SAP's Q4 FY2020 - not bad, not great

Profile picture for user gonzodaddy By Den Howlett January 14, 2021 Audio mode
Summary:
An initial analysis of SAP's Q4 FY2020 results. No shocks but no real surprises coupled to an as-expected weak outlook.

SAP Q4 FY2020
(via SAP press release)

The current board at SAP has made pre-announcing results something of a habit and Q4 FY2020 is no exception. SAP says that it finished strongly in what has been a tough year but in reality, the results reflect almost exactly where the company thought it would end up when it announced results for Q3 FY2020, albeit at the lower end of that forecast. 

While the company was understandably short on detail in the press release, two numbers stood out. First, the level of predictable revenue increased during the year by around five per cent to 72%. Second, operating cashflow ended up in a much better place than SAP expected just a few months ago. From the press release:

Operating cash flow for the full year is expected to be at around €7.0 billion, approximately doubling year-over-year and significantly above the raised outlook of approximately €6.0 billion. Free cash flow for the full year is expected to be at around €5.9 billion, significantly above the raised outlook of above €4.5 billion. Cash flow was positively impacted by lower tax and restructuring payments and a successful working capital management.

Assuming it goes ahead as planned, SAP will see a substantial cash inflow from the planned Qualtrics IPO while retaining many of the benefits of holding onto the vast majority of its current holding. In that context, SAP is offering a preliminary outlook for 2021 as follows:

  • SAP expects €9.1 – 9.5 billion non-IFRS cloud revenue at constant currencies (2020: €8.09 billion), up 13% to 18% at constant currencies
  • SAP expects €23.3 – 23.8 billion non-IFRS cloud and software revenue at constant currencies (2020: €23.23 billion), flat to up 2% at constant currencies
  • SAP expects €7.8 – 8.2 billion non-IFRS operating profit at constant currencies (2020: €8.28 billion), down 1% to 6% at constant currencies
  • The share of more predictable revenue (defined as the total of cloud revenue and software support revenue) is expected to reach approximately 75% (2020: 72%).

Long story short, SAP is forecasting flat revenue overall for 2021 but has plenty of cash to invest in its future. That means we can expect to see a continuing slide in the sale of on-premises licenses balanced by subscriptions and a tighter operating model. It won't be an easy trick to pull off and the degree of flexibility SAP has depends in part on the extent to which shareholders view SAP as a growth rather than a value investment.

One of the problems SAP faces is that it reports under IFRS but attempts to iron out currency fluctuations by referring to 'constant currency.' In the coming year, SAP anticipates currency headwinds that will fall in the range of 2pp-4pp at the operating profit level. 

My take

There is too little detail at this point upon which to make a thorough analysis of this outcome.

On the one hand, the company must be relieved that it hits its mark for the full 2020 financial year, however that was achieved. On the ground, soundings suggest that SAP's push to shift license and maintenance to cloud subscriptions was aggressively pursued in Q4. The proof points for that will come when SAP puts on its RISE event scheduled for 27th January. Our understanding is that customers will speak so expect more at that time. RISE will be followed by the more formal earnings call on 29th January. 

This sequence of events does not go un-noticed. In releasing these results, SAP gets time in which to digest market reaction while tuning up its messaging for RISE and then go into what I expect to be a probing analyst call on the 29th. By that stage, SAP will have a clear understanding of what the market thinks. This is a difficult balancing act. CEO Christian Klein has made clear that his priority list follows this order: employees, customers, stockholders yet most financial analysts were clearly sideswiped by the Q3 announcement as evidenced by the collapse in stock price immediately following the earnings announcement. 

The good news for SAP is that at this point in time, expectations are so low, that any good news will be seen as upside. A discussion about the impact of COVID vaccines and SAP's assessment in this regard is interesting. I am firm in the belief that COVID serves to amplify the long-running problems that many industries face. For example, automation should have been solved for core processes like AP/AR years ago but it wasn't. SAP needs a good story there, it needs it now and it needs to be consumable at a price that customers can not only afford but from which they can also derive clear value.  

What happens next? I could speculate on all manner of SAP-related topics but for me, there are two clear imperatives, both of which have been long in the doldrums but both of which play to SAP's outlook:

  1. Sort out the cloud story. Customers want clarity about how SAP helps to drive value. I alluded to this in my earlier critique of the business roadmap but RISE is where we will see what for me is a once in a generation opportunity. If executed well, then the market will forgive and wait. 
  2. Get real about industries. COVID has sharpened the C-suite focus on solving specific problems and, with the exception of cash management, those are almost always industry-specific. Other vendors are marching ahead and winning plaudits. What's the SAP story for deals where seven and eight-figure checks won't be written any time soon?