SAP Earnings Software Licenses Decline But Cloud And HANA Lend Support

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After posting strong growth for the last thirteen quarters, SAP AG (NYSE:SAP) reported mixed Q2 earnings as revenue growth slowed down to 4%. [1] Total revenues clocked €4.09 billion, slightly below the market expectations. A decline in software licenses for the first time in the last three years weighed on growth as Asian companies reduced spending on software amid Chinese growth concerns. The growth in new software licenses is the key to measuring future growth as it allows for recurring revenues from the high margin maintenance and support business. However, non-IFRS support revenue increased by double digits. Further, the cloud and SAP HANA business also continued to do well and offset some of the pressure.

Operating margins (after adjusting for one-time items) declined marginally primarily due to unfavorable foreign currency movements. However, on a constant currency basis, operating margins improved due to improved efficiency and higher contributions from the support and cloud businesses. Non-IFRS operating income rose 3.9% to €1.22 billion. [2] Below we take a look at key trends observed during the earnings.

Check out our complete analysis for SAP

Software Business Disappoints, Operating Margins Improve

In Q2, overall Software and Software-Related Service units revenue grew to €3.35 billion, a 10% y-o-y jump on a constant currency basis. However, this came in lower than SAP’s initial expectations of 14%-20% growth. [3] This was mainly due to a slowdown in its core software business with Asia going through a tough time. China is seeing a slowdown in growth and this has had an impact on many export oriented Asian countries like Australia and Japan. However, we believe a part of this decline is likely due to cannibalization from its own cloud offerings. Since the company has moved its focus on transition to the cloud, this may have eaten into SAP’s traditional on-premise CRM and HCM businesses. SAP is making more of its software available through cloud and therefore, cannibalization is likely to accelerate going forward with more companies opting for cloud services.

What comes as a good sign is that SAP did well in the U.S. and EMEA markets despite overall weakness in the European markets. While its largest competitor Oracle saw a decline in revenues from Europe in Q4 results (the quarter ending on May has historically been one of the strongest quarter for Oracle), SAP registered a 3% growth, which implies it increased its overall market share (Read our note Oracle Doubles Dividend, Steps Up Buyback As Software Sales Disappoint). The company is confident of putting the software business on the growth track in the second half of the year and has set a target of 10% overall growth, despite a 3% decline in the first half. Revenue from software maintenance continued to grow at mid-single digits as the existing clients continued to pay recurring fees for software support and updates.

HANA Likely To Witness Higher Growth In The Second Half, Cloud Business Picking Up

SAP seems to be riding the Big Data trend comfortably as SAP HANA revenue increased by 21% to €102 million. The SAP HANA platform and solutions from Sybase help organizations unlock the business value of ‘Big Data’ by enabling them to access and deliver information faster than before with real-time insights. The company now has over 2,500 customers including small companies using the platform. While the growth in Q2 was a little lower than previous quarters, the second half of the year is expected to see higher growth. Business Suite on HANA was released in May and will drive growth going forward. SAP continues to see revenue from HANA doubling to €650 to €750 million in 2013.

SAP’s cloud business is showing promise with revenues from the cloud shooting 170% higher on a constant currency basis. Revenues got a major boost from its acquisition of Ariba last year. However, even after excluding Ariba business, the cloud business saw double digit growth. Its cloud run rate reached $1 billion during the quarter with approximately 30 million users in the cloud, which represents one of the largest subscriber bases in the cloud market. The pace of growth is expected to increase with SAP unveiling a line of cloud-based applications that run on top of the HANA platform. Many big clients like Florida Crystals have already started to use HANA enterprise cloud to run the SAP Business Suite. The company is targeting to double its cloud computing revenues in 2013 to €750 million and looks set to reach €2 billion cloud business in the long run.

Overall, overall gross margins increased to 72.9% as the revenue share of high margin software maintenance and cloud business increased during the quarter. The higher gross profit lifted operating margins despite the rapid increase in sales & marketing and R&D costs. Sales and marketing costs as % of revenues increased to about 25% from around 23.5% as SAP added an additional 800 employees during the quarter. The company is investing heavily in its sales efforts to boost its cloud business and gain momentum through new contracts and strategic partnerships. This should help the company maintain high growth rate despite ongoing turbulent in the software industry.

We are in process of revising our $74 Trefis price estimate for SAP to reflect recent industry trends and Q2 results.

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Notes:
  1. SAP Announces Second Quarter and First Half Results 2013, SAP, July 18 2013 []
  2. SAP AG Management Discusses Q2 2013 Results – Earnings Call Transcript, Seeking Alpha, July 18, 2013 []
  3. Oracle’s CEO Discusses F3Q13 Results – Earnings Call Transcript, Seeking Alpha, March 20 2013 []
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