Currency Tailwinds Expected to Lift SAP’s Q2 Results, But Tough Times Lie Ahead?

-20.98%
Downside
195
Market
154
Trefis
SAP: SAP logo
SAP
SAP

European software giant SAP SE (NYSE:SAP) is set to report its fiscal 2015 second quarter earnings on July 21st. [1] The company reported strong first quarter results, in which rapid cloud growth was buoyed by favorable foreign exchange movements. [2] We expect this trend to continue in the second quarter as the traction in cloud bookings is likely to continue in the near term. However, cloud computing major Salesforce.com (NYSE:CRM) recently announced plans to expand in Germany, bringing the fight to SAP’s home ground. [3] Consequently, investors will be keenly looking for answers on how SAP plans to counter Salesforce’s aggressive expansion in the region.

In the first quarter, SAP heavily benefited from favorable currency movements, which pushed its year on year revenue growth to 20%. Non-IFRS cloud revenue as well as bookings shot up by triple digits, indicating rapid and sustained adoption of SAP’s cloud computing services. (Read: Currency Tailwinds and Cloud Business Lift SAP’s Q1 Results) On the other hand, the non-IFRS operating margin contracted slightly by 140 basis points due to the transition from the legacy on-premise software business model to a cloud computing model.

We expect SAP’s cloud computing business to continue to grow in the second quarter, since the triple-digit growth in bookings in the first quarter suggests that SAP’s cloud products are gaining traction. Further, the company expects currency movements to provide a tailwind of 10 to 13 percentage points on revenue as well as operating profit growth. [2] Consensus estimates place revenue growth at 18% year on year in the second quarter, while non-IFRS EPS is expected to expand by about 9%.

Relevant Articles
  1. Flush With Cash Following Qualtrics Deal, Is SAP Stock A Buy?
  2. With Enterprise Spending Slowing, Is SAP Stock Still A Good Buy?
  3. Up 29% Over The Past Month, What’s Next For SAP Stock?
  4. Where Is SAP Stock Headed Following Q2 Results?
  5. Forecast Of The Day: SAP’s Cloud Subscriptions And Support Revenue
  6. SAP’s Q1 Results Were Mixed, But The Stock Still Looks Like A Buy

Our price estimate of $80 for SAP SE is about 10% higher than its current market price.

See our complete analysis for SAP SE here

SAP Needs a Plan of Action to Check Salesforce’s Expansion in Europe

Salesforce’s breakneck pace of growth in its cloud business seems to have plateaued (Read: Salesforce Posts Robust Q1 Results, Raises Fiscal 2016 Guidance), forcing the company to look for new avenues to maintain a growth rate acceptable to investors. Hence, Salesforce has now turned its sights to Europe and plans to pour $1 billion over the next five years into Germany. [3] Considering the size of Salesforce’s operation, its latest move is bound to have major ramifications for the European software industry. It is worth noting that Salesforce’s latest move comes soon after opening a new data center in France, [4] which further reinforces the belief that the company has got major plans for Europe.

The importance of Europe for SAP cannot be understated. The fact that SAP derives 12% of its total revenues from Germany alone underscores the importance of the country for the European vendor. The EMEA region (Europe, Middle East and Africa) accounts for over 40% of SAP’s revenues. [2] Therefore, investors will be keenly looking for answers in the earnings call on how SAP plans to protect its turf from Salesforce’s expansion plans.

Software Support Revenue and Operating Margin May Suffer Due to SAP’s Push Into Cloud

While SAP’s revenues from cloud have growth at triple-digit rates over the last few quarters, Software Support still accounts for more than half of the company’s total revenues. Revenues from software support are derived by providing software updates and customer-specific support services to clients. This revenue stream is present only in the legacy on-premise software business model. In the cloud model, software support and update services are replaced with an annual subscription fee for accessing the cloud services. As a result, an increase in the proportion of revenues from cloud may cause growth in software support revenues to slow down. While this phenomenon is unlikely to play out in the second quarter, it remains a matter of concern for SAP’s long term growth.

Similarly, the shift to a cloud business model causes a modest decline in operating margins during the transition period. Unlike the slowdown in software support revenue, this phenomenon is already in play, as is evident in SAP’s first quarter results. (Read: Currency Tailwinds and Cloud Business Lift SAP’s Q1 Results) In the on-premise business model, most revenues from a new contract are booked upfront. On the other hand, in a cloud model, revenues from a new contract are spread out over the life of the contract. Consequently, while all expenses incurred in acquiring a new customer are booked immediately, the corresponding incremental revenues are recorded over a number of years. This disparity causes a decline in margins during the transition period. Consequently, we expect operating margin expansion to remain muted or negative in the second quarter, excluding the impact of currency movements.

More Trefis Research

Notes:
  1. SAP Investor Relations []
  2. SAP SE 2015 First Quarter SEC Filing, April 21, 2015 [] [] []
  3. Salesforce’s Benioff Says SAP Rebuffed His ‘Olive Branch’, Bloomberg, July 2, 2015 [] []
  4. Salesforce Press Release, June 25, 2015 []