SAP takes ‘margin hit’ amid COVID-19 cloud reset

• Shares for German software giant SAP tanked 20% amid a pessimistic outlook citing withering software spend in 2020 
• The firm will scrap ambitious plans, and refocus on shifting customers to the cloud — but the benefits will take time

We’re certainly not through the thick of it, and SAP’s slashed revenue and profit forecasts are indication that the enterprise software industry still has a rough time ahead as it goes through the mangle.

SAP’s chief executive Christian Klein said Sunday (October 25) that the firm is going all-in on a shift to cloud computing as it abandons medium-term profitability targets. 

While spending has been reeled in elsewhere, the pandemic has accelerated spend on cloud, which rose 37% to it US$29 billion during the first quarter of 2020, according to PwC, which expects the trend to persist as an “exodus” to virtual work underscores the urgency for scalable, secure, reliable, cost-effective off-premises technology services.

Despite the inevitable economic downturn in the wake of the pandemic, cloud spending is estimated to rise 19% for the full year, according to Gartner, even as IT spending as a whole is forecast to fall 8%. 

Europe’s largest and most valuable software company cautioned that customers were spending less as a resurgence of COVID-19 and subsequent government-imposed restrictions in some markets hurt business confidence. Curbed forecasts saw shares drop by 20% wiping $35 billion of its value, marking the biggest 30-day drop in 24 years, according to Reuters. 

“Lockdowns have been reintroduced in some regions, recovery is uneven and companies are facing more business uncertainty,” SAP said, adding that it expected this to continue through at least the first half of next year. 

“As a result, larger projects are examined more closely. Transactional revenue continues to be affected, particularly in SAP Concur, where business travel-related revenue has not yet seen a significant recovery.”

The call heralded an abandoning of ambitious plans made ‘pre-Covid’, according to EAConsult’s Josh Greenbaum speaking to Reuters, as well as an earlier outlook that assumed economies would reopen and lockdowns would ease, according to SAP: “Lockdowns have been recently re-introduced in some regions and demand recovery has been more muted than expected.” 

“I think it’s a good time to take the margin hit of transitioning to the cloud, and clearly the pandemic economy is helping justify the move,” Greenbaum commented.

SAP’s chief financial officer, Luca Mucic told reporters that the shift to the cloud means the software giant’s revenues will languish over the next three years, but headwinds will turn to tailwinds after that.

Cloud revenue from subscription-based services hosted at remote data centers is expected to triple to US$20 billion by 2025, eclipsing the traditional license sales that SAP has long been built on. However, investors question whether SAP will win in the cloud against more innovative competitors. Diginomica notes that while reported growth for SAP’s cloud-based experience management platform Qualtrics looks good on paper, it’s only slightly ahead of other rivals like Medallia.