SAPGF - VGI Partners - SAP: Trading At A Meaningful Discount To Fair Value
Summary
- SAP is in the midst of a multi-year transition of its business to the cloud which continues to gain momentum.
- SAP's BTP business has a sales run rate exceeding €1.5 billion with high margins and we expect it to grow substantially over the next few years.
- Recent results from SAP have been mostly supportive of our thesis.
- We believe SAP trades at a meaningful discount to fair value.
The following segment was excerpted from this fund letter .
SAP SE ( SAP )
SAP is in the midst of a multi-year transition of its business to the cloud which continues to gain momentum. We attribute much of its success – which has not been without challenges and setbacks – to the strategy initiated by Christian Klein after he became sole CEO in mid-2020, in particular “RISE with SAP.” Launched in January 2021, RISE is a commercial construct to migrate customers onto SAP cloud products such as S/4HANA Cloud (Cloud ERP) and SAP’s Business Technology Platform (BTP).
Late last year, we travelled to Germany and met with SAP management to learn more about BTP specifically. The platform offers data and application services which customers and partners can use to integrate SAP and non-SAP applications, in effect a “digital core” with powerful flywheel effects. It is foundational to SAP’s RISE offering with 80% of customers adopting the platform. The BTP business has a sales run rate exceeding €1.5 billion with high margins and we expect it to grow substantially over the next few years.
SAP’s cloud transition has resulted in some one-time and duplicative costs (infrastructure, R&D and sales), resulting in a circa €200 million lower operating profit in 2022 versus 2019, despite circa €3 billion higher sales. Having studied these transitions, we believe the shift is camouflaging the underlying earnings power of what will be higher quality earnings (>80% recurring revenue). We expect the one-time and duplicative costs will dissipate from 2023 onwards, resulting in positive operating leverage and sustainable double-digit operating profit growth.
Recent results from SAP have been mostly supportive of our thesis with leading indicators, specifically Current Cloud Backlog, accelerating despite macroeconomic uncertainties. The BTP flywheel has improved integration between SAP’s cloud modules (SuccessFactors, Concur, etc.) and S/4HANA, leading to improved cross-sell/upsell rates. Recent results from back-office software peers Oracle and Workday have also been resilient.
SAP’s moat is stable-to-growing and the business is well-positioned in many of the world’s largest corporations as an essential component of their IT operating platform. Our field trip to Germany gave us incremental confidence that the strategy is gaining traction following a painful period of transition. We also view the appointment of a new CFO, Dominik Asam, who joins in March from Airbus and has a solid reputation, as one of the many positive catalysts building in the business.
Given the cloud transition and some execution missteps, SAP trades at a meaningful discount to fair value. Earnings are poised to accelerate as they execute on the cloud transition. In our view, a more meaningful reflection of the company’s earnings power requires looking out to at least 2025, with SAP trading at a 6% free cashflow yield and a 15.5x PER on our forecasts.
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VGI Partners - SAP: Trading At A Meaningful Discount To Fair Value