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SAP Q1 earnings solid, but long-term danger lurks

SAP reports first-quarter growth in cloud revenue but a drop in license revenue as the COVID-19 crisis threatens to delay IT infrastructure projects; analysts warn about overly rosy projections.

SAP earnings for the first quarter of 2020 were solid for the most part, but there's much uncertainty ahead as the COVID-19 pandemic wreaks havoc on the world economy.

SAP reported its earnings just after announcing news of co-CEO Jennifer Morgan's unexpected departure by the end of April. Christian Klein assumes the role of sole CEO.

Christian KleinChristian Klein

While the SAP Q1 earnings are healthy, with increases in cloud revenue and a growing customer base for S/4HANA, analysts see warnings ahead and some believe the company's projected growth to be overly optimistic.

Total revenue rose 7% over the previous year to €6.521 billion, the company reported. Cloud revenue was up 29% year-over-year to €2.01 billion. Software licensing revenue came in at €451 million, a decline of 31%.

SAP attributes a loss of €36 million to the cancellation of the in-person Sapphire Now conference and other live events.

SAP S/4HANA showed growth with a reported 300 new customers. This brings the overall S/4HANA customer base up to over 14,100, a 23% year-over-year increase.

SAP's peripheral businesses also reported revenue increases in the first quarter. Concur, the travel and expense platform, reported a 14% growth in revenue to €428 million. Qualtrics, the experience management platform that SAP acquired in 2018 for $8 billion, reported a revenue increase of 82% to €161 million. SAP Services segment, which provides customers with services such as designing and implementing digital transformation projects, reported a 5% revenue increase to €851 million.

Cause for concern amidst the solid numbers

SAP's earnings report looks solid, but there are reasons for concern, said Andrew Bartels, vice president and principal analyst at Forrester Research, as the first-quarter numbers might not reflect what will happen the rest of the year.

"Effectively, of the 13 weeks in the quarter, 10 of them were still looking good, but they only show three weeks of the pandemic hitting, which really hurts and really matters," Bartels said. "It also matters because in the case of license revenues, which were down 31%, those deals are typically closed at the end of the quarter. So the fact that it's down so much is more of an indicator of what's going to happen going forward."

SAP's cloud businesses, which include SAP Ariba, SAP Fieldglass and Concur, and which are now grouped together as SAP Intelligent Spend Management, could also take a significant hit because they generate the bulk of their revenue from businesses that will be affected by an economic slowdown, Bartels said.

However, on the positive side, SAP brings in significant revenue from maintenance, which should continue to be solid. SAP's core industries and geographies may also not be hit as hard by a turndown.

For example, although SAP gets a good portion of its revenue from the U.S., which may be hit hard by the turndown, it also gets significant revenue from the Asia/Pacific and EMEA regions, which suffered early setbacks but may rebound earlier.

SAP's outlook may be a little rosier than warranted, agreed Andrew MacMillen, research analyst at Nucleus Research.

SAP may be overly confident that the business turndown caused by the crisis will be pushed off to the third and fourth quarters, MacMillen said, but more ominously, companies may be significantly reevaluating their technology infrastructure.

"They're asking whether they should move up cloud transition timelines or refresh their enterprise applications," he said. "Given SAP's position as an on-premises provider of enterprise applications, it's likely that some customers might consider leaving SAP entirely for something else."

However, this is tempered by SAP's own solid cloud performance, with the increase in S/4HANA customers, he said.

"Considering that they reported that S/4HANA just broke 14,000 customers, that's a good sign as far as maintaining pace or catching up with Oracle's cloud deployment base," MacMillen said.

Holger MuellerHolger Mueller

SAP's numbers were good, apart from the license revenue miss, said Holger Mueller, vice president and principal analyst at Constellation Research. But it needs to keep cloud revenue growing to make up for those shrinking sales.

"It's the same old story: If that on-premises revenue does not happen, then it will be tough to make the numbers," Mueller said. "It all depends now how Q2 and Q3 go, otherwise SAP will have to adjust cost structures and that always means personnel reduction."

Opportunities to modernize in the slowdown

There could be opportunities for companies to modernize their infrastructures, said Joshua Greenbaum, principal at Enterprise Applications Consulting.

Joshua GreenbaumJoshua Greenbaum

"Companies that are running on-premises systems may see that it's time to really step up to making that shift now or at least to keep planning that shift," Greenbaum said. "It's only going to become more complex to run these on-premises systems on older technology, and this may be the crisis that pushes companies to make that shift."

Jon ReedJon Reed

Uncertainty is the biggest risk for SAP, said Jon Reed, an analyst at Diginomica.com.

SAP is a cash-rich company that has a fairly loyal customer base and can rely on maintenance revenue streams, but there's a lot of uncertainty in the market now, Reed said.

This makes it hard to plan for the future, particularly on big IT infrastructure projects.

"One thing we do know is that, for a while, it's not going to be a great time to get a lot of new customers and new large-scale projects of the S/4HANA variety," Reed said. "SAP is pretty well prepared from a resources standpoint to weather this, but there are some uncertainties that could really hurt them."

 

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