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SAP issues warning following credit crunch collapse

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7th Oct 2008
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Only weeks after an optimistic forecast for the future, software giant SAP has announced that its third-quarter results will be below expectations. With software stocks taking a hit following the news, could there be wider implications?

By Stuart Lauchlan, news and analysis editor

If the banking crisis and the housing slump weren't enough to convince you already that there's a recession underway, there was bad news to chill the hearts of the vendors in the applications market this week: SAP has missed its sales targets for the quarter.

Only weeks after a remarkably upbeat set of predictions form the firm, the applications market leader was forced to announce that its third-quarter financial results will be below expectations after the credit crunch and resulting financial meltdown "triggered a very sudden and unexpected drop in business activity at the end of the quarter."

SAP now anticipates that its third-quarter software and related services revenue will be between €1.97 billion and €1.98 billion. That's still up 14% on last year's numbers, but below the originally-set figures that Wall Street had been expecting.

"Predictability disappeared once the financial crisis accelerated. It had had a strong impact on our ability to sign contracts. Many customers reacted with a suddenness that I haven’t seen in the last years."

Henning Kagermann, CEO, SAP

"We executed well during most of the third quarter," said CEO Henning Kagermann, but he added that "the dramatic acceleration of the financial and economic crisis" had undermined that. “Predictability disappeared once the financial crisis accelerated," he said. "It had had a strong impact on our ability to sign contracts. Many customers expressed the need to focus on shorter-term concerns and put planned IT investments on hold for now. Many customers reacted with a suddenness that I haven’t seen in the last years.

“The market developments of the past several weeks have been dramatic and worrying to many businesses. These concerns triggered a very sudden and unexpected drop in business activity at the end of the quarter. Throughout the third quarter we felt quite positive about our ability to meet our expectations. Unfortunately, SAP was not immune from the economic and financial crisis that has enveloped the markets in the second half of September, causing us to report numbers below our expectations.”

"The information we have received from customers is that the decisions that have been made at the later stage of this quarter have been broadly IT based," said co-CEO Leo Apotheker. "These things are correlated with hardware, with networking and with other types of software. This is still a short-term hold. Let's see how things evolve in the next couple of weeks.”

But SAP is also implementing cost-cutting measures, including a hiring freeze in which employees who leave won't be replaced and the number of temporary workers will be reduced – but insists that there are no redundancies. "I want to just emphasise that these are sensible steps in an uncertain time," Kagermann said. "We are not cutting out [jobs] or downsizing."

Wider implications?

SAP's share price tumbled on news of the shortfall. More alarmingly, other software stocks also took a hit, including – ironically – arch-enemy Oracle which took a 10% slump. Elsewhere Microsoft dropped 5.9%, IBM 4.4% and EMC 7.5%.

The wider implications remain to be seen. “The last two weeks of September saw a slowdown in deal flow. This is true of many companies and not just of SAP. Deals were either cancelled or deferred because of the current market climate,” said David Mitchell of research firm Ovum. “Losing a deal to 'no deal' rather than to a competitor was commonplace. The suddenness of the stall should not surprise anyone that is familiar with the way the software market works; market changes can be quite sudden. The reversal of the trend can be equally sudden and each sales week is significant in the current climate.

"The suddenness of the stall should not surprise anyone that is familiar with the way the software market works; market changes can be quite sudden. The reversal of the trend can be equally sudden."

David Mitchell, Ovum

“Most global software companies have very uneven revenues, with revenue peaks in the fourth quarter being the most visible phenomenon. However, there is also significant revenue variation within each quarter, with large volumes of business being signed in the last few days of each quarter. While this may not be healthy, it is a fact of life in this market and one that customers use to their advantage to gain the most favourable commercial terms. I have seen situations when 50% or more of the revenue in a given quarter is booked on the last 2-3 days.”

Mitchell said the hiring freeze was understandable, but not the whole solution. “This is entirely prudent. Many of the other major companies are doing the same - it's a market response not a SAP response. It needs to continue but it should not be main focus of the executive team; selling their way out of the problem is more worthy of their focus,” he said.

Companies that can demonstrate diversity in three areas are most likely to successfully ride out the storm. “The first is geographic diversity,” said Mitchell. “When the US started to decline there were still pockets of growth in EMEA and parts of Asia-Pacific. As the EMEA markets enter their phase of decline it is likely that Asia Pacific will still see growth pockets, but - more significantly - that we'll see the US markets emerging first from the crisis.

“Second is product category diversity. In an economic downturn business applications are frequently a leading indicator, with business-change-led projects being first to be suspended while 'spend to save' infrastructure projects, such as consolidation initiatives, continue unaffected. Having exposure to multiple technology product lines allows the counter-cyclicality smoothing effect to take place.

“The third diversity facet is the balance of product and services, especially those highly valuable recurring revenue services. Companies with diversity along these three axes have the best chance of riding out the storm more smoothly. Inevitably, these facets of diversification mean that the largest software companies, with the broadest portfolios, will remain the most solid during the market turmoil.”

For his part, Kagermann remains upbeat, insisting that this should not be seen as a long-term indicator for the firm's fortunes. “We could not overcome the dramatic financial crisis,” he admitted, but added: “We can weather the storm better than most.”

RightNow Technologies also saw shares fall sharply after warning that while third quarter revenue and profits will be consistent with its previous guidance, it expects to report negative cash flow from operations in the quarter “primarily due to a lengthening of payment terms and slower cash collections.”

The company also said it expects to reduce its full year guidance for cash from operations. “We are seeing more contracts with periodic or annual payment terms and slower cash collections which we believe are both being driven by recent economic conditions,” said CEO Greg Gianforte.

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