SAP Warning Spooks Investors as Company Accelerates Shift to Cloud

Halloween came a week early for investors spooked by Sunday’s SAP warning that business will remain weak. In addition to lowering revenue and profit forecasts for 2020, the pain could extend for the next several years.

The news came with SAP’s third quarter earnings release. Revenues of €6.53 billion (equivalent to $7.67 billion USD) fell by 4% compared to the same period last year. The operating profit fell 1% to €2.07 billion ($2.43 billion USD). Cloud revenue, however, climbed 10%, totaling €2 billion ($2.35 billion USD). Currency headwinds and COVID-19 contributed to the quarter’s shortfall with SAP warning those factors will linger through 2023.

SAP CEO Christian Klein announced that the company will accelerate investments in moving all of its on-premises customers to the cloud. This migration will result in more significant investment in software modernization and integration. It will also hasten the demise of highly profitable perpetual license and maintenance revenues. The SAP warning caused shares to fall 23% on Monday, the largest one-day drop in 21 years. Shares fell another 6% Wednesday.

SAP’s Christian Klein

“We have decided to speed up the modernization of our cloud delivery, to enable a more resilient and scalable cloud infrastructure,” Klein told investors. Over the next two years, SAP will invest more aggressively in modernizing its legacy solutions and creating better compatibility. The investment will result in a negative operating margin of 5% through 2023. But, looking forward, the company’s gross cloud margins will reach 80%.

Moving to a Common Data Model

“All our main solutions will adopt the cloud platform and share one semantical data model, one AI and analytics layer, one common security and authorization model, and the same application business services such as workflow management,” Klein said. “With our cloud platform powered by SAP HANA, processes can be changed, enabling agile workflow.”

Customers and partners accessing the SAP open platform can develop innovations and extensions “quickly,” he added, “using exactly the same data model and business services as our own SAP apps.”

Industry analyst Josh Greenbaum of Enterprise Applications Consulting said the moves SAP is making are long overdue.

“I think he was just being brutally honest in saying that they’re not going be able to deliver the kind of margins that they had been delivering in the past,” said Greenbaum. “He basically acknowledged they’re going to have to tough it out during the transition to a more cloud-centric future.”

SAP is not the only major IT player investing more in transitioning customers to cloud, said Forrester analyst Jay McBain.

Forrester’s Jay McBain

“Partners are quickly grappling with a subscription-based future as IBM, Dell, Cisco, and HPE have all announced 100% consumption-based models in the past 60 days,” he said. “It is a realization of the cloud acceleration driven by COVID-[19].. IaaS companies are growing in the 40s and large SaaS companies are growing in the 30s. Most of the other parts of the $3.5 trillion tech industry are double-digit negative.”

Sanjay Shah, founder and CEO of SAP Cloud Platform partner Vistex, said the move was necessary.

“It’s a reflection of the fact that SAP has not yet executed well on [its] cloud strategy,” Shah said. “They’ve a strung together a bunch of acquisitions, but they haven’t harnessed the full power and capability of these. But I believe this new management has been trying to put that in place, and then then this pandemic hit.”

Partner Impact?

Shah is not concerned that the moves will have a negative effect on SAP’s partners. Eighty percent of his customers still run on-premises SAP software. Shah said the SAP Cloud Platform is already helping to drive business modernization efforts.

Vistex on Wednesday rolled out new solutions deigned to work on SAP’s new industry cloud offerings.

“We are partnering with SAP along with the SAP Industry Cloud initiative, and offering our applications on the SAP cloud platform,” Shah said. “We feel the SAP Cloud Platform is ready for primetime now.”

The SAP warning will not result in any changes in its partner strategy, according to chief partner officer Karl Fahrbach. In an email, Fahrbach said the move actually reinforces SAP’s partner initiatives.

“Next-generation partnering focuses on helping customers transition successfully to the cloud,” he said. “SAP’s decision to accelerate cloud adoption further supports the partner ecosystem. We will continue equipping partners with the solutions, tools and access they need to thrive.”