit yet as opportunities arose left and right.