SAP's Sudden Price Drop
Reports of slow sales in Europe have dropped SAP's stock price
25% below its recent trading range. Have SAP's long-term
prospects changed?
The Questions
Analysts in Europe have expressed doubt about SAP's ability to
meet its earnings targets this quarter, and the stock price
has consequently dropped much faster than the sector has.
In this Short Take, we ask three, interrelated questions about
the price drop. First, are SAP sales actually slow, relative
to the sector? Second,
if sales are slow, is this the effect of war jitters, or is there
something wrong at SAP? And third, what are SAP's long-term
prospects? All readers of Short Takes care about this question, but
it is particularly salient for the analysts. For you, the question
translates to, "Is this a much-needed
correction for a company that is incapable of justifying
its premium valuation, or is this
a buying opportunity?"
Let's have no surprises. We think it's a buying opportunity. Our
basic answers to these questions are as follows:
First, we see no indications in the Americas that sales
are particularly slow for SAP this quarter; our European Correspondent
sees roughly the same thing in Europe. Second, we think the
entire sector may have been hurt by war jitters, but
we think SAP will be hurt less than most.
Third, we don't think anything in SAP's business model
or long-term prospects have changed. Much as I love to
criticize SAP, it is the best company with the best product suite
and the best prospects. There are many long-term issues, and the
way they are managed will ultimately determine what valuation is
justified. But all the issues are manageable.
Are SAP's Sales Slow?
We have spent the last few days talking to customers, partners, and competitors
of SAP about the current sales climate. In the Americas, we have not found any indication
of particularly slow sales for SAP (though no one thinks the climate is great). The
deals are there, small and large. Not all will close, but some will.
There is no sign of unusual malaise or depression in the SAP sales force.
Europe seems much the same. According to our European
Correspondent, "The economic climate in Europe is
what it was. No changes in sight. It is unlikely that sales problems in Europe
warrant such a dramatic impact [a 25% price drop -- Ed.].
Europe is fragmented and Germany is pretty resilient.
With Germany, Switzerland and Austria still having a revenue share of
similar size to the US, minor hiccups can occur, but landslides are not
to be expected. The rest of Europe is more volatile - but the impact is
smaller."
Given our policies (we don't ask people to violate laws or risk getting fired; we
don't violate confidences; we don't publish insider information), we have reasonable
confidence in this picture.
That said, we also want to empahsize how very unreliable our snapshot (or any
snapshot) is. Year on year comparisons are always difficult, but Q1 y/y's are
particularly difficult. Q1 always looks bad after Q4, and nobody remembers
with any clarity whether this year's bad is worse than last year's bad.
And this year, comparisons are more difficult than ever. We've been told
that in the Americas,
the salesforce compensation system has changed in two fundamental ways. First,
salespeople now take responsibility for all revenue coming in. License revenue
is still primary, but revenue from consulting and training also count more
heavily. So, while pure license activity may be down, the total may not be. Second,
salespeople now have quarterly quotas, so they're under more pressure than
they would have been a year ago.
These changes make it very difficult for us to
generalize accurately from our small sample
of contacts. But they are equally a problem
for anybody else's sample. None of us who comment
on these matters with legal information really
have a big enough sample size. Of course, my conclusion
could be based on an anomalous
local willingness to invest in applications. Somebody else's could equally
well
be contaminated by local unwillingness to invest in these applications.
Frankly, even if you did have access to all available information,
I'm not sure how much visibility you'd really get.
SAP does keep track of its pipeline, but any rollup
they would do at the highest level simply must have a good
deal of uncertainty to it. The underlying data is
simply too doubtful. They can make a guess, based on
past experience, knowledge of economic trends, etc., but
even if the guess is a good one, events that occur
in the next two weeks could invalidate it.
If the German army deal or
the Microsoft deal (just to name two deals in the news about
which I have zero special knowledge) go the wrong way,
that guess will be so much waste paper.
Economic Jitters and the War
How much will the prospects of war affect applications sales overall?
It seems to me that when war is looming, people's willingness to invest in applications
is probably on a par with their willingness to
invest in stocks. So you should expect some problems.
As one (non-SAP) salesperson said, "My best
deal just got delayed because the company's business went down
10% during the Gulf War. So they're playing it defensive, assuming
that the business will go down again."
Even if the quarter started well (and I think it did), the
emotional climate of
late February and early March have to mean that some projects were
delayed, enough to make it doubtful that the sector will make its numbers.
But remember, not all is black. Certain kinds of projects will not be
affected all that much by
war jitters. Small projects and projects recently budgeted should
still go forward. So should projects in industries that are helped
by the war or in companies that feel the projects are strategic.
Speculative applications deals are less likely, of course, but
how many of those were there anyway?
If this logic is right, then overall, SAP should slightly out-perform
the sector, and so should PeopleSoft. Siebel should be hurting a little
more, and the smaller companies should really hurt. The core SAP
customer base is fundamentally in extension and upgrade mode. These
are the kinds of projects that are most likely to keep their momentum.
They are budgeted for already. They have clear goals. They are deferrable,
as all infrastructure projects are, but deferring a project that
you are in the middle of is significantly harder than deferring
a new project whose value was doubtful in the first place.
Long-Term Issues
I look on SAP as a great big, multi-currency money machine which
the Germans, in the German way, have chosen to operate at well less
than
capacity.
The issues at SAP, in other words, are quite real, but they simply
impede the flow of profit; they don't prevent the stream from flowing.
In no particular order, here are some of these issues:
- Leadership
- We all know that the current leadership is gradually letting go (Hasso went
sailing during the last Sapphire!!). We know, too, that in all empires,
the wars of succession are rarely pretty. SAP politics are complex and
by all accounts terribly consuming for the participants.
- One additional worry I have
is that the layers two levels down from the current leaders are not
terribly strong. As the new leadership emerges and the losers leave
the company, this layer will be asked to do more, and in my experience,
that will be problematic. This was a big problem for i2,
as less than competent people were promoted during the growth spurt based
on length of service with the company, and they (i2) are still suffering
the consequences.
- New Products
- SAP has a tremendous array of new products that ought to be ready
for the marketplace and bringing in new revenue. There's SRM. There
are the x-apps. There is the integration framework. And there are even
more products that have reached some level of maturity, but have not
become accepted standard parts of the product. There's the portal, the
supply chain management suite (only 60 reference customers in the
States), and the CRM suite. These products should all be bringing
value to customers and revenue to SAP faster than they are.
- Long-Term Revenue Accession
- SAP has become the default infrastructure for an enormous number
of very large companies. The challenge for any infrastructure company
is threefold. One, keep the switching cost high. (SAP does this well.)
Two, provide more value-added services. (See previous note.) And three,
while keeping TCO reasonable, take control of as much revenue as possible.
- Here, I've been arguing for some time, SAP has been remiss. In the end
game, SAP ought to be trying to get control over every revenue stream
that's related to their product--services, training, even hardware, as
well as license revenue and extension revenue. They clearly are doing
this some--the web application server, for instance, grabs at hardware revenue.
But they could do more. One advisory board member, for instance, recently
told me that R/3 Enterprise requires a mirror version for the upgrade, a windfall
for hardware manufacturers, a windfall that SAP created but does not share in.
- The Shelf
- It is also the case that SAP sold a lot of seats that are unused, and there is
a lot of depreciation out there for projects that were too expensive. I'm not
necessarily talking about the ridiculous stuff, the $300 million spent without
a line of code going into production, but just the day-to-day impediments that
the past keeps on throwing into SAP's path. I think, for instance,
of the SAP shop that went outside for its CRM recently, because
the original SD implementation was inflexible, and no one in the organization
wanted to try the upgrade.
Our European Correspondent and other members of the advisory board
can add others, all of which are serious. But of course,
at any company, there are always big differences between "is" and "ought."
For SAP, these differences don't show up in any single, dramatic way.
There is no single line item in the income statement that is clearly suspect.
Instead, they show up as ASP's that are a little smaller than they should be,
as wages paid to developers who don't produce the product they should, as a cost
of sales that seems excessive given the current sales processes, etc., etc.
In the long run, it is the weakness in these kinds of numbers and not
whether we go to
war with Iraq that will determine SAP's valuation. If the company remains
as it is, that money machine will still operate at well less than capacity. Fix
the issues, and a market cap of $25 billion will look puny.
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