SAP slapped with 'sell' rating; Pushback from customer base cited

Societe Generale analyst Richard Nguyen hit SAP with a sell rating on Wednesday citing increased odds of a fourth quarter profit warning and signs that customers are pushing back on the software company's attempt to upsell them following a maintenance price increase.Nguyen's report--he downgraded SAP shares from a hold to a sell--come amid some worrisome signs for SAP.

Societe Generale analyst Richard Nguyen hit SAP with a sell rating on Wednesday citing increased odds of a fourth quarter profit warning and signs that customers are pushing back on the software company's attempt to upsell them following a maintenance price increase.

Nguyen's report--he downgraded SAP shares from a hold to a sell--come amid some worrisome signs for SAP. Part of that pushback Nguyen refers to can be seen in the American SAP User Group (ASUG). Dennis Howlett reports that ASUG is firing Steve Strout, the group's full-time CEO. The problem: ASUG wants someone who will better represent their interests.

Translation: SAP's maintenance price increase hasn't gone over well and Strout wasn't pushing back enough.

That customer turmoil--along with a weak economy--is likely to bite SAP in the fourth quarter, argues Nguyen. Here's the meat of his argument:

Based on our recent channel-checks with integrators and resellers, we believe that there is a significant risk that Q4 08 license revenue will fall short of consensus expectations. SAP traditionally makes 40% on average of its annual license revenue in Q4; as such the worsening macroeconomic environment may set the stage for another profit warning in January. In order to achieve SAP's target of c.20% growth for FY08 in constant currency product revenue, we estimate SAP needs to grow by at least 3% in Q4 08. However, we are concerned that this may not be achievable as 1) Europe (50%+ of total license revenue) may slow even more sharply than expected, with Germany, France and the UK under particular pressure -- while the US (35%) remains mired in difficulty; 2) the installed base clientele continues to find ways to reduce the total cost of their SAP systems following the group’s decision to increase maintenance fees to 22% from 17%. According to the SAP User Group Executive Network survey in October, 90% of the respondents did not completely understand the benefits of this new maintenance policy despite SAP's efforts to put the focus on the TCO (Total Cost of Ownership) instead of just the maintenance part. Pushback from the current installed base means that cross-selling and up-selling could be difficult in the current context.

The tough economic environment along with customer resistance to upselling provides interesting bookends to SAP's talk (partial infomerical) on Friday. SAP's message--delivered by co-CEO Leo Apotheker (right)--was that companies should invest in IT during a downturn--presumably with SAP--but it's unclear whether customers are buying it. Underneath the surface Nguyen's argument appears to be carrying more weight. Remember, large software vendors increasingly have to squeeze more revenue from existing customers. If they push back growth projections can crumble quickly.

Nguyen lowered his fourth quarter license revenue forecast to 1.2 billion euro from 1.4 billion euro, down 26 percent in constant currency. Nguyen lowered his total revenue estimate to 3.3 billion euro, down from 3.5 billion euro, and earnings estimate to 0.63 euro a share from 0.69 euro a share. Nguyen's estimate cut puts him in line with Merrill Lynch's projections.

Also see: Breaking: SAP User Group fires CEO