Fourth quarter will be 'dynamite', says SAP

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The key question for investors is whether a tipping point is at hand for SAP.
The key question for investors is whether a tipping point is at hand for SAP.

SAP, Europe's most valuable technology stock, predicted a "dynamite" fourth quarter for its cloud computing business, helping its shares erase losses after third-quarter results fell short of market expectations.

The German software maker is in the midst of a transition to offering cloud-based services to business customers, and management had flagged that 2017 would see a trough in profit margins as it invested in data centres and redeployed staff.

CEO Bill McDermott said SAP was seeing more customers using its new cloud-based S/4HANA business planning products to overhaul their organisations and supply chains. Such large-scale deals tend to close in the fourth quarter.

"You can expect a dynamite Q4," McDermott told investors during a conference call. "Don't worry about bookings, relax, it's going to be terrific." He added that SAP would report "at least 30% year-over-year cloud bookings growth".

SAP shares erased earlier losses of more than 2% to trade flat at 1310 GMT following McDermott's bullish comments. The company, the biggest component of Germany's blue-chip DAX index, has a market value of EUR116.5 billion ($138 billion).

Third-quarter revenue for the business planning software provider grew 8% to EUR5.59 billion ($6.6 billion) from a year earlier, falling short of the mean forecast of EUR5.71 billion from 16 analysts surveyed by Reuters.

Core profit excluding special items rose by 4% to EUR1.64 billion at constant currency rates, below the EUR1.69 billion expected.

The euro's strength sliced four percentage points off core profit, which was flat after taking currency moves into account. Analysts at Baader Helvea said they expected currency headwinds to continue for the next three quarters.

The company nudged up guidance for full-year core operating profit to between EUR6.85 billion and EUR7 billion, and said 2017 total revenue would range from EUR23.4 billion to EUR23.8 billion, marking year-to-year growth around 6% to 8%, excluding currency effects.

In the cloud

Cloud subscriptions and support revenue rose 27% in the quarter to EUR938 million, excluding currency effects, compared with the 29% analysts had expected, on average.

This was offset by its classic software licence and support business revenue, which rose 4% to EUR3.72 billion, slightly above the 2.2% growth rate expected.

CFO Luka Mucic said the slowdown in new orders growth in the last quarter had coincided with accelerated investments in the cloud business.

As this spending rolls off, an improvement in margins will start to shine through in the current quarter, setting the scene for "exponential" growth in gross margins thereafter, he said.

The number of S/4HANA customers rose 70%, year-on-year, of which 40% were net new customers, SAP said.

The platform drives SAP's core product offering ? delivered via the Internet or on-site ? but its human resources, travel management and business-to-business marketplace products are still being integrated into it.

Competitors such as, Workday and Amazon Web Services offer cloud-only services, challenging the legacy businesses of SAP and its long-time rival Oracle.

The key question for investors is whether a tipping point is at hand for SAP to return to delivering consistent growth in profit margins late this year or during 2018.

That would reverse five years of declining growth in core profit margins as the company spent heavily to shift its business into the cloud, instead of relying on traditional software licence sales for its suite of business planning tools.

SAP management has signalled its rapid employee expansion since 2015 should slow in coming quarters as its cloud-focused hiring spree runs its course.

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