Just relax, Europe's tech leader SAP tells investors

The German software maker, SAP, is in the midst of a transition to offering cloud-based services to business customers, and management had flagged that 2017 would see a trough in profit margins as it invested in datacenters and redeployed staff.

CEO Bill McDermott said SAP was seeing more customers using its new cloud-based S/4HANA business planning products to overhaul their organisations and supply chains. Such large-scale deals tend to close in the fourth quarter.

“You can expect a dynamite Q4,” McDermott told investors on a conference call. “Don’t worry about bookings, relax, it’s going to be terrific,” he said, added that SAP would report “at least 30% year-over-year cloud bookings growth”.

The company, the biggest component of Germany’s blue-chip DAX index, has a market value of €116.5 billion ($138 billion).

Third-quarter revenue for the business planning software provider grew 8% to €5.59 billion ($6.6 billion) from a year earlier, falling short of the mean forecast of 5.71 billion from 16 analysts surveyed by Reuters.

Core profit excluding special items rose by 4% to €1.64 billion at constant currency rates, below the 1.69 billion expected.

The euro’s strength sliced 4 percentage points off core profit, which was flat after taking currency moves into account. Analysts at Baader Helvea said they expected currency headwinds to continue for the next three quarters. The company nudged up guidance for full-year core operating profit to between €6.85 and 7.0 billion and said 2017 total revenue would range from 23.4 to 23.8 billion, marking year-to-year growth around 6 to 8%, excluding currency effects.

In the cloud

Cloud subscriptions and support revenue rose 27% in the quarter to €938 million, excluding currency effects, compared with the 29% analysts had expected, on average.

This was offset by its classic software license and support business revenue, which rose 4% to €3.72 billion, slightly above the 2.2% growth rate expected.

Chief Financial Officer Luka Mucic said the slowdown in new orders growth in the last quarter had coincided with accelerated investments in the cloud business.

As this spending rolls off, an improvement in margins will start to shine through in the current quarter, setting the scene for “exponential” growth in gross margins thereafter, he said. The number of S/4HANA customers rose 70%, year-on-year, of which 40% were net new customers, SAP said.

The platform drives SAP’s core product offering - delivered via the internet or on-site - but its human resources, travel management and business-to-business marketplace products are still being integrated into it.

Competitors such as Salesforce.com, Workday and Amazon.com’s web services unit offer cloud-only services, challenging the legacy businesses of SAP and its long-time rival Oracle. The key question for investors is whether a tipping point is at hand for SAP to return to delivering consistent growth in profit margins late this year or during 2018.

That would reverse five years of declining growth in core profit margins as the company spent heavily to shift its business into the cloud, instead of relying on traditional software license sales for its suite of business planning tools. SAP management has signalled that its rapid employee expansion since 2015 should slow in coming quarters as its cloud -focused hiring spree runs its course.