SAP’s Performance Does Not Support Its Valuation

Richard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I’ve said it before and I’ll say it again -- valuation will always matter. This is true even in the tech sector where high expectations are par for the course. Although software giant SAP (NYSE: SAP) continues to deliver the goods, the premium investors are willing to pay today as evident by a P/E of 24 is too high.

While the case can be made that SAP is beginning to get a stronger foothold in the Software as a Service (SaaS) market, I worry that the sort of returns investors expect might not come -- at least not to the extent of what rival Oracle (NYSE: ORCL) can offer. Better still, Oracle and even IBM (NYSE: IBM) are trading at much lower levels. Going into SAP’s Q4 report, investors were looking for justification of their faith. They didn’t get it.

A Tough End to an Otherwise Good Year

I suppose it says a lot when a company opts to disregard its prior schedule as SAP did by announcing earnings one week earlier than expected. My guess is the company knew it was going to disappoint and was hopeful that the results would be drowned by the influx of other reports. But today, there’s no place to hide.

The company reported a 12% increase in revenue that arrived at 5.06 billion euros ($6.8 billion). This was below analyst estimates of $5.16 billion, according to data from Reuters. Disappointingly, operating profit grew much slower than expected – advancing 10% to 1.96 billion euros. As a result, the company shed 8 basis points in operating margin, which arrived at 38.8%.

By contrast, Oracle, which is SAP’s biggest rival, proved last month that it is able to grow where others can’t. Oracle had a solid Q4, during which the database giant posted an 18% jump in net income, reaching $2.6 billion.

Oracle said profits actually were 64 cents per share when excluding charges related to acquisitions and other costs -- enough to beat analysts’ estimates of 61 cents per share. Oracle’s revenue grew 3% to $9.1 billion, exceeding Street estimates by $900 million.

Competition 'Sapping' the Life Out of SAP

However, the most impressive aspect of Oracle’s report was the 17% surge year-over-year in the company’s software licenses and subscriptions business. This was good enough to exceed management’s most bullish projections. That SAP was only able to grow by 10% should be considered a red flag at this point.

This clearly means that SAP is losing market share to Oracle. Then it begs the question, why is SAP trading at such a premium? Conversely, investors should also be encouraged by Oracle’s ability to grow its software and subscription business an impressive 17%, particularly since that business contributes one quarter of the company’s revenue.

This means that Oracle is indeed stealing market share from not only SAP, but also Microsoft, and Salesforce.com (NYSE: CRM), all of which are jockeying for SaaS market share. Although Salesforce has a decent lead in the SaaS environment, unlike Oracle, Salesforce.com has shown an inability to develop internally through its own R&D.

Consequently, Salesforce.com was “forced” to spend close to $1 billion buying up niche cloud/social media names such as BuddyMedia, on which it spent almost $700 million, which came shortly after acquiring Radian6.

Although it seems that SAP is being left behind by more nimble rivals, at least the company is performing better than IBM, which has fallen behind in the sector. In IBM’s third quarter, Big Blue reported earnings per share of $3.33 on revenues of $24.7 billion.

Though EPS climbed 4.4% year-over-year, it fell short of analysts’ expectations of $3.61 per share. Likewise, revenue also disappointed Street forecasts of $26.28, as it also declined 5.4% year-over-year.

Bottom Line

Despite the poor results, SAP still has a great business with an excellent management team. I just don’t like the stock at these levels – not when it is being outperformed and outmaneuvered by rivals. SAP’s business still lags behind Oracle’s in every meaningful category.

However, I’m willing to overlook valuation concerns if strong growth was present, but it’s not -- 10% for a P/E that is 8 points above industry leader Oracle is not going to cut it. Then again if SAP shares should ever fall below $70, I would have to reconsider.


rsaintvilus has no position in any stocks mentioned. The Motley Fool recommends Salesforce.com. The Motley Fool owns shares of International Business Machines. and Oracle. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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