Is The Market Pricing SAP Fairly?

Software giant SAP (NYSE:SAP) has performed strongly over the past couple of years, with a nearly 11% annual growth in revenue. While revenue growth was seen across segments, SAP’s Cloud business, aided by a strong increase in new bookings, was the standout performer. The company continued its dominance in the Enterprise Resource Planning (ERP) software market, with more than over 7,900 customers adopting its S/4HANA platform since inception in 2015. This should assuage some investor concerns about the long-term value of the platform. Moreover, with 80% of its customers still using the older platform and expected to shift to the newer one in the near future, there is tremendous potential which the company expects to tap. Our price estimate of $107 suggests that the market is pricing SAP, 3% below our estimate.

We have also created an interactive dashboard which shows our forecasts and estimates for the company; you can modify the key value drivers to see how they impact the company’s revenues, bottom line, and valuation.

Steps To Arrive At Our Price Estimate

SAP generates revenue from two segments: Cloud and Software revenue, and Services revenue. We expect SAP’s Cloud and Software revenue to hit $25.2 billion in 2018. As more and more companies adopt cloud services, the overall cloud market has been expanding at a rapid rate. Aided by a phenomenal increase in new cloud bookings, SAP’s revenue from Cloud Support and Services grew 34% annually in between 2015-2017. SAP is also rapidly expanding its presence in the Internet of Things (IoT) space with new products and partnerships. This is a multi-billion dollar market which could help drive the next phase of SAP’s Cloud revenue growth. We expect it to reach around $5.2 billion in 2018. The recent addition of multiple Internet of Things (IoT) solutions to the SAP Leonardo digital innovation system highlights SAP’s renewed focus on bolstering its foothold in the IoT domain, which could drive the company’s top line in the future. Combined with its ongoing efforts to strengthen its offerings in the machine learning space, SAP is likely to fare well going forward despite the heavy competition. Software revenue is likely to be around $25.2 billion in 2018.

Further, we expect Services revenue of around $4.9 billion. As more customers adopt SAP’s products, it should lead to more demand for professional services such as the implementation of cloud and on-premise software, premium support, messaging and payment services.

We expect cloud margins to continue declining in the near term, as the company faces tough competition from software behemoths like Microsoft, Oracle, and Salesforce. However, growth in software and services margin should be able to offset the decline from cloud. Consequently, we expect restricted growth in the overall net margin to around 17.3% in 2018.

A revenue estimate of $30 billion results in Net income of $5.2 billion. Given the average share count of 1.2 billion, this gives us Earnings per share of $4.32. We expect SAP’s trailing twelve-month P/E multiple to be around 24.9 at the end of 2018, which when multiplied with expected Earnings per share, gives us $107.40 as a fair price estimate.

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