SAP restructures as it sets long term ambitions while meeting Q4 FY2018 expectations

Profile picture for user gonzodaddy By Den Howlett January 28, 2019
Summary:
SAP announced an ambitious target for cloud earnings by 2023 as it sets to take an estimated €800-950 million restructuring hit, hits Q4 expectations.

As is required by all CEO's these days, Bill McDermott, SAP's leader was upbeat today as he announced a plan to triple the company's cloud earnings by 2023. At the same time SAP announced a restructuring that CFO Luka Mucic described as a 'fitness program' but which is set to cost the company €800-950 million in the coming year. Today was also the day that SAP announced earnings that just met market expectations. Onto the detail, starting with the restructuring plan.

Restructuring for fitness

According to the company, the restructuring is designed to put the company in a better position to meet its cloud ambitions, offering early retirement to some staff and reassigning others. Mucic says this is not a cost-cutting exercise and the company plans to increase headcount and cross the 100,000 mark in 2019. SAP believes the estimated costs it will incur in the current financial year will be largely recouped in 2020 from savings estimated at €750-800 million.

SAP is no stranger to restructuring operations since the company frequently reassigns staff during the year. This is different and while details are still emerging this move should not surprise anyone. There are several important factors that will have weighed into this decision,

As Phil Wainewright recently observed, the way cloud solutions are built and marketed is fundamentally different to the manner in which you build and go to market with on-premises software. Having just closed out the Qualtrics acquisition and with McDermott pinning much on that acquisition as a revenue driver, the business has to change,

Coincidentally, Josh Greenbaum recently penned an analysis of how SAP (and other legacy vendors) are struggling to get the LOB focused messaging across at the field sales level, arguing that:

They’re focused on selling their cloud upgrades primarily to the ERP side of the business, and that means they’re selling an incomplete vision of what a cloud ERP system can do to only one of the many decision makers and stakeholders who stand to benefit from a cloud upgrade.

In SAP's case, its portfolio of solutions is vast, claiming to offer a soup to nuts vision of how a 21st century can compose a technology landscape that serves all purposes. There is plenty of skepticism around the company's true ability to deliver on what is now a largely acquired cloud portfolio that has to be integrated in order to succeed but restructuring the company to make ready for a different kind of sale makes complete sense.

Talking to the question of workforce changes, McDermott said:

We have a highly motivated and committed workforce. We are going to be creating thousands of costs. We are going to be moving people to areas where business needs us most, machine learning, the blockchain, quantum computing. We are building a company that's a fighting machine that can go into the market and win. This is a growth company move not a cost cutting move. Every dollar will go into strategic reinvestment.

Immediate jobs lost globally are projected to be around 4,400 although SAP expects the total at its Walldorf HQ to rise. More to come on this but in the meantime, Mucic pointed out that the employee retention rate is at a marketing leading rate of 94%.

Lofty goals

SAP Q4 FY2018

Counterbalancing the restructuring plan news, SAP needed to give a bold message about its future outlook and here Mucic said:

We are building a company for a sustainable future...we've just hit a point where two-thirds of our revenue is predictable and will get to close to 80% in the next five years.

Commenting on macro-economic and global issues, McDermott said:

We live in uncertain times. Whether it's the US-China situation or Brexit it will be something else. We see China is a jewel in the crown and we call China our second home. I think China is going to do just fine. Don't be too short on China. We are expecting a deal.

Q4 2018 numbers

SAP talked up its cloud revenue growth the numbers for which came in at just under €5 billion, representing growth of 32% in IFRS terms. Total revenue was €24.7 billion. Operating profit came in at €5.7 billion in IFRS terms. Talking to the detail, the company showed the following slide:

SAP Q4 FY2018

Talking to the impact of revenue mix on margin, Mucic said:

We can now see margins increasing...cloud and services grew faster than the market expected.

My take

The numbers were as expected and that speaks strongly to Mucic's faith in predictable revenue. The question on my mind is how SAP delivers the growth it is forecasting while at the same time undertaking what will be the most significant restructuring since 2015, a time when SAP cut jobs.

There will be angst among the German contingent since any talk of layoffs is considered very bad news in that country. The fact that SAP emphasized growth will help allay fears and confirmation the company plans continued expansion at its HQ is good news. But much of SAP's plan depends on voluntary measures and in the past, these have not worked as well as the company would like, despite the fact SAP is generous in its severance programs.

On outlook, SAP is certainly confident and as I have said in the past, the Qualtrics acquisition is the one I see as key to driving that growth, acting as a pull along for S/4HANA and other solutions. Already the company is talking large double and triple digit growth for C/4HANA but let's not get carried away. SAP is coming from relatively small numbers in the customer-focused areas of its portfolio. It has a lot of work to do if it is to credibly challenge the market leader, which is already carving out a position ahead of where SAP is today.