Thursday, August 22, 2013

An Earnings Miss And Asian Woes; What's Next for SAP?

The world’s leading developer of business-management software, SAP (ADR) (NYSE: SAP), is expecting more efficiency from its staff. The company is eyeing cost cuts following a reduction in revenue guidance. SAP is now expecting its software and other, related service sales to increase by 10%, as opposed to its previous guidance of 11% to 13% growth due to a slowdown in Asia. According to unconfirmed reports, SAP wants to save around $265.6 million in the next two quarters of its fiscal year.
Earnings miss
SAP announced its quarterly results a few weeks ago in which its license sales missed estimates while the reduction in guidance caused a 2.3% drop in its shares. In the second quarter of the current fiscal year, SAP reported
a 4.2% and a 9.5% year-over-year increase in revenue and profits to $5.4 billion and $960 million, respectively. Adjusted operating income rose 3.9% to $1.6 billion, below estimates of $1.6 billion. On an adjusted basis and in constant currency terms, software and software-related service revenue rose 10% to $4.4 billion -- below market’s expectations of $4.5 billion.
Asia woes
For the first time in three years, SAP’s revenue from selling software licenses fell by 3% to $1.3 billion led by 8.8% drop in the Asia Pacific and Japan (APJ) region. Ideally, APJ should never be negative. Although the drop here was led by Australia and Japan, SAP’s management believes that this is a direct impact of the slowdown in China, which is affecting other countries as well.
SAP wasn’t the only one reporting a weak quarter and declining revenue in Asia Pacific. Its competitors Oracle (NYSE: ORCL) and Accenture (NYSE: ACN) have also reported similar results. The broader industry is now favoring Internet-based applications against the traditional long-term contracts that are usually offered by SAP, Oracle and Accenture, which is making things difficult for these firms.
In its previous quarter, Oracle’s Asia Pacific license sales also dropped by 7% due to weakness in China and Australia. Despite putting better numbers in the Americas and EMEA regions, overall, Oracle has been facing sluggish growth as it tries to catch up with its bigger cloud-computing rivals. It has been forming deals and partnerships with its peers such as Netsuite, Deloitte, Microsoft and
In its last two quarters, Oracle missed both top- and bottom-line estimates. Its stock is not expensive at the moment and is trading 11.4 times its annual profit estimate and offers a decent return on equity of 24.5%. But its shares have remained nearly flat this year, which is a reflection of a company that is becoming a cash cow with little growth potential. I would rather stay away from this boring stock.
Like SAP, Accenture has also given weaker-than-expected revenue guidance. The company now expects to net $6.7 billion to $7 billion sales in Q4 (current quarter) as opposed to the market’s expectations of $7.4 billion. Annual earnings will be between $4.18 and $4.22 per share, below its own guidance of $4.24 to $4.32 per share and easily missing consensus of $4.28 per share. Like its peers, Asia Pacific was its weak spot where its revenue fell by 5%, the largest drop in its reported regions.
Stock performance
SAP’s stock has under-performed this year and has fallen by 4.3% when Oracle has been up 0.4%, Accenture has increased by 12% and the broader S&P-500 ETF (SPY) is up 21.4%. Its stock is also trading more than 22 times its trailing- and current full-year’s profit estimates, which makes it considerably more expensive than Oracle and Accenture. At these price levels, SAP will continue to under-perform in the near term.
P/E Fwd
Accenture is a relatively better option. The company’s revenue growth has also slowed down considerably from double-digit growth throughout 2011 to just 0.9% in its most recent quarter. But its stock has outperformed most of its peers and it offers a good yield of 2.2%, which is considerably above the industry’s average of 1.9%. It also generates a solid return on equity of more than 60%, which is far above SAP and Oracle’s numbers.
So what’s next for SAP?
SAP is now relying on cloud-subscription and its flagship database technology called HANA to drive its future growth. For FY 2013, SAP is eying robust growth of 118.7% in cloud subscription to adjusted revenue of $994 million. Similarly, adjusted software revenue from HANA is expected to grow by 65.8% to 78.6% to $928 million.
A significant portion of SAP’s growth has come on the back of acquisitions. According to Bloomberg, the company has spent more than $12 billion in the last three years in Silicon Valley acquisitions. Rumors abound that SAP is eyeing the takeover of Jive Software. However, some unconfirmed media reports (such as here) suggest that the company is no longer interested in the purchase.
Like Oracle, SAP has also been slow in shifting towards cloud computing and is now playing catch-up with industry leaders such as and Amazon. The company has a history of rolling out a major acquisition every 12-to-18 months so I wouldn't be surprised if by the end of the year, SAP makes a big purchase of Jive or a similar large organization.
My Foolish take
I do believe that SAP is going to become a bigger player in cloud computing in the coming years. While it is true that it has been spending billions of dollars on takeovers, it is still significantly behind Oracle, which has spent around $50 billion by acquiring nearly 100 firms since 2005.
Secondly, while SAP has been able to grow both mobile and HANA at an impressive pace, it is still a very small part of the organization. Its growth is not going to offset the slowdown coming from a weak business environment, particularly China, where GDP growth fell from 7.7% in Q1 2013 to 7.5% in Q2 2013.
I do believe that there is going to be near-term pressure, but I am more optimistic for the long term with improvements in Asian economies and SAP’s growth in mobile, cloud computing and HANA.
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Disclosure: I, Sarfaraz A. Khan, have no position in any stocks mentioned and no plans to initiate any within the next 72 hours of this publication. I have no business relationship with any company mentioned in this article.
The Motley Fool recommends Accenture. The Motley Fool owns shares of Oracle.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.