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Ambitious strategy could spark complete rethink of German firm’s valuation
Thursday 21 Oct 2021 Author: Steven Frazer

We believe German software giant SAP’s ambitious cloud computing strategy is working and while stock market investors have been slow to give credit, this will change. Cloud revenue is growing increasingly fast – up from 11% in the second quarter Q2 (to 30 June) to 20% in Q3, the company has already said.

Investors will get more detail today (21 Oct), when full Q3 results are reported, but we have already had the company’s first glance at the numbers (12 October), when SAP upped full year to 31 December revenue and profit on the back of a 24% jump in order backlog. Some of its cloud products are powering even faster forward, with its analytics platform HANA posting a 60% backlog surge.

SAP has been providing critical business applications for decades, mainly to an army of small and medium-sized enterprises (about 80% of sales). Its vast enterprise resource planning suite are tools without which businesses simply could not run. They cover areas such as supply chain management, human resources, customer experience management and analysis, spend intelligence, machine learning-based analytics, and more. There’s also a €4 billion venture capital arm called Sapphire Ventures.

SAP has embraced the cloud for years but in 2020 it went all-in, unveiling a strategy to migrate its thousands of business clients. The company wants €22 billion cloud revenues by 2025, more than double the €9.3 billion to €9.5 billion raised 2021 guidance.

The long-run cost, distribution and efficiency benefits are too attractive for clients to dig their heels in. While the switch may depress SAP’s overall revenues and margins in the short-term, the long-run pay-off is increasingly ‘sticky’ subscription revenues from a cheaper, more flexible platform for users, plus a lower cost of distributing new tools, updates and enhancements.

This is a great opportunity to buy a global software giant trading a vast discount to other fast-growing cloud specialists. US rivals, Workday and ServiceNow trade on an average 20-times 2025 revenue.

Apply the same multiple to SAP’s targeted €22 billion of cloud sales, and that division alone should be worth more than €440 billion, including net debt, roughly three-times SAP’s current enterprise value.

Put it another way,, Workday and ServiceNow trade on premium valuations to SAP despite having none of its profit and cash flow power. SAP currently trades on a price to earnings multiple of about 25, with operating profit margins of more than 22% and €4.5 billion of free cash flow expected this year.

ServiceNow and Salesforce trade on triple-digit ratings and low single-digit operating margins. Workday isn’t even profitable yet.

SAP stock should be easily accessible on any decent investment platform, with both German and New York Stock Exchange-listed options available.

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