SAP SE (SAP)

by | Dec 30, 2021 | Companies, Episodes | 0 comments

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SAP Headquarters.  Image Source: ArchDaily

History of SAP

  • American company International Business Machines (IBM) was approached in the early 1970s by Xerox, another large technology company.  Xerox was trying to get out of the hardware business and wanted to use business systems that were developed by IBM.
  • As part of the deal, IBM got access to software made by another American company called Scientific Data Systems.  
  • Five IBM engineers working in Germany started working on enterprise wide software that was based on SDS’s software, in order to create a solution.
  • Unfortunately during development, these five engineers were told by their bosses at IBM to stop working on the project, as the work was being transferred to another part of the company.
  • Instead of giving up on the project, these five engineers felt like they were on to something, so they left IBM, forming what would become SAP.  They founded the business as a private partnership in Mannheim, Germany in 1972.
  • Slowly but surely they developed software capable of supporting the early digital infrastructure of businesses in their area.  They didn’t take bank financing, venture capital financing, or government assistance, but gradually built up the business from operating cash flow.
  • Though they started out with smaller regional companies as clients, they eventually gained enough expertise and notoriety that they attracted large German multinational companies as clients, such as BMW and Siemens.
  • The idea of selling “all in one” business software was relatively new at this time.  So far, the software companies that did exist created software for specific tasks, and there was no guarantee that one company’s software could work well in the contexts of another company’s software.  SAP’s unique proposition was that they could create integrated workplace software for a variety of tasks – manufacturing, accounting, human resources, etc. which would be advantageous to the client.
  • By 1978 SAP had 40 companies as clients.  In time they developed the “R/2” suite of software solutions.  A decade later in 1988 SAP became publicly traded on the German stock market.
  • By the early 1990s, SAP could count 80 of the largest 100 companies in Germany as clients.  They expanded internationally and began selling to companies in other countries, such as the U.S.  SAP America became the company’s fastest growing subsidiary in the mid-90s.
  • Companies did not want to fall behind with their technology infrastructure, so if one company adopted SAP’s systems, their competitors were likely to follow just to stay relevant.
  • Throughout the 1990s SAP released their “R/3” system, which relied on networks of clients and servers instead of mainframes.  Mainframes were large centralized computer processing stations.  But with the growth of personal computers (PCs) and servers, software was now linked in a more de-centralized structure.  By this point nine out of ten large U.S. companies were using SAP’s systems.
  • Outside of the U.S., SAP began to expand aggressively in other markets.  They made their software available in 14 languages, and set up subsidiaries in places like South Africa, Malaysia, Japan, China, Mexico, Russia, etc.
  • These products were not cheap, and because big companies had the money and wanted to stay at the forefront of the technological boom, they were willing to buy $100,000 for a single module (keep in mind this is in 1990’s dollars), and well above $1,000,000 for a complete installation.  Some installations cost eight figures.
  • This was successful for a while but the world continued to evolve and competitors began to emerge that were hungry for market share.  The most formidable of SAP’s opponents were Oracle from the U.S. and Baan from the Netherlands.  Baan even won a contract from Siemens, which was in SAP’s backyard.  The installation time required for R/3 and the significant cost started to weigh on customers, and these other companies saw it as an opportunity.
  • SAP was however, able to remain successful.  They continued to invest a significant amount of their revenue into research and development (at times over 25%) and enabled their R/3 product to be accessible via the Internet relatively early in the growth of the technology.  This meant that customers could purchase things online and the purchase would immediately register in the company’s SAP installed system.
  • SAP also had a big win in the 1990s through partnerships with various tech giants.  For example, they partnered with Microsoft and made their software able to integrate with Microsoft’s operating and database systems.  Microsoft also became a customer and used SAP for their finance and accounting data.
  • Going forward in time, SAP continued to upgrade their offerings and continue technology research.  In 2014 they changed legal structures and became SAP SE.  SE stands for societas Europaea, which in English translates to “European Society”.  This is the form of company that a lot of large European companies take – it is a particular legal structure that allows companies to operate more freely within the European Union.
  • Around this time the company began making significant acquisitions of companies that operate in the cloud business.  This included the acquisition of Concur (cloud-based travel and expense software) for over $8 billion.  I’ve used Concur and it’s a solid platform.
  • They also acquired a company called Qualtrics in 2018 for around $8 billion as well.  This was an acquisition I found interesting because of the eye-popping growth of this subsidiary – from the most recent half-year report this cloud platform grew revenue by over 50% in a single year.  Well get more into the numbers in a moment.

 

Business Overview

  • At a basic level, what does SAP do?  They are a business that creates enterprise application software.  Essentially, they make software solutions for businesses – both internal businesses processes as well as for interactions with customers (this is called experience management).
  • I know this is a broad definition, but it truly describes SAP because what they are able to do is indeed very broad.  SAP states that their goal is to use technology to equip enterprises around the world with the intelligence they need to serve their customers and employees better.  They help gather, analyze, and communicate data so that companies can take intelligent action.
  • SAP is a huge company – they are the largest company in the DAX, which is a blue chip index of German companies.  It is the largest company traded on the Frankfurt Stock Exchange.  They have over 100,000 employees with over 425,000 customers in over 180 countries.  Over 27,000 of those employees work in R&D.  I do not think it is an exaggeration to say that they are one of the key businesses that enables other businesses to run the world.
  • SAP intention is to inject artificial intelligence and machine learning into every business process and every facet of their software.  If you’re unfamiliar with these terms, this means that computer programs can grow and adapt on their own without being manually programmed by an engineer.  It is a life-changing paradigm that is already altering the way that technology works.
  • SAP’s flagship product is called SAP HANA, like it’s predecessors, it is a platform meant to accommodate a wide range of business needs.  This includes: human resources, sales, service, procurement, manufacturing, asset management, and research and development.  Around 14,000 customers use this product as of 2019 data.
  • With the Qualtrics acquisition, they have also expanded into experience management.  Think of experience management like this.  Traditionally, companies gather data related to their operations (called O-data).  This tells you what is going on, but it doesn’t tell you why.  It is up to humans to interpret this data and then make decisions.  Experience data, or X-data, is meant to fill that gap and help determine the why, by using AI and machine learning.  Qualtrics was built around creating complex surveys using algorithms, and focuses on this “experience” data.
    • For example, imagine you go to a local retail store and inquire about a particular shirt you’d like to buy.  You talk with a salesperson, browse a few items, and then ultimately purchase something and leave the store.  Let’s think about all the touchpoints that that company could theoretically have with you before, during and after your purchase.
    • Before: Before you even walk in the door the company may have advertised to you.  If this was the case this probably took the form of a digital ad, on your smartphone, based on other data sets that have been used to track your interests, desires, and historical behavior.
    • During: When you enter the store, what time of day is it?  What day of the week is it?  What season is it?  When you enter the store, where do you walk within the physical space?  How much time is there between when you enter and when you talk with a salesperson?  Much time is there between that conversation and your ultimate decision to purchase an item?
    • After: After you leave, your credit card information is now tracked.  Perhaps you get a thank you email from the store with a follow-up survey.  Maybe you own an Apple Watch and now get a one-question survey on your screen about how satisfied you are with your purchase.
  • The point is, the nature and frequency of data touchpoints are evolving rapidly, and companies like SAP are diving headfirst into this new world by enabling other businesses with these capabilities.
  • There are four business segments: Cloud, Software Licenses, Software Support, and Services.  Software Support is the biggest revenue driver, followed by Cloud.  Cloud is the fastest growing segment.  Software License revenue has been falling, but that has been replaced by the cloud.  Software licenses used to be the primary businesses model for software, but now recurring revenue is king.  Take a look at other software businesses that have been switching to this model, such as Adobe, which we covered in episode 58.
  • Software licensing is considered to be a “product” where-as cloud-based services are considered to be services (SaaS).
  • Cloud revenue has gone from 15% of total revenue in 2015 to 37% of revenue in 2019, which is a big transformation.
  • Geographically, revenue sources are well diversified.  41% comes from the Americas, 44% from Europe, and 15% comes from Asia/Oceania – primarily Australia, China, and Japan.

Financials

 

2012

2019

CAGR (%) / Comments

Sales

16.3

27.5

7.7%

Net Income

2.8

3.3

2.3% 

Earnings Per Share

€2.37

€2.78

2.3%  Doesn’t account for restructuring costs

Cash

2.5

5.3

Long Term Debt

4.4

13

Operating Cash Flow

3.8

3.5

🙁

Investing Cash Flow

(5.9)

(7)

Financing Cash Flow

(0.2)

0.1

Dividends

(1.3)

(1.8)

Dividends Per Share

€0.85

€1.50

8.4%

Shares Outstanding

1.2 MM

1.2 MM

-%


 
Valuation and Closing Thoughts

 

  • In the past seven years, SAP, which was already a big company, managed to double its customers from over 200,000 to over 400,000.
  • In recent years, sales have been marching upwards at a solid pace, thanks to their cloud products.  Gross profits have been good, though this has not translated well into the net income growing quite as well.  This is due to increased marketing, R&D, and restructuring expenses.  Even if we just back out the restructuring expenses, SAP is doing very well.  It’s earnings per share would be closer to €3.66.
  • As far as the ADR trading on the NYSE, the current stock price is around $155/share.  This is against trailing twelve month earnings of $4.14, putting the stock’s high-level valuation at 37x.  
  • I think the price is a bit rich for the growth profile, but this does seem to be a quality company.  They seem to have a strong competitive advantage based on the fact that most companies don’t want to build their own software systems to run the “mundane stuff” that makes modern businesses work.
  • Even though they are growing their cloud revenue quickly, it doesn’t seem like shareholders are benefitting much.  More and more money is getting plowed into R&D, sales, etc. which is good in a way.  
  • There aren’t any buybacks long-term but the dividend continues to increase and seems well supported (only a tiny 1% yield right now, which is typically of software firms that pay any dividend at all).
  • I wouldn’t be upset owning SAP.  From what I’ve seen it looks solid.  But the price does not seem to leave much of a margin of safety from what I see.
  • One other interesting tidbit is that the super fast growing Qualtrics subsidiary is apparently going to be spun off in an IPO – that is a story that could be interesting.  SAP looks like it will get a one-time infusion of cash but in turn, is going to give up one of it’s prize assets.  We’ll see how that story unfolds.

Sources

 

Want to listen to another episode or check out another company?  Check out the full archive here.

Alex Mason

Hi, I'm Alex and I'm an individual investor and podcaster who's curious about the world, especially when it comes to long term investing in the stock market. I'm always looking for better ways to analyze businesses and add more mental models to my brain's tool belt.

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