SAP Sapphire: Reading the tea leaves demand, margins and M&A

SAP's Sapphire customer powwow concluded this week and the takeaways appear to focus on what wasn't there: Subscription pricing, a sign of an enduring rebound and confidence that the company can maintain its profit margins. Among the notable business points (Dennis Howlett has the product overview):The outlook for the second quarter is still rocky.

SAP's Sapphire customer powwow concluded this week and the takeaways appear to focus on what wasn't there: Subscription pricing, a sign of an enduring rebound and confidence that the company can maintain its profit margins. 

Among the notable business points (Dennis Howlett has the product overview):

The outlook for the second quarter is still rocky. Piper Jaffray analyst Rajeev Bahl concludes:

SAP's customer conference was well attended but company and partner feedback points to a tough Q2 and no real upturn by the end of this year. Larger deals have, unsurprisingly, been particularly hit as financing has dried up and approval processes have become tougher as customers seek out rapid ROI and buy in a more targeted fashion.

Jeffries analyst Ross MacMillan notes a disconnect between SAP's view and its partners:

While clearly 2Q09 will be a tough quarter due to pipeline coverage, lower close rates and tough compares, management indicated that there were some encouraging signs that customers are coming back and planning for future projects. Management believes this could have positive implications for 2H09. Meanwhile SAP partners seemed more cautious on the environment and said nothing much had changed since 1Q09, with few big deals and no material change pipeline or activity. While partners may not see a pipeline build of higher volumes of smaller deals, they would often be involved in bigger project lead generation, in our view.

And Goldman Sachs analyst Sarah Friar echoed McMillan's comments:

The spending environment remains challenged, with few signs of thawing for now (and) SAP’s sales approach is increasingly tactical, in selling quick implementation, quick ROI modules into the installed base, and providing flexibility on ratable subscription payments.

Also see: Sapphire 09 Live: Smart business plans, moral benchmarks

Subscription pricing plans brewing? The economy is creating tough sledding for big bang projects. Bahl writes:

Partners have a clear appetite for subscription pricing of SAP's products, to get to a lower entry cost and more variable costs of ownership as a sales pitch in a tough market. SAP is open to this, but we see this mix shift happening only gradually and, as such, continue to view SAP as cyclically exposed.

Wall Street remains focused on SAP profit margins. Wall Street is expecting an operating margin of 31 percent for fiscal 2010, but that assumes SAP can grow without increasing costs. Piper Jaffray is projecting 2010 margins of 27 percent. 

MacMillan writes in a research note:

Last year the big news from Sapphire was management's new found intention to focus on margin expansion. While the economy and subsequent license revenue misses delayed the extent to which this occurred, it is clear that the company intends to move to a 35% non-GAAP operating margin before increasing investment in the business to drive future growth. While the company won't be pinned down on when this margin will be achieved, it seems that it could be as early at CY10 and no later than CY11.

Merger and acquisition speculation abounds. Bahl said he expects SAP to become more acquisitive. Meanwhile, MacMillan stoked the IBM-SAP rumors:

While we don't think any game changing event between SAP and IBM is imminent, we do think the two companies continue to work ever closer together. We believe SAP and IBM are close to signing a new co-development agreement, which will further align some of IBM's infrastructure software products (Websphere Middleware, Tivoli System Management and Rational Development and Testing) with SAP's products.

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