SAP rally could bode well for sector

Wall Street analysts speak of an Internet-sparked rebound for the software giant, which is expecting fourth-quarter profits to double.

Kim Girard
Kim Girard has written about business and technology for more than a decade, as an editor at CNET News.com, senior writer at Business 2.0 magazine and online writer at Red Herring. As a freelancer, she's written for publications including Fast Company, CIO and Berkeley's Haas School of Business. She also assisted Business Week's Peter Burrows with his 2003 book Backfire, which covered the travails of controversial Hewlett-Packard CEO Carly Fiorina. An avid cook, she's blogged about the joy of cheap wine and thinks about food most days in ways some find obsessive.
Kim Girard
4 min read
After several bruising quarters for SAP, Wall Street analysts today touted a rebound for the software company after it said it expected fourth-quarter profits to double.

The Q4 surprise sent SAP's shares soaring 27 percent in trading this afternoon to reach 55.88, after setting a new high of 57. Shares closed at 60. In research notes issued today J.P. Morgan analyst Devika Malik said she saw strong sequential turnaround from SAP, while Merrill Lynch analyst Coleen Kaiser called it a turnaround of great proportion.

Analysts say SAP's expected results could mark the first signs of a recovery within the enterprise resource planning (ERP) software market. Others believe the turn simply means that SAP, the world's No. 1 enterprise software maker, is pulling further ahead of rivals Baan, PeopleSoft and others, and succeeding with plans to transform its software for the Internet.

While companies use ERP software to automate business management functions, including financials, order entry, manufacturing and accounting, SAP and others are quickly expanding into new areas such as selling procurement software and setting up online marketplaces where customers can do business with partners and suppliers.

Overall, this week was a mixed bag for ERP companies. On a high note, PeopleSoft, which has struggled with reorganization and employee turnover, said it expects to meet or beat Wall Street expectations for the fourth quarter with license revenues expected to grow 30 percent to 35 percent. Rival Baan warned of wider-than-expected losses as its popular CEO Mary Coleman handed in her resignation after just seven months on the job.

For the quarter, SAP said in a statement it expects pre-tax profits will be "significantly" higher than the same period in 1998, excluding charges of roughly $123.5 million in the quarter for the company's employee bonus program. Those results are a far cry from last quarter, when SAP shocked investors with profits that fell 64 percent to $48.6 million from nearly $135 million in the year-ago quarter.

"The third quarter really was the bottoming out (of the market), but we're starting to see the growth again in the traditional ERP market validated by SAP today," said Merrill Lynch's Kaiser. Kaiser said she plans to raise her earnings forecast for SAP within several weeks and maintains a "strong buy" rating on the stock.

Rob Kugel, a financial analyst at FAC/Equities called SAP's announcement today a "leading indicator that the ERP market is recovering, but also an indicator that SAP is further distancing itself from its rivals. Their results are a heck of a lot stronger than anyone else's."

Kugel, who predicted SAP's software license sales would be flat for the quarter, called SAP's news "verging on a blowout."

New software license sales are expected to reach $823.25 million in the fourth quarter, an increase of about 40 percent compared with the same period a year earlier. SAP rival Oracle, which saw its shares soar last month after a break-out quarter, reported a 31 percent increase in license revenue growth.

While SAP is not expected to detail results until Jan. 24, analysts say stronger software sales are credited, in part, to the company's mySAP.com Internet products.

"Software sales are really what everyone is focusing on right now, which indicates mySAP.com is being well received and that bodes well for their future," said J.P. Morgan's Malik.

Merrill's Kaiser said while she'd like to believe strong numbers were fueled by SAP's Internet software, a hefty dose of revenues came from ERP software sales. She added that SAP, which released a chunk of its CRM Internet-based software in mid-December, has a backlog of companies waiting to buy the new applications.

Chuck Phillips, a financial analyst at Morgan Stanley who upgraded his rating today on SAP's stock to "outperform" from "neutral," cited overall modest improvement in the ERP market, driven by a move to Internet software, although most analysts don't expect the market to ever return to its high-flying 60 percent growth rate.

"ERP plus (the Internet) is really the story here," Phillips said.

Phillips said while companies' stock option programs will hurt earnings, SAP's decision to offer one is beneficial to the company in order to retain employees.

On the conservative end, Lehman Brothers analyst Brian Skiba, who rates the stock a "buy," said that despite SAP's stock improvement, the company continues to face troubles with sales-force performance and employee turnover, as well as executing its new Internet strategy.

"We advise investors to be cautious with this name in the near term," he said.

Phillips, however, said SAP's news signals "the worst is over."