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Re-evaluating SAP's Qualtrics acquisition in the light of Medallia's blowout IPO

Den Howlett Profile picture for user gonzodaddy July 22, 2019
Did SAP get it right when it bid and paid $8bn for Qualtrics? That's been a bee in many analysts' bonnets for some time. Medallia's IPO suggests otherwise.

bill mcdermott via CNBC
Bill McDermott - CEO SAP (Bill McDermott via CNBC)

When SAP acquired Qualtrics, many analysts gasped at the price paid. By some measures, it was the equivalent of 20x revenue, a very high multiple even in these frothy times and some 60% ahead of the anticipated IPO valuation.

Last week, Medallia, a competitor to Qualtrics, debuted on NASDAQ at a valuation of $3.6bn. It closed up 76% on the IPO strike price, which values the company at around $6.3bn The Medallia event, along with other data, provides us with an opportunity to re-examine the Qualtrics deal. 

In back channels, the belief is that it was the Qualtrics event, coupled with a less than stellar performance at the 2018 Capital Markets Day that triggered Elliott Management's incursion into SAP's space. That, in turn, kicked off something of a turnabout in SAP's strategy. 

By the end of January 2019, SAP was hip-deep in restructuring, a process that was executed in a ham-fisted fashion and which left a bitter taste. 

Forget the money

At the time of the Qualtrics acquisition, I was clear that I could care less about the price paid - I'm not that interested in what investors think. I was and remain much more interested in the potential impact on customers. Of course prices paid have an impact on resource allocation but in my analysis, I noted the significant cultural differences between the two firms, a problem that many corporate marriages face. Even so, I along with folk like Josh Bersin saw the potential for Qualtrics to add serious value to the SAP portfolio. Bersin said:

One of the executives at SAP I talked with put it this way. For almost 40 years SAP has dominated the world of building software companies need to run their business. This is an “inside-out” problem.

Today companies want to do the opposite. They want every employee to feel like they’re facing a customer, and every decision to be customer-led. This is an “outside-in” problem.

If SAP can pull this off, they could build a set of tools that help every company behave like Amazon; deliver real-time feedback to managers about customers, prospects, and employees – in an actionable and useful way. That market is probably 10 times bigger than the “survey” market, and it leverages SAP’s expertise in data management, infrastructure, and enterprise solutions.

In a later analysis Phil Wainewright said:

I like the vision, but I think the execution is going to be a challenge. The vision maps onto my own framework for thinking about business models in a connected world — the XaaS effect of continuous connection to customers that fosters a virtuous cycle of engaging customers, monitoring their interactions and iteratively improving their experience...

...If SAP needs Qualtrics to introduce that dimension, it's a warning that it's not yet got the right culture in place. And that is a stumbling block many of its customers will face too, one that I suspect SAP's newly formed experience management engineering team will be unable to help them overcome.

Bring on the money?

Also last week, SAP reported its Q2 2019 numbers in extraordinary detail including some numbers related to Qualtrics. Those numbers say that Qualtrics contributed €165 million ($185 million at current rates) to the top line in Q1-2 2019. In the presentation, SAP said that if the deal had been consummated at the beginning of the financial year then there would have been no material difference to the numbers. 

On the earnings call, Bill McDermott, CEO SAP pointed to SuccessFactors and Qualtrics:

SuccessFactors is an early adopter of the XM vision with employee experience. By combining the Qualtrics and success factor's offerings, we have differentiated against legacy HCM. That's why our success factors portfolio had a strong quarter, growing bookings in high double-digit year-on-year, with multiple wins against Workday and Oracle.

Market-leading companies like Merck in Germany are shifting away from old HCM in favor of employee experience. In the quarters to come, we will use all aspects of XM as the differentiator for the intelligent enterprise, including employee, customer, product, and brand experience. Experience management has superseded stand-alone digital transformation talk. I personally shared this message with CEOs around the world. The reaction is unanimous. Every one of them wants XM.

Luka Mucic, SAP's CFO said: 

Cloud revenue was, obviously, again a big driver of this. Our cloud revenue surged 40% and as Bill said, we saw an amazing performance of our Qualtrics experience management solutions. 

How amazing was that performance?

In a detailed analysis of Qualtrics financials pre-IPO filings, Alex Clayton noted that Qualtrics added $136.2 million in revenue in Q1-2 2018. On that basis, Qualtrics revenue grew just a tad under 36% in year over year half years between 2018 and 2019. That, in turn, compares with 28% between 2017-18. So yes, there was a degree of acceleration. How much of that is attributable to SAP's stewardship is open to question but SAP remains incredibly bullish, based on the language of the analyst call.

How does this compare with Medallia?

Once again, we turn to Alex Clayton who provides a helpful comparison between Qualtrics and Medallia. In his detailed analysis, Medallia is slipping back against Qualtrics as this graph illustrates:

medallia v qualtrics

There are other ways in which Qualtrics and Medallia can be compared and contrasted but that is of lesser importance in this discussion than reviewing what has happened in terms of valuation.

What we have are two companies in much the same space but where Qualtrics has overtaken Medallia in terms of revenue but the price premium for which was lower than that which the market was prepared to pay for Medallia post-IPO. 

My take

At the time that SAP acquired Qualtrics, McDermott said that in the lead up to the IPO, it looked like Qualtrics would be massively over-subscribed and therefore the premium paid was not unreasonable. The market didn't like that (among other things) and hammered SAP's stock price. Today, the pundits reckon that Medallia will hold its price premium - we shall see. But, if that is the case then regardless of how you crunch the numbers, it looks as if McDermott got it right. 

Of course, the difference is that SAP has loaded itself up with debt in order to finance the Qualtrics acquisition while the price premium Medallia currently enjoys is purely in the minds of the market. If a raider was to come along, the price could only go higher. 

On the other hand, SAP quite rightly points to the feet it has on the street and the sheer number of global brands over which it exercises significant account control as the implied shoo-in for SAP's XM message and implied accelerated sales.

Regardless, SAP has to do a much better job of explaining how it's making progress. The 32-page Q2 2019 report was a good start but the company could have added a lot more color and come out smiling. For example, SAP could have pointed to what appears to be the actual growth achieved by Qualtrics and equally pointed to the six months anticipated sales lead time for enterprise deals that Qualtrics flagged in its S-1. 

Ironic endnote

In a final touch of irony, on the Q2 2019 analyst call, Mc Dermott said:

Since 2000, there were 4,500 companies in the IT industry that were founded and took a Series A investment. Only 75 of them made it to an IPO. Only 36 became the dominant category winners. Those winners now own 76% of the entire addressable market in their respective categories. So when it comes to experienced management, you're going to hear plenty of noise out there who'd like to catch this wave. The question is who created the category? And the answer, of course, is Qualtrics.

Hubris aside, compare that to this quote, attributed to Leslie Stretch, president and CEO Medallia in a Forbes article:

About 4,500 companies raised Series A funding in 2000, and we were one of them. Only 75 made it to IPO. 

And who is Leslie Stretch? He's the CEO who sold Callidus Software to SAP for $2.4 billion. 

It's a strange old world, isn't it?

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