In this moderate-growth environment, large software deals continue to close. However, based on comments from software vendors large and small on their June-quarter earnings calls, large deals can be few and far between.
Large deals are also susceptible to delays and disruptions because of long sales cycles and the increasing number of signatures (i.e., approvals) needed to close such transactions. To some companies, a single lost or delayed big-company deal can mean the difference between a great quarter and one that's not so great. To offset this risk and to tap a market that we still see as underserved, software vendors are increasing their attention to the SMB segment, we believe.
DIFFERENT ANIMAL. While we have seen a number of software companies announce initiatives and devote resources to sell to SMB, relative success rates are often difficult to compare on an apples-to-apples basis. This is due to the varying quality and quantity of details and metrics provided by companies that can be used to measure success.
German software maker SAP (SAP
; ranked buy; recent price: $43) provides detailed metrics that have allowed us to gauge its success in tackling the SMB market. SAP has made its name selling back-office accounting and budgeting software called enterprise resource planning (ERP) software, supply-chain automation, and customer-relationship-management software to the biggest companies. It also has a sizable market capitalization of more than $50 billion. SAP is still commonly associated with behemoth software deals that were much more common in the late 1990s than now.
When placed in that context, SAP's evolution and resulting success in selling to SMB is particularly impressive, in our opinion, because selling into this segment is different from selling directly into an enterprise or other large account. For one thing, many more SMB customers exist than the largest companies.
ENGINEERING ADVANTAGE. And while the traditional direct salesforce can be highly effective at selling into a large enterprise, the cost to sell in that manner to millions of potential SMB customers could be prohibitive. To leverage its sales resources efficiently within the SMB segment, a company needs to sell indirectly by developing and relying on strong partners.
We believe SAP has successfully developed a network of partners, evidenced by the 300 new ones it added in the first half of 2005, bringing it to 1,600 partners. Over this same period, the volume of deals grew 23%, with overall growth from indirect sales (sales coming from partners, which we are using as a proxy for SMB sales) outpacing direct license-sales growth. In addition, SAP added 2,400 SMB customers during the first half of 2005, to make a total of 13,700 SMB customers as of June 30. The rising volume of smaller deals has also resulted in overall first-half license-revenue growth of 17% (at constant currency), beating the 4% to 6% average growth rate we forecast for software companies.
Aside from SAP's success with SMB and its ability to lower its reliance on megadeals, SAP also stands out from the pack, in our opinion, because its above-average license growth has been primarily organic, vs. acquired. We don't frown on acquisitions, especially if the price paid is reasonable and the strategic rationale has merit. However, we have a favorable view of SAP's strong in-house engineering talent.
SOME RISKS. For these reasons, we have a buy recommendation on the ADRs of SAP AG and a 12-month target price of $52. Our recommendation is based primarily on our analysis of enterprise value-to-sales and forward p-e-to-growth metrics, which we expect will trend to the high end of the three-year historical range for the ADRs. We think this is warranted by our view of the company's superior organic growth, solid execution, and growing market share.
Risks to our opinion and target price include a rapidly changing technology landscape, a prolonged period of weakening in the U.S. dollar, and intense price competition in the software industry. Other risks include a significant downturn in corporate spending on enterprise software and ongoing weakness in the major European markets including Britain, France, and Germany.
In the U.S.
As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 30.2% of issuers with buy recommendations, 57.5% with hold recommendations, and 12.3% with sell recommendations.
As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 34.4% of issuers with buy recommendations, 46.8% with hold recommendations, and 18.8% with sell recommendations.
As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 33.3% of issuers with buy recommendations, 47.2% with hold recommendations, and 19.5% with sell recommendations.
As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 31.0% of issuers with buy recommendations, 55.4% with hold recommendations, and 13.6% with sell recommendations.
5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.
Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index, in Asia the S&P Asia 50 Index, and in Malaysia the KLCI or KL Emas Index.
For All Regions:
All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.
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