Analysts Expect SAP to Meet Third-Quarter Profit Target
By MATTHEW ROSE
Staff Reporter of THE WALL STREET JOURNAL
LONDON -- Is there some respite ahead for SAP AG?
After a torrid two months, during which its share price has halved, the German software giant is gearing up to release its much-anticipated third-quarter results. Despite recent concerns, most analysts think the company will hit its targets.
"There will be a sigh of relief when SAP meets estimates or does slightly better," says Derek Brown, a software analyst at BT Alex. Brown in London. He expects SAP to report pretax earnings of 1.71 marks ($1.06) per preference share, or eight cents per American depositary receipt, for the quarter ended Sept. 30, in line with analysts' consensus forecast.
Comfort, however, is likely to be temporary. SAP's 1999 earnings estimates have been sliced by up to 10% by some analysts amid a slackening in corporate spending on technology. If SAP misses its numbers, the effect on an already nervous stock market could be ugly. "It would confirm people's worst fears that SAP hasn't managed to close enough deals," says Mr. Brown. "It would all point toward the software industry going into a recession."
Sales Outlook
The Walldorf-based company, a bellwether for Europe's technology sector, is officially due to announce its results on Oct. 20, but as it has done in the past, the earnings report could be released earlier.
After a triumphant listing on the New York Stock Exchange in early August, little has gone right for SAP. Many investors have worried that sales of SAP's expensive and complex software could slow as potential clients divert spending toward fixing their Year 2000 problems. That concern, coupled with senior executive departures, a pending lawsuit and fears of declining global economic growth, has made many investors leery of holding on to shares of SAP -- once a darling of the market.
Charles Elliot, who covers technology for Goldman, Sachs & Co. in London, points to worsening prospects at SAP's leading clients, such as Gillette Co., Coca-Cola Co. and Royal Dutch/Shell Group. "If customers are having a rougher time, that is not good news for enterprise software," he says. Earlier this week, Goldman Sachs cut its 1999 earnings forecast for SAP to 15.50 marks a share from 17.20 marks, citing currency fluctuations and a worsening macroeconomic outlook.
Shift of Interest
In the past two weeks, as major Wall Street houses have shifted their enthusiasm for enterprise software firms to safer investments, shares of SAP rivals Baan NV and PeopleSoft Inc. have fallen sharply. In Frankfurt trading Thursday, SAP's preference shares closed down 29.25 marks at 619 marks, 54% below their 1998 high. On the New York Stock Exchange Thursday, SAP closed at $31.3125, down 93.75 cents. Still, the stock hasn't been as badly hit as its rivals, in part because of SAP's dominant industry position.
"In the long term, SAP offers a very creative product, but in the short run there is concern about the deferral of software spending," says Jim Weiss, deputy chief investment officer at State Street Research in Boston, a significant holder of SAP stock.
Earlier this year, SAP Co-Chairman Henning Kagermann had predicted 40% sales growth and pretax profit growth of between 30% and 35% for this year.
Most of the analysts who thought these targets were too conservative -- SAP's sales soared 62% in 1997 -- now agree that a slowdown is imminent. Mr. Kagermann declined to comment Thursday on the third quarter but noted there is, "no reason to change the [earnings estimate] at all."
One of the main concerns about SAP is currency risk, especially the weakening of the U.S. dollar against the mark. About 80% of the company's revenue comes from outside Germany.
SAP "has never been fully hedged in the past," says Jochen Klusmann, an analyst with Bank Julius Baer in Frankfurt.
Rising Costs
Analysts are also keeping a close eye on the company's rising sales and marketing costs. Competitors such as Oracle Corp. have reported that SAP is aggressively cutting prices and making financing deals in the U.S. Mr. Kagermann says there is "no strategy to compete on price," although he concedes that financing deals are sometimes offered in new markets.
Longer term, analysts are divided over SAP's prospects. Steve Bonadio, an analyst for the Hurwitz Group, a market research firm in Framingham, Massachusetts, is confident the sector has a lot of growth potential. He says SAP is attacking new markets with some just-released products and that there are many midsize companies that have yet to buy an enterprise software system. "You have to take a broader view of the marketplace and look at what these folks are doing," Mr. Bonadio says. Hurwitz forecasts growth of 40% in the enterprise software market this year to $6.9 billion, and 35% in 1999 to around $9 billion.
SAP points to a number of recent wins against the competition. It has lured Siemens AG over from PeopleSoft, Eli Lily & Co. from J.D. Edwards & Co., and Ford Motor Co.'s Visteon unit from Baan.
That doesn't mean investor concerns will disappear, even if SAP beats expectations for the third quarter. SAP is still trading around 50 times expected 1998 earnings, a higher level than Microsoft Corp. "For a final sigh of relief, we'll have to see what happens with general economic activity," says State Street's Mr. Weiss.
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