Strong Numbers and New Products for SAP

Second-quarter results from the German software maker go a long way toward restoring investor trust as it develops Internet-based software

Executives at German software maker SAP (SAP) are not generally given to chest thumping, but there was a palpable sense of self-satisfaction in the second-quarter results the company released July 19. "They're good numbers," Deputy Chief Executive Officer Léo Apotheker told BusinessWeek.

SAP shares rose more than 6% after the company said that second-quarter operating profits were up 10%, to $790 million on sales of $3.3 billion. The results reassured investors that the Walldorf (Germany) maker of enterprise software can continue to maintain profit margins as it spends $550 million over two years to develop software that will be distributed over the Internet to business customers. "The company managed to restore trust," says Knut Woller, analyst at Unicredit Markets & Investment Banking in Munich.

But is the growth sustainable? SAP reported a 15.6% increase in sales of software and software-related services in the quarter compared to a year earlier. Much of the growth in that key indicator came from customers upgrading to new products from SAP's warhorse R/3 software, which companies use to automate business functions such as bookkeeping, procurement, or logistics. However, Dan Sholler, analyst at market researcher Gartner (IT), predicts that the upgrade revenue will tail off toward the end of 2008.

Huge Departure from Tradition

To keep the growth going, SAP is counting on its new Web-based, software-as-a-service product, code-named A1S. The Web-based model frees customers from having to invest in major computer infrastructure and IT departments, and it makes SAP software more accessible to small and midsize companies.

But the product, to be launched early next year, is also a huge departure for SAP, which has traditionally sold software that companies installed on their own computers. "[A1S] is not a product launch; it's an entirely new business," SAP CEO Henning Kagermann told reporters on a conference call.

If all goes according to plan, the new product will generate enough sales to compensate for a decline in upgrade revenue. If not, there's a risk SAP growth could slow. "This whole A1S thing is a big bet that they can get those revenue curves to cross," Gartner's Sholler says. "If A1S doesn't go as they expect it to, there's a possibility that by the end of next year they're going to be under some pressure" (see, 5/18/07, "SAP Caught Between Two Worlds").

Dominant in Enterprise Software

There's no question that SAP is one powerful company that has proven it can master extremely complex software launches. "Everything is going according to plan," Deputy CEO Apotheker says of the A1S development, which cost SAP $69 million in the first half of 2007 (see, 5/16/07, "SAP's Tough Guy Ready to Rumble").

SAP continues to dominate the market for enterprise software. According to company figures, SAP built its share of the $48 billion market for so-called core enterprise applications to 26% in the last quarter from 23% a year earlier, compared with 15.5% for Oracle and 3.1% for Microsoft. "They are a very good engineering company," Sholler allows.

And SAP has other growth areas. For example, Asia has become SAP's fastest-growing region, with sales rising 20% in the second quarter to $417 million, or 12.5% of total sales. India also is seeing particularly good growth, Apotheker says, as companies there strive to become as well-managed as their international peers. "They have high ambitions for the future," he says.

Still, in a sign of caution, SAP executives did not raise their forecast for the full year, despite the unexpectedly strong quarter. "It's realistic guidance," Apotheker says, adding, "We feel we can continue to perform very well."

    Before it's here, it's on the Bloomberg Terminal.