UPDATED 10:29 EST / OCTOBER 18 2018


SAP cloud sales surge, but profit squeeze knocks back shares

Strong growth in cloud sales led SAP SE to raise its full-year revenue and profit projections for the third time this year, but third-quarter profits missed analyst estimates, prompting a selloff in its shares today.

SAP stock dropped nearly 7 percent in trading today, to its lowest level since May. A defiant Chief Executive Bill McDermott (pictured) brushed off the shortfall, saying SAP wasn’t going to repeat the mistakes of “past leadership” who had put margins ahead of growth.

“That isn’t our strategy; we’re going to grow and be number one in the cloud for decades to come,” he said. SAP has recently claimed to be the world’s top cloud computing vendor based upon the number of users of its services.

The profit squeeze may be rooted in one of SAP’s most successful products ever, the S/4HANA enterprise resource planning system. SAP boasted on this morning’s analysts’ call that it expects to log its 10,000 S/4HANA customer soon, but many of those customers haven’t yet implemented the software, according to George Lawrie, vice president and principal analyst at Forrester Research Inc.

In fact, Forrester believes only a fraction of the 9,500 S/4HANA customers SAP claims are in full production, Lawrie said. As customers go live, SAP’s services organization will be called into help with installation and tuning, which drives up services revenue but pressures margins. “Growth in revenue is not necessarily a good thing if it’s services people solving problems,” he said.

S/4HANA’s performance has been a particular question mark in the early going, Lawrie said. “There are great features but it’s a polyglot database,” he said. “When you bundle a lot of features together it’s not clear what happens to performance. Some of our clients are muttering about that.” But customers are still likely to push ahead because they’re confident SAP will work out the problems, he noted.

There was certainly much to crow about in the European tech leader’s cloud story in the third quarter. Cloud subscription revenue surged 41 percent to just over €1.3 billion ($1.49 billion), a slight acceleration from the previous quarter’s growth rate. Revenue from cloud subscriptions now exceeds software license revenue, a shift that SAP said happened faster than expected.

The company’s business is actually benefiting from growing global trade tension because customers look to SAP as a safe haven, McDermott said. “The global scenario of growth at SAPis well-dispersed across geographies and industries,” he said. “SAP has never been more relevant as the trusted innovator.”

Total revenues for the quarter were €6.03 billion ($6.93 billion) up 10 percent year-over-year and slightly better than analysts’ estimates. Earnings per share of $1.14 were about a nickel higher than estimates. Profit margins grew 10 percentage points, to 29.4 percent, which was slightly below forecasts.

Good news/bad news

SAP blamed the profit squeeze on customers’ accelerating conversion to the cloud at the expense of software licenses, a trend that will pay off for the company over time. Although cloud subscriptions are more lucrative and predictable over time, they are less profitable in the short term.

The company’s aggressive move to the cloud may throttle profits for now, but that doesn’t change the strategy, said Chief Financial Officer Luca Mucic. “We will trade a software dollar for a cloud dollar every time,” he said.

Executives underlined their confidence by raising their full-year revenue forecast to a midpoint of €25.35 billion ($29.14 billion), up about €210 million from the midpoint of previous estimates. It also raised profit estimates slightly.

By all indications, SAP’s shift to a cloud-first model is going well. Accelerated new cloud bookings growth – an important indicator of future business – grew 37 percent. Combined cloud and software revenue of €5 billion ($5.75 million) was up 8 percent and the share of predictable revenue grew to 68 percent from 65 percent, which indicates that business stability is improving.

At the same time, the company’s software license business is declining at a manageable rate, McDermott said. “I wouldn’t be at all concerned with any changes to the core license business,” he told analysts.

Mucic noted that sales of just two software products — S/4HANA and digital supply chain management — now make up more than half of overall license revenues. “The rest is basically migrating to the cloud,” he said.

S/4HANA revenues grew 37 percent the customer count surged to 9,500, up about 600 from the previous quarter. About half of S/4HANA sales during the quarter were net new customers, the company said.

SAP’s efforts to diversify its portfolio continues to show good progress. The company’s SuccessFactors Employee Central human capital management offering added more than 200 customers in the quarter and sales of the new C4/HANA customer relationship management platform grew more than 200 percent, leading a 54 percent overall growth in what SAP calls “customer experience-related” software to €232 million ($267 million).

Photo: SAP

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