SAP's costly catchup strategy in cloud computing is starting to deliver. The world's largest business software company has been generating most of its sales growth through services for web-based computing lately. As revenue from SAP's traditional business of software licences declines, the rationale for its expensive cloud acquisitions is beginning to show.
Since December 2011, SAP has splashed out $9 billion for cloud software specialists Successfactors, Ariba and Hybris. Without this M&A spree, SAP probably would be in a very difficult situation right now. Cloud sales increased threefold to euro 547 million in the first nine months of the year. For every euro of revenue SAP lost in its established business, it created euro 3.40 of additional cloud revenue.
Better still, SAP's cloud performance remained strong between July and September 2013 - the first full quarter after former US security analyst Edward Snowden's revelations about internet surveillance by American and British intelligence agencies. Some industry experts feared that heightened security concerns might weaken corporate appetite to move core operations to the cloud. A year ago, the Walldorf-based company generated a mere six per cent of its sales over the internet. Now, that share has risen to 17 per cent.
SAP's results drove the shares up seven per cent by European lunchtime trading on October 21, ending the bear market in the stock that has endured since April and leaving shares trading on a forward price-earnings ratio of 14.8, a slight premium to peers.
The snag is that SAP's sales growth in cloud is barely profitable. The division spends more than half of its total revenue on sales and marketing, resulting in a disappointing profit of just euro 83 million. True, last year the division made a small loss. But with a margin of 11.7 per cent, it has a way to go to match the 49 per cent margins of SAP's traditional business.
For now, the software giant is probably right to favour growth and market share gains in cloud. But if the share price bounce is to become sustained outperformance, a convincing strategy to boost profitability is required.
