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Significant Cloud Momentum

SAP announced the preliminary financial results for the third quarter 2021 last week. The full results of the SAP 3rd Quarter Financial Review will be issued on Thursday, October 21st (2:00pm CEST) at a virtual analyst conference, so IgniteSAP is taking a look this week at SAP’s performance over the period and over the last 9 months as a whole. We will present some of our thoughts about SAP’s long term strategy in light of these results at the end of the summary of the financial review.

SAP states that cloud momentum has accelerated significantly and has raised the full year outlook. This is because the current cloud backlog is up 24%, with the SAP S/4HANA current cloud back log up 60%. Cloud revenue is up 20% and operating profit is up 2%. Due to the strong third quarter the full year revenue and profit outlook have also been raised.

SAP CEO Christian Klein said: “Our strategy is clearly working. Customers are choosing SAP for their business transformation in the cloud. We see record adoption of our applications and our platform. This has resulted in strong acceleration of our cloud growth.”

Luka Mucic, SAP’s Chief Financial Officer commented: “This has been an excellent quarter across all key financial metrics. We are seeing sustained, strong progress in SAP’s transformation. Our cloud business is growing at an accelerating pace and has led to our improved full year outlook.”

The Business Update

The business update for the third quarter summarises the events behind this growth. Principally, the growth is attributed to businesses around the world reevaluating their business models, as a result of the pandemic and in the context of a background of widespread digital transformation.

SAP believes that their recent success is due in part to a set of clearly differentiated capabilities. Alongside helping manage technical migrations SAP is offering businesses the opportunity to redefine and optimise their core end-to-end processes.

In addition the Rise with SAP offering is seeing strong demand from customers of all sizes. As more customers adopt the subscription model, software licenses are decreasing proportionately.

SAP Financial Performance

The current cloud backlog is now valued at €8.17 billion, and the S4/HANA Cloud backlog is valued at €1.28 billion. Cloud revenue has risen to €2.39 billion, and S/4HANA Cloud has increased to €276 million as anticipated. The reduced software licenses revenue stands at €0.66 billion, and cloud and software revenue has reached €5.91 billion.

Year over year services revenue has reduced to €0.93 billion, primarily due to the divestiture of SAP Digital Interconnect. The total revenue year over year is up by 5% to €6.84 billion.

Importantly, the share of more predictable revenue has increased to 77% in year over year in the third quarter. This is in line with the strategic move to cloud and subscription-based business models that has developed particularly over the last year.

Operating profit has decreased 15% to €1.25 billion and operating margin decreased by 4.3% to 18.2% “due to higher share-based compensation expenses (primarily related to Qualtrics)”. Another point to note here is that the launch of SAP Fioneer (the financial services unit) meant that operating profit includes a disposal gain of €77 million.

Earnings per share decreased 10% to €1.19 (IFRS) and increased 2% to €1.74 (non-IFRS), including another strong contribution from Sapphire Ventures.

The Financial Results at a glance.

The Business Outlook for 2021

The full-year outlook for SAP has been raised because of the strong business performance which is expected to accelerated cloud revenue growth. As more customers take up Rise with SAP the company anticipates further revenue decline in software licenses.

Overall, SAP expects €9.4 – 9.6 billion cloud revenue, €23.8 – 24.2 billion cloud and software revenue, and €8.1 – 8.3 billion operating profit. The share of more predictable revenue is expected to be 75%, operating cash flow of €6.0 billion and free cash flow of €4.5 billion is anticipated.

SAP Strategy Moving Forward

At IgniteSAP we are constantly looking at the road ahead for SAP for the benefit of our community. We take into account not only the obvious and traditional indicators of the intentions of the corporation such as: share price, mergers and acquisitions, hires, and what statements SAP make themselves, but also the opinions of others like SAP user groups and tech industry analysts, and the wider economic context.

In order to bring these sources of information into a coherent whole we can take a step back and review a longer period than a quarter or year to date, and look at all the actions of the company: not just those that can be presented on a spreadsheet.

In our previous article we alluded to SAP’s long-term strategy with respect to S/4HANA Cloud and the Rise with SAP platform. In this case we can put the financial review of the quarter in context with a look at the last twelve months from September 2020 to September 2021.

What a Difference a Year Makes

Last September IgniteSAP reported on the hiring of an ex-Microsoft executive with a specialisation in the cloud: Sabine Bediek to take up a post of “Chief People and Operating Office”: essentially a human resources role but in the pandemic context ,which suggests that SAP were keen to keep their cloud workforce motivated and updated as this was naturally a key area for SAP development in the months to come.

There were echoes of this appointment in the hiring of Julia White in January and Arpan Shah which we discussed last week. These were two other ex-Microsoft executives with a background in cloud and product management and marketing.

Cloud and more Cloud

In among announcements of a variety of sustainability projects and new partnerships, or extensions to existing partnerships, SAP was busy reacting behind the scenes to the pandemic and in line with wider trends in the industry. This meant cloud and more cloud. Here is a quote of Christian Klein from about this time last year:

“By accelerating the move into the cloud, we will even further increase the productivity improvements in our cloud delivery operations. We have decided to speed up the modernisation of our cloud-delivery to enable a more resilient and scalable cloud infrastructure. This will require additional investments in the next two years but allow us to largely complete the modernisation in this timeframe and achieve a cloud gross margin of approximately 80% in 2025… For our cloud business, we assume that the negative COVID-19 impact will start to ease in mid-2021.”

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That was Klein speaking during the 3rd Quarter financial statement for 2020. During the same conference Luka Mucic made clear the other half of the strategy:

“…we’ll be moving large parts of our ERP customer base from on-premise to the cloud, move them out of the upfront software licensing model and into the rateable subscription licensing model… so it will not be as rapid in our case as we are talking about an option for the customers. Why does this make financial sense? That’s the second important point, because we are increasing customer lifetime revenue as we are expanding our role from a software vendor to a cloud provider for a significant part of our portfolio.”

Honest Ambitions

The 3rd quarter statement made last year and the “revised mid-term ambitions” were widely described as a terrible blow for SAP and the markets reacted accordingly. Consequently the share price took a big dip.

We could argue however that SAP realised that they were going to need to scale back economically observable growth in order to compensate for the pandemic, and consolidate their new position. What could be described as being too honest with the public and investors appears now to have been SAP taking the difficult steps that allowed them to set new, achievable goals.

The Fruits of Their Labours

A year later SAP have demonstrated that they have assessed the economic environment and their position within it, defined clear goals and achieved them. This could be considered prudent and resilient management of a corporation. The 2020 3rd quarter statement caused a big dip in SAP share price but over the course of the last year to the SAP 3rd Quarter Financial Review, SAP has almost recovered the whole of that share price and the corporation is set on a course which, given a much stronger place in the cloud market, in moving their existing customer base to cloud, moving to a subscription-based licensing model, and adding net new customers, appears to be a far stronger and more stable direction.

Read More: SAP Financial Report Q2 2021: Every Cloud Has A Silver Lining