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SAP Q3 earnings tumble in wake of pandemic economic woes

SAP's stock value sank as third-quarter earnings disappointed investors, but analysts believe the short-term pain does not reflect SAP's long-term prospects as it more fully commits to the cloud.

SAP earnings took a major hit in its third quarter of 2020, resulting in a significant drop in the company's stock value.

The news shook investors, but the long-term prospects for SAP appear to be fundamentally strong as it emphasized its commitment to transitioning to the cloud.

SAP reported earnings of €6.535 billion for Q3 2020, a 4% drop from the same period in 2019. Investors were not pleased with the results, and the company's share price fell about 20% on Monday, or around €28 billion in market value.

On the bright side, SAP reported that cloud revenue increased by 11% and that SAP S/4HANA momentum continues. SAP added 500 more S/4HANA customers in Q3 2020, for a total of 15,100 customers. The company reported that about 8,100 of these deployments are currently live.

Christian KleinChristian Klein

SAP's future strategy centers primarily on becoming a cloud-first company. The focus is largely driven by the ongoing COVID-19 pandemic and how businesses need to respond to those challenges, said SAP CEO Christian Klein in an Oct. 26 earnings call. However, Klein did not provide specific details on how SAP planned to execute the cloud strategy.

"Our updated strategy is in response to the fundamental changes in the market caught on by the COVID-19 pandemic," Klein said. "COVID-19 is an inflection point for our customers. Many enterprises have real issues to produce, sell and deliver a product in times of country lockdowns and people working from home."

To do this, SAP needs to establish itself as "a leading cloud platform company," Klein said.

"We have always been the leading on-premises application platform, and thousands of partners and customers have built applications and extensions on SAP for almost 50 years," he said. "Our intention is to repeat that for the cloud, to position SAP as the leading cloud platform, to transform and change the way enterprises work in the digital age."

Concur losses understandable

The financial results were concerning for SAP, but not as dire when the results were broken out more fully, said analyst Andrew Bartels, vice president at Forrester Research.

"License revenues were down, which was a disappointment, but maintenance revenues held up fairly well," Bartels said. "If you dig deeper, one of the negatives on their cloud revenue was that Concur was down significantly, which is not surprising because Concur's revenues are directly linked to [travel and expense] spending, which is in the toilet."

We've been waiting for the shoe to drop, and it finally did.
Joshua GreenbaumPrincipal, Enterprise Applications Consulting

Revenues from SAP's other "intelligent spend" cloud business -- including the SAP Ariba Network, a B2B commerce and procurement platform, and SAP Fieldglass, a contingent workforce management platform -- held up fairly well, Bartels said.

Joshua GreenbaumJoshua Greenbaum

While the SAP earnings drop and stock devaluation was significant, it wasn't a huge surprise, said analyst Joshua Greenbaum, principal at Enterprise Applications Consulting.

"We've been waiting for the shoe to drop, and it finally did," Greenbaum said. "This is indicative of the ADHD nature of the markets, which is unfortunate because it diverts from the real issue which is, how an enterprise software company delivers value to its customers, not how it delivers quarterly results to its investors."

SAP's issues in becoming a cloud-first company are much more complex than those faced by its cloud-native competitors, he explained.

"SAP has to transition a customer base that Salesforce or Workday don't have to, so this is more about the shortsightedness of the financial community than an understanding of long-term strategy," Greenbaum said. "SAP is definitely pulling the cloud strategy together and the continued growth of S/4HANA licenses in the installed base bodes well for SAP's continued relevance."

Predrag JakovljevicPredrag Jakovljevic

SAP's method of reporting revenue was punished by investors but it should begin to even out going forward, said Predrag Jakovljevic, principal industry analyst at Technology Evaluation Centers, an enterprise applications analysis firm in Montreal.

"A vendor who has candidly committed to the cloud gets cut slack by Wall Street for less than sterling revenues, as long as cloud revenue does OK," he said. "For example, PTC started doing subscriptions accounting in 2015 even if many of its products are not yet cloud. SAP is just beginning on that positioning path. After a couple of cycles, Wall Street will be trained to look at cloud revenue."

SAP's relatively inexperienced executive management team and poor communication with investors, such as not signaling the poor results before the official reporting, along with the COVID-19 headwinds faced by Concur, likely contributed to the investors' reaction, he said.

Short-term pain, long-term prospects

SAP's signaled full commitment to being a cloud-first company is long overdue, but there are understandable reasons why it has continued to follow an on-premises license revenue model, said Trevor White, analyst at Nucleus Research.

Trevor WhiteTrevor White

"SAP is really one of the last holdouts of the big tech companies to accept that cloud was the future," White said. "However, part of SAP's delay is that they have a very large, traditional supply chain-oriented customer base, and those folks, for whatever reason, tend to be the most nervous to move. But the pandemic is dragging everyone, SAP included, into a full cloud future."

The short-term hit on the stock value is painful, but SAP has the depth of technology expertise and a diverse product portfolio that should help it remain viable in the enterprise market, he said.

"[The cloud focus] is going to be beneficial for SAP and their customers in the long run; but certainly in the short run, there is going to be a hardship on their stock price," he said. "Coming from the more tech side of it, I'm not as worried about their fundamental business or the quality of their products."

The cloud isn't for everyone

The shift to becoming a cloud-first company needs to be taken with several caveats, Bartels said, most prominently that it doesn't always make sense for SAP to stop offering licensed on-premises software.

"The shift to cloud is much more pronounced in the U.S. than it is elsewhere," he said. "There's still a lot of demand for the type of on-premises systems that SAP offers in emerging markets where the cloud infrastructure is simply not there. So there's actually no advantage for SAP to get out of that business when the market for cloud in those countries is very immature and the demand for on-premises is still relatively strong."

This kind of long-term and more expansive strategic thinking on the cloud and enterprise applications doesn't always get accounted for by investors, Bartels said.

"SAP may want to state the necessity of moving to the cloud because it seems like from the perspective of investors that they like cloud revenues better than license, so maybe they'll give us a better [price-to-earnings] ratio, but that's financial engineering," he said. "Fundamentally, the investors in that case are being somewhat myopic in thinking that everything should be in the cloud, when the reality is, there's a lot of stuff that makes no sense to move to the cloud, and investors who don't get that are just lost in the 'everything's got to be in the cloud' model."

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