SAP Sags on Slower Growth

Investors get spooked over weaker-than-expected software license sales as well as worries about competition from archrival Oracle

by Andy Reinhardt

It was a black Friday for German software giant SAP on Jan. 12, as shares dropped 7.5%, to €39.00 ($50.38) in heavy trading on the Frankfurt Stock Exchange. That followed a 10.5% plunge in SAP's U.S.-traded ADRs on Jan. 11, to $48.50, after the company warned that fourth-quarter software license sales grew more slowly than expected.

The shortfall wasn't huge—SAP (SAP) says licenses for its corporate software packages, a leading indicator of future growth, climbed 7%, to €1.26 billion ($1.6 billion) vs. expectations for a 9% rise. All told, revenues for the quarter should come in at €2.95 billion ($3.8 billion), almost precisely what Wall Street was expecting. Operating profits were in line with consensus estimates, while per-share earnings were slightly above forecasts, due to tax effects.

So why were investors spooked? Chalk it up to skittishness about SAP's performance over time—plus concerns over the health of the U.S. IT market and continued questions about the competitive threat posed to SAP by archrival Oracle (ORCL).

Hit by Declining Dollar

This is the second time SAP, based in Walldorf, Germany, has been forced to pre-announce weaker-than-expected results for 2006. Of course, some of the revenue shortfall is due to the falling dollar. In constant currencies, SAP would have reported license sales up 12%. But that doesn't disguise a more serious concern for analysts: SAP's performance in the important U.S. market, where sales grew just 4%, or 15% in constant currency terms.

While that sounds decent, it's the slowest rate in three years. Given a disappointing North American performance in Oracle's November earnings report, "enterprise software stocks could come under pressure near term till there is evidence that U.S. spending can regain footing," Merrill Lynch (MER) says.

No doubt, one of the factors capping revenue growth in the U.S. and elsewhere is fierce price competition from Oracle. "Oracle appears to have been more price-aggressive and is appearing in more bids, forcing a more aggressive pricing stance from SAP," says JPMorgan (JPM) software analyst John Segrich in a report.

Off-Message Marketing?

But it's not just tough prices from Oracle that could be giving SAP trouble. The California maker of databases and corporate applications has spent the last few years bulking up with massive acquisitions and now appears to be taking market share from SAP, according to JMP Securities. What's more, says JMP analyst Patrick Walravens, "SAP's product message has become convoluted." Though the company introduced more than two dozen new packages in 2006, "many customers are confounded by the new applications…and see no compelling reason to upgrade."

Indeed, this is a common theme voiced by software analysts. SAP has spent four years and hundreds of millions of dollars developing an ambitious new set of "middleware" software tools called NetWeaver that are intended to link its applications more flexibly to one another and to products from other companies. The goal is to allow SAP programs to be delivered over a wire as if they were services, such as electricity or a dial tone.

But the massive project risks being at the same time ahead of conservative customers and behind nimbler rivals. "We believe SAP is struggling to adapt to new technologies like service-oriented architectures and on-demand software," says JMP's Walravens, who argues that rivals such as Salesforce.com (CRM) and i2 Technologies (ITWO) are better exploiting those approaches to go after SAP's installed base.

Succession Rumors Circulating

It doesn't help matters that the company has suffered questions about its leadership. For months, unfounded rumors have circulated that CEO Henning Kagermann might retire before his current contract runs out at the end of 2007. But this week, chairman and co-founder Hasso Plattner indicated that he hopes to see the 59-year-old Kagermann stay on at least another year.

Other changes may be afoot in the ranks below. Walravens says that SAP Americas CEO and über-salesman Bill McDermott may move to Germany and assume joint responsibility for global sales operations with longtime SAP exec Léo Apotheker. McDermott, Apotheker, and 38-year-old software whiz Shai Agassi all are seen as potential successors to Kagermann. Some sources paint a picture of a bitter internal power struggle.

Despite these challenges, analysts see SAP as a fundamentally well-run company with strong prospects. Merrill Lynch figures revenues for the year will come in at €9.43 billion, up 10.7%, and should rise another 11.5% in 2007, while already-strong operating margins rise over the next few years by two percentage points to 29.5%.

That's why Merrill analyst Raimo Lenschow thinks investors are overreacting. "The 10% negative slide in SAP's shares in the U.S. seems overdone," he said in a Jan. 12 report. Lenschow has a price target on SAP of €57.50. Somebody was apparently listening: In U.S. trading, SAP shares rose more than 3% the day of his report.

Reinhardt is Europe channel editor for BusinessWeek.com.