Alphabet, Uber, Applied Materials, and 19 Other -3-

Barron's · 2025-01-24 12:27

The third A-plus asset is a collection of high-end custom reagents that scientists use to conduct experiments. Long-term growth should be in the high-single to low-double digits, driven by pricing power, the growth of biotech, proteomics, and other factors. Revvity's largest reagent competitor trades for 36 times earnings. There is no reason this business couldn't trade for 30 times.

Together, these three businesses could be worth $137 a share in a year, implying that, at the current stock price of $113 [as of Jan. 3], you're getting the other 38% of Revvity for about negative $25. The rest of the businesses have 4% to 5% organic growth and are probably worth at least 20 times earnings. Based on a sum-of-the-parts analysis, Revvity could be worth $158 a share.

Revvity has a unique licensing business that helps drug companies reduce the time it takes to bring new drugs to market and increases the odds of success. The company earns milestone payments as drugs progress through trials, and royalties on drugs that get approved. It has about 150 different licenses. This licensing and royalty business could be transformative for Revvity over time.

Another plus: Margins are about 28% now, and could expand to 35% in five to seven years. Third, with the exception of Danaher, we expect Revvity to have the highest rate of free-cash-flow conversion [to earnings] in the industry, which will support a higher multiple. By the end of the decade, Revvity could earn almost $10 a share and trade for 30 times earnings.

What else do you like?

Giroux: Last year was tough for software stocks. As a result, valuations look compelling. PTC is one of our favorites. The company has a $22 billion market capitalization. It focuses on software for product and service life-cycle management, and computer-aided design. It is growing revenue organically by low-double digits, and earnings per share at a midteens rate. PTC is a market-share gainer, with a new CEO who came from the investment firm Silver Lake. Management is refocusing the company on its competitive advantages.

Unlike heavy cyclicals, many of which are expensive, PTC isn't pricing in an economic recovery. We expect continued low-double-digit growth even without a robust economy, although growth could accelerate if the economy strengthens.

PTC is early in transitioning to the cloud. We think 70% of the business could become cloud-based, versus a quarter to a third today. If the rest of the business converts to the cloud over the next 10 years, organic revenue growth could accelerate by as much as two points a year.

PTC is a "Rule of 50" company.

Meaning what?

Giroux: It has 10% to 12% organic revenue growth and 40% operating margins. Earnings are growing by four percentage points more than revenue, due to buybacks and acquisitions. The big deals are behind it, but PTC can make tuck-in acquisitions. The company announced plans to buy back $2 billion of stock in the next three years.

PTC is targeting about $1 billion, or $8.25 a share in free cash flow, in fiscal 2026, which starts in October. The stock is in the low $180s and sells for 22 times estimated free cash, versus other vertical software companies, which trade closer to a multiple of 30 times free cash. We expect the stock to trade up to $240 to $250 in less than a year.

Next, Fortive is trading for $75 and has a $26 billion market cap and $6.3 billion in annual sales. It is trading for 18 times 2025 estimated earnings, and 17 times free cash flow. The stock is trading at about a six- to seven-multiple point discount to high-quality industrial stocks such as Ametek and Ingersoll Rand, and a four-multiple point discount to the industrial conglomerate index. Yet, Fortive has more software, recurring revenue, and free-cash conversion [to earnings], higher gross margins, and less cyclicality than peers. Gross margins are in the 60% range, versus 40% for peers. Earnings have grown at a compound annual growth rate of 14% over the past five years.

So, why the discount?

Giroux: Partly, Fortive had poor capital allocation in recent years on larger deals. Its purchase of EA Elektro-Automatik last year didn't turn out well. Its bid for National Instruments luckily failed. Also, earnings guidance was too aggressive. And, there is a lot of complexity in mixing heavy cyclical assets like Tektronix with software and healthcare businesses.

The good news is, Fortive has announced it will split into two entities in the second half of 2025. We think that is a catalyst for a rerating of the stock. Olumide Soroye will be the CEO of the new Fortive, which will include software, healthcare, and Fluke, the market leader in professional test and measurement tools that has mid-single-digit organic growth and 40% operating margins. The new Fortive will have the highest gross margins in industrials, the best free-cash-flow conversion, one of the best organic growth rates, and most important, a vastly improved capital-allocation strategy that will emphasize high-return bolt-on acquisitions and share buybacks. This is what has made Ametek and Ingersoll Rand such amazing stocks.

We expect Fortive to generate double-digit returns on capital within three years from acquisitions, and buy back stock. The new Fortive will grow earnings and free cash flow faster than its high-quality peers over the next five years. Olumide has done an amazing job running the IOS [Intelligent Operating Solutions] division of Fortive, the rock star of the company's portfolio.

What is the outlook for the company that Fortive will spin off?

Giroux: The new spin-co will include the more cyclical Tektronix test and measurement assets, and the sensors business. The best comparable for Tektronix is Keysight Technologies, which trades for 20 times Ebitda. Tami Newcombe, CEO of the new company, is a great operator; she turned around Fortive's healthcare business in her spare time over the past 18 months. We expect capital allocation to focus mostly on share repurchase and bolt-on acquisitions. Earnings could grow 9% to 11% through a cycle. We think Fortive is worth $90 to $100 a share on conservative sum-of-the-parts basis. Over a five-year period, low-double-digit earnings growth plus multiple expansion should lead to midteens returns.

Next, Roper Technologies is a collection of high-market-share software assets and high-growth healthcare assets with about $7 billion of annual sales, a 41% Ebitda margin, and a $55 billion market cap. I have watched its evolution for about 25 years. I am excited about what Roper looks like today, but more important, what it will look like in four to five years.

Give us a sneak preview.

Giroux: Roper sold a majority stake in its industrial assets in 2022 to become faster-growing and less cyclical. It essentially increased organic growth from 4%-5% to 7%.

The company has altered its acquisition strategy to focus on faster-growth assets, and has been doing more high-return bolt-on deals in the past four to five years. This improved capital allocation should drive better returns on capital, faster earnings growth, and price/earnings multiple expansion. In the next five years, Roper's organic growth rate could increase to 8%-9%, and maybe even 10%. The increase in organic growth could drive midteens earnings growth.

Roper is trading for about 20 times estimated 2026 free cash flow. Peers tend to trade for 25 to 30 times free cash flow. This should be a recipe for high-teens total shareholder returns.

Roper's earnings and free cash flow are higher quality than many software peers, as stock-based compensation is only 2% of sales versus 8% to 15% for peers. Also, Roper tends to serve low-cyclical end markets such as education, insurance brokerage, utilities, and healthcare. It is a defensive stock from a trading and fundamentals perspective.

There is also hidden value here. Roper still owns more than 40% of its legacy industrial assets, with private equity owning the rest. I would expect Roper's legacy industrial business to come public sometime in the next three years. Roper's ownership could be worth an incremental $2 billion and $3 billion.

What are your last two names?

Giroux: I have recommended Becton Dickinson in the past. There are multiple ways to win here. The company has $21 billion in revenue, 30% Ebitda margins, and a $66 billion market cap. Becton has grown organically by 5% to 6% a year almost every year for the past five years, and that's despite a disruptive product recall, headwinds in China, and more recently, a slowdown in the life sciences and diagnostics business. In addition, the company has made a series of acquisitions -- including a pharmacy automation business -- that should accelerate organic growth. China was once 10% of revenue, but has fallen to 5%-6%.

Becton is the dominant player in prefilled syringes, at six times the capacity of the industry's No. 2. This business should accelerate from the growth of GLP-1s, other biologics, and emerging on-body products that could make infusion centers less necessary. This could be a $500 million to $1 billion opportunity by the end of the decade.

If Becton does nothing in the next five years, it is on a path to 6% or 7% organic revenue growth just because of the product mix, growth of the pharmaceutical systems business, fewer China headwinds, and acquisitions. That would support a P/E multiple in the low 20s, versus a current multiple of 15.5 times 2025 estimated earnings.

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January 24, 2025 12:27 ET (17:27 GMT)