SAP reported Q1 quarter financial performance this week, but the most significant headlines related to the likely possibility of continued corporate restructuring along with an equity stake investment taken by a noted activist investor. How one can interpret this week’s reports is dependent of whether you are an SAP investor or customer.  SAP

Q1 Financial Performance

SAP reported that total revenues exceeded € 6 billion, up 16 percent. Of that number, Cloud and software revenues were up 17 percent to just over € 5 billion. Cloud based subscription revenues were reported as € 1.6 billion, up 45 percent year-over year with gross margin increasing three percentage points.

Beyond revenue and margin, the company reported an operating loss of € 136 million compared to an operating profit of € 1.025 million in the year-over-year quarter. The loss was attributed to the previously declared cost of 2019 restructuring (€ 886 million) and higher than expected acquisition-related charges and share-based compensation primarily due to the prior announced acquisition of Qualtrics.

In January’s financial performance report of Q4-2018  and full year financial performance, where the Qualtrics acquisition was touted, CEO Bill McDermott declared that: “we are building a company that is a fighting machine,” and later added: “We are ready to go against any dotcom in America and win.”

The enterprise software company took the opportunity to declare Ambition 2023, a rather aggressive effort defined as tripling Cloud subscription and support revenues and growing total revenues to more than € 36 billion, with gross margins upwards of 78 percent. Further included is the stated goal of a dividend payout ratio of 40 percent or more of the prior year’s profit after tax.

 

Enter the Activist

In conjunction with this week’s financial reporting, SAP disclosed that activist investing firm Elliott Management has taken a € 1.2 billion stake in the company.

According to a published report from the Financial Times, Elliott has built a reputation as a hardball activist, showing a willingness to engage in protracted legal fights in order to push through changes for increased short-term shareholder returns. The firm’s latest battle involved a stake in eBay and a demand that the company break itself apart.

The FT report points to building shareholder disappointment in SAP’s profitability track record and its share price underperforming.

In the briefing call to investors and in the accompanying press release, CEO Bill McDermott amplified on a best-run SAP as driving significant margin expansion and extending the company’s commitment to mid-term improvements and stronger shareholder returns. The CEO once again hinted to added corporate restructuring, stating that: “Companies don’t become great by the number of people that work for them.”

He went to state that new recruits to the company will either code software or will be on the front lines with customers and directly addressed eliminating future middle layers of management, later indicating: “We’re going to expand the margins in this company and run a profitability machine.

On Wednesday, SAP unveiled a number of new corporate-wide initiatives including the formation of a special Executive Board committee to oversee an operational review of the company, with a report expected in November of this year.

 

Supply Chain Matters Perspective

To our knowledge, this may be the first time that a noted aggressive activist investor has targeted a large-scale, globally focused technology provider, at least in a publicly visible sense. What that implies is likely dependent on one’s frame of reference.

If you are an SAP shareholder or another activist, the news is likely perceived as positive. SAP shares rose 10 percent on the first day after the quarterly financial performance briefings and the news of the Elliott investment. Then again, with close scrutiny, with the implied de-emphasis on large acquisitions of Cloud based providers to accelerate annual subscription revenues, the goals of Ambition 2020 can become somewhat messy. SAP’s overall headcount may well be overloaded in certain overhead areas.

There is speculation from industry observers, and we included, that SAP’s multi-billion acquisition spree over the past five years masked the lack of internally generated product innovation. The HANA database initiative was not core to SAP’s market strengths, has confused customers and delayed added internal innovation.

If you are an SAP customer, close follower or employee, the news is somewhat concerning. In its commentary this week, ZDnet reminded readers that: “..companies that start to focus predominantly on shareholder value often short change innovation, research and development and customers.

Supply Chain Matters echoes those same concerns. One signpost would be the 3G Capital orchestrated acquisition of Kraft Heinz that promised significant short-term shareholder benefits that has since been exposed as a huge corporate misstep resulting in the and utter destruction of two iconic brands and the need to write-off over $15 billion.

Add the dimension of an ongoing highly competitive enterprise software market where innovation and timely quarterly innovation cycles lead, thus placing a higher priority on innovation and growth as contrasted with stockholder dividends.

Then there is the frame of reference of SAP’s existing or future B2B direct procurement, product lifecycle and supply chain management applications technology support.  With latest big bet placed on Qualtrics as the termed CRM and Salesforce.com killer, if it really is, brings into question SAP’s continuing commitment to supply chain applications or digital transformation focused innovation.

These are all lingering questions that SAP had better address, and soon.

 

 

Bob Ferrari

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