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Morningstar | Roper's Powerful, Acquisition-Heavy Business Model Keeps Bearing Fruit

Narrow-moat-rated Roper Technologies had yet another great quarter, and its full-year 2018 results slightly exceeded our expectations for the firm. As we roll our model forward going into 2019, we plan to modestly raise our fair value estimate by about 3%. We are retaining, however, our narrow moat, stable trend, medium uncertainty, and Exemplary stewardship ratings. The firm continues to build upon the power of its business by acquiring other businesses that serve niche markets, have strong competitive positions, operate asset-light, software-based business models, and have large amounts of deferred revenue. Even with the passing of former CEO Brian Jellison, we think the firm’s culture is institutionalized and we trust both CEO Neil Hunn and CFO Robert Crisci will do a good job preserving the culture of the firm, particularly since both were at ground zero in evaluating M&A deals.

For full-year 2018, top line growth came in at $5.2 billion against our expectations of $5.1 billion, growing 11% for the full year, or 8% on an organic basis. Segment operating profit came in at $1.6 billion, closely mirroring our own expectations, while adjusted diluted EPS of $11.81 exceeded our own expectations by 1%. The firm continues to be a compounding machine as it has grown large amounts of deferred revenue (about $682 million in 2018 versus $488 million at year-end 2016). While GAAP accounting books this figure as a liability, we consider it a trust asset since it allows Roper’s team to receive cash upfront and reallocate that capital to purchase more cash-generating businesses. This concept is not all too different in principle from using low-cost insurance premiums to invest in high returns on capital business in the mold of Berkshire Hathaway (CFO Robert Crisci, incidentally, received his MBA from Columbia Business School). The proof is in the firm’s results, fourth-quarter free cash flow actually increased 27% year over year from the last year’s fourth quarter.

Turning to the firm’s segments, the firm’s RF technology & software segment, which constitutes 43% of Roper revenue, produced top-line year-over-year gains of 18% during the fourth quarter (10% on an organic basis). Deltek, Roper’s applications software business focused on government contracting and professional services made profitable market share gains according to management on the enterprise, small and medium businesses, and government contracting space. Deltek is also launching VantagePoint, a software as a service platform that could create switching costs as the units cross sells more products. Other segments like energy systems and control raised operating margins an impressive 320 basis points over the prior year, despite only making 2% year-over-year gains in organic revenue. While we like Roper’s business model and its management, the stock price and potentially slowing growth in some of its businesses keep us on the sidelines for now.