EUR 850.00 For Business Accounts Only

Morningstar | Roper Continues to Drive Shareholder Value With the Acquisition of Foundry

Wide-moat rated Roper had a solid first quarter, with broad-based organic top-line results that beat our near-term expectations. The firm also raised the top and bottom end of its adjusted diluted EPS range with the acquisition of Foundry, and a smaller-than-expected hit to this metric from the Gatan divestiture (to a nickel per share from a quarter per share previously). As a result of both near-term outperformance and raised guidance, we expect to raise our fair value estimate by about 1% to 2%, even as our EPS estimate was higher than previous guidance. Our new estimate would still imply a fair value of about 26 times our 2019 raised adjusted EPS expectations. While shares are down on the news today (less than 1%), we think it’s more a function of market expectations slightly outpacing the performance of this exceptional and well-run enterprise’s stock.

Roper continues its stellar performance of compounding shareholder returns, and we see a continuation of its preference for targets in niche markets as well as its cash-return focused acquisition strategy with the purchase of Foundry. Foundry will be folded into Roper’s Network Software and Systems. While Foundry is not optically cheap at a purchase price of just over 17 times EBITDA, by our math, we think Roper paid a fair price for a business that “checks all the boxes.” First, the business has strong share of mind and fits neatly in Roper’s portfolio. Foundry software works on composite imagery and combines visuals effects, animation, and 3D content in the media and entertainment industry, including in popular shows like Game of Thrones. Foundry has been used on every VFX Oscar award-winning film for the past decade, and customers include Pixar, Mercedes, and New Balance.

Second, legions of graphic arts students are trained in college on Foundry’s applications, which we think creates a sticky offering, underpinned by its strong base of recurring revenue. Other hints of switching costs here include the ability to create photo-ready designs that materially cut down on clients’ product development time tables, which may lower clients’ total cost of ownership.

Third, we think Foundry benefits from a network effect. Its ecosystem is the communication standard for outsourcing of visual effects, and we think that ecosystem becomes more valuable the more users are added, both to the user (which is trained on the system) and Foundry alike.

Finally, CEO Neil Hunn added that Foundry comes with an excellent all-around management team, which we think is important given that Roper’s unique culture forms a key part of our investment thesis. Foundry also adds to the asset light nature of Roper’s business (it also runs on negative working capital) and has an impressive unleveraged free cash flow yield (FCF divided by sales) of 33%, which is better than Roper’s core businesses (which currently convert about 26% of revenue into free cash flow).

On the call, management gave additional insightful commentary concerning the moats and growth drivers of its various businesses. For example, wide-moat rated Oracle recently made comments at an investor conference in February, that the markets that Deltek served were an opportunity given that users of its software were “sitting there with no upgrades, no automation, and security concerns.” We don’t believe it’s easy to displace Roper’s businesses, as underpinned by our wide-moat rating.

Deltek serves business in very specific niches with solutions that are very specific for a particular user. We’ve mentioned in our moat analysis, for example, that government contracting work requires an alphabet soup of forms to fill out and various reporting requirements that are subject to audit. These solutions serve specific customer pain points because they don’t require active customization. Deal parameters on a government contractor’s bill of materials, for example, are very germane to this type of work. We point to a customer retention ratio of 97% in support of the switching costs in this business, and we expect this business will continue gaining new wins.