Industrials

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Investors are keeping industrial CEOs on a tight leash these days, but when it comes to Roper Technologies Inc.'s Brian Jellison, it's more out of possessiveness than as a way to keep him in line.

Jellison was named CEO of the now $24 billion maker of legal software and electronic highway-toll systems in November 2001, just two months after Jeff Immelt ascended to the top post at General Electric Co. Immelt's retirement announcement last month and a rise in CEO departures across the industrial sector has drawn fresh attention to the question of how much longer Jellison will stick around at Roper, and who could succeed him. He's one of the oldest leaders among members of the S&P 500 Industrials Index and about a decade Immelt's senior at 71. 

New Management
Industrial CEOs are departing in greater numbers than had been typical over the previous five years. They're also accounting for a greater percentage of overall CEO turnover.
Source: Challenger, Gray & Christmas

The two men's situations couldn't be more different. GE says Immelt's decision to step down was the result of years of succession planning, but it coincided uncomfortably with investor ire over a perpetually weak stock price and disappointing cash flow. And Jellison? This is what's happened at Roper under his watch: 

Heavy Lifting
Roper has become a more profitable, cash-generative company under Jellison
Source: Bloomberg
Note: Roper had a 2-for-1 stock split in 2005 and EPS is adjusted for that, per Bloomberg data. Estimated 2017 market capitalization is derived from analysts' average 12-month price target. Roper's market value as of July 7 was $23.9 billion. Free cash flow data is based on Bloomberg's standardized calculations and may vary from the company's own reports.

It's an outsized performance no matter how you benchmark it, and it's put Jellison in the position of having investors concerned about -- rather than clamoring for -- his exit. Enviable for him, perhaps, but it creates a quandary for his eventual successor. 

That'll Do
Roper shares have surged under Jellison, while GE stock is trading at a discount to where it was when Immelt took over
Source: Bloomberg
Roper had a 2-for-1 stock split in 2005

Jellison's retirement may be a while off. Asked about it in 2015, he said he was "still having fun" and noted the mandatory retirement age for the board is 78. In the meantime, the company has made more of an effort to bring other executives out from behind the scenes, most notably Neil Hunn, who's in charge of much of Roper's medical business and recent software acquisitions. But Jellison's success will be difficult to duplicate, no matter how skilled his underlings are.

When Jellison took over, Roper primarily sold industrial technologies such as fluid-testing equipment and sensors and valves for the oil and gas industry. More than a decade and dozens of deals later, half the company's Ebitda is now tied to software. What was once a business reliant on heavy spending now flirts with negative working capital. You can understand why Jellison last year called out the "Johnny-come-latelys" in the industrial sector who have only recently made noise about software.

Smart Spending
Jellison's purchase of Deltek looks cheap relative to other software splurges by industrial companies on more nascent technologies. Whose strategy is the best remains to be seen.
Source: Bloomberg
The Arcam data is derived from the implied valuation by GE's purchase of a 46 percent stake.

What's different about Roper's approach is that it's targeted niche markets where the capabilities are already proven and competition is scarce, rather than building new Industrial Internet of Things systems that cater to everyone. Last year's $2.8 billion takeover of Deltek, which sells business-management software to government contractors, and the $632 million purchase of ConstructConnect, a software-as-a-service platform for the construction industry, are examples of that.

There's something to be said for that strategy; Roper's margins and returns speak for themselves. But what that's meant in practice is that the unifier for Roper's operations is financial metrics, rather than traditional cross-selling synergies. Legal software isn't an obvious fit with radio-frequency technology for highway tolls and laboratory information systems. Not to mention the fact that Roper is still holding on to those legacy industrial and energy businesses. 

Best-in-Class
Even relative to the better-performing industrial conglomerates, Roper's margins stand out. That's also meant its valuation is near the top of the pack.
Source: Bloomberg
Note: Screening universe is North American industrial companies valued at more than $5 billion.

Shareholders haven't been too bothered because, well, all the parts of the business are good. Roper's energy systems and controls unit had a 29 percent Ebitda margin last year, just 3.7 percentage points off its 2014 profitability despite taking in almost $200 million less in revenue. But ensuring this dynamic continues won't be an easy task; few CEOs who inherit conglomerate empires built by their predecessors also inherit the vision and operating wherewithal that made sense out of the randomness. The job is made even harder when you also inherit a very high price-earnings multiple.

Working in Roper's favor is an almost private equity-like structure where business heads operate like mini-CEOs. They're nimble, and they know what they’re doing. The difference, notes RBC analyst Deane Dray, is that private equity firms have to sell their businesses, usually after about five years. Roper stills need someone with an overarching, cohesive strategy to make it all work, lest an activist investor come knocking. They've already shown a willingness to jump on even the slightest incongruence at industrial conglomerates, as demonstrated by Third Point LLC's push for a breakup of Honeywell International Inc.

Roper's not a one-man show, but, rightly or wrongly, Jellison is perceived as the primary architect of the company's success and it wouldn't be surprising to see the stock drop whenever he does decide to depart. There are worse problems to have as an industrial CEO, but there are downsides to being so beloved.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net