SAP SE (SAP, Financial) stocks plummeted by 4.4% following the company’s decision to revise its profit target for 2017 from an earlier $7.7 billion to $6.3-7 billion. The company’s stock fell as low as $54.69 in what is considered its biggest loss in the last three months. SAP’s operating profit is estimated to only marginally increase in 2015 compared to the previous year, with the figure ranging between $5.6-5.9 billion as against a predicted $6.1 billion. However, this should not be viewed as bad news. The short-term setback could possibly spell a brighter future for investors as well as the company, whose software is used to run the operations and finances of large enterprises.
Future is in the Clouds
With cloud delivery making the management, analysis and use of data easier, not only on computers but also on other devices such as mobile phones, the industry is witnessing a paradigm shift in the way clients purchase their software. Consequently, customers are increasingly opting for the cloud-computing versions of SAP’s software, making it necessary for the company to invest towards adding and upgrading data centres as well as sales staff.
The target cut announcement by SAP is seen as a result of low margins associated with cloud-based software delivery, which demands higher initial costs alongside subscription-based earnings that are realized not immediately, but over a period of time. And while the trend impairs the sales of traditional software versions that demand on-premise installation on the clients’ computers but offer the more attractive upfront revenues, it heralds good news for SAP’s cloud venture in a market that is likely to double by 2018 to nearly $83 billion.
Step in the Right Direction
Although SAP’s expected earnings from the sales and support for cloud-based software in the current year is around $1.95-2.05 billion, down $30 million from industry estimates, the company expects these figures to witness a seven-fold increase by 2020 when it foresees revenue of around $7.5-8 billion for the same sector. SAP, alongside established players in the US software developers’ market such as Microsoft (MSFT, Financial), Oracle (ORCL, Financial) and IBM (IBM, Financial), is up against rivals such as Workday (WDAY, Financial) and Salesforce.com (CRM, Financial) that offer pure cloud-based products to customers. Consequently, SAP has already invested over $20 billion in acquiring various businesses such as Concur Technologies Inc. and SuccessFactors Inc. (SFSF, Financial) to allay competition and boost sales of its web-based software. With rival Oracle offering its flagship Java enterprise and 12c database software as online services, SAP also announced plans to launch its product S4Hana, which would allow clients to run the company’s HANA database software along with its flagship Business Suite offering, in early 2015.
SAP is targeting an operating profit, of between $8-9 billion (excluding special items) in 2020 based on earnings of $26-28 billion. However, growth is likely to be slow to start with, with the company’s operating profit expected to clock between $6.3-7 billion by 2017. SAP also expects greater revenue from cloud subscriptions than from the sale of software license by the year 2018, when the company’s cloud venture is likely to reach a scale that would allow for accelerated expansion in operating profits, with sales of cloud-based products eclipsing that of on-premises software by 2020.
Final Thoughts
SAP is currently the fastest growing cloud business amongst peer group companies that boast of over $1 billion in annual revenues from their cloud-based products. Moreover, despite an accelerated transition towards cloud-based product delivery that allowed the company to post a 72% growth in earnings as per its preliminary 4th quarter results for FY2015, SAP have also shown a robust performance in its traditionally delivered software and related services. The company expects the combination of a healthy growth of the cloud-delivery business and high rates of renewal by loyal customers to potentially help in expanding profit margins. Further, if the rise in Oracle’s shares in Dec 2014 following an increase in profit and sales of cloud-based products and SAP’s own exceptionally solid growth in the cloud sector in 2014 are anything to go by, investors would do well to be patient. The year 2020 is likely to herald an upswing in the fortunes of both SAP and its investors.
