SAP Growth Getting Challenged

SAP AG (SAP) reported slightly higher revenues and weaker-than-expected earnings in second quarter of 2008 due to the costs of BOBJ acquisition. The company continued its growth in Asia, Americas and Europe.

Additionally, the company proved it is still competitive with the larger deals, winning Heinz Company (HNZ) and Hallmark during the second quarter. Despite this, the uncertainty regarding its willingness to look for larger acquisitions to help fuel its growth, compared to its previous organic growth strategy is likely to hinder the company’s stock performance in the near term.

The majority of the company’s top-line growth comes from higher software license sales, which grew by 34% year-over-year in 2Q08 while support revenue grew by 29% in constant currencies in 2Q08. The company’s total market share in Core Enterprise Applications stood at 33.7% at the end of 2Q08, the highest in its industry. It also reported its tenth consecutive quarter of market share gain in 2Q08.

However, our four major concerns about SAP revolve around competition, currency, integration risks and valuation. Based on the results of the second quarter and the guidance given by the company, we have slightly increased our previously estimated revenue and maintained earnings estimates in US Dollar and Euro terms, while fixing an average exchange rate of Euro 1=$1.5403 for 2008 and Euro 1=$1.54 2009.

We continue to expect the company to continue to grow its revenues and earnings in excess of 10% on a constant currency basis in 2008 and for 2009, and the second quarter only strengthens our beliefs. Therefore, we continue to rate shares of SAP a Hold with a target price of $58.75 over the next six months or 22.34x our 2008 EPADS estimate of $2.63.

Udayan Mukherjee contributed to the report.

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