BREAKINGVIEWS-SAP valuation flips from overegged to undercooked

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

By Jennifer Johnson

LONDON, Jan 29 (Reuters Breakingviews) - It’s a disorienting time to be an SAP SAPG.DE shareholder. Less than a year ago, the $250 billion German group was trading on a higher multiple of its following year's earnings than Big Tech juggernauts like Microsoft MSFT.O and Apple AAPL.O. But since then, much of the software sector has sold off as investors worry artificial intelligence could upend it. Now, an apparent slowdown in SAP's secret weapon – a mass of client cloud migrations it still has to do – has sent its stock even further south. Both its new slump and the previous peak look a bit overdone.

Major IT overhauls are rarely a quick or easy business, especially at large corporations. Yet this is exactly the sort of change SAP is looking to push on its clients with a cloud-based version of its core offering, known as S/4HANA. The pace of their migration to the new product is a key driver of sales growth – and investor sentiment. That's probably why the company's shares dived 14% on Thursday after growth in its current cloud backlog $(CCB)$ undershot prior guidance.

The figure, a measure of signed deals that will soon be recognised as revenue, reached 21 billion euros in 2025. Though that represents 25% year-over-year growth, it’s still a touch below the 26% that CEO Christian Klein promised investors at the end of the third quarter. While a deceleration isn’t good news, there’s little reason to think that clients will delay their cloud migration indefinitely – even if they’ve been slow to get started.

Analysts at HSBC estimate that only around 5% of customers using SAP’s legacy on-premise product are making the shift every year – with 60% of them yet to launch the process. They’ll soon have a painful incentive in the form of higher maintenance fees for the old system, which are due to come into effect from next year. Meanwhile, customer support will effectively be discontinued sometime around 2030.

Geopolitical tensions have also led clients to seek out sovereign software solutions, and it can take time to configure these bespoke, security-conscious setups. Upgrading existing enterprise software is also a chore for companies. Hence it seems unlikely that SAP’s customers will seek out new vendors altogether.

SAP still has to prove that it has a longer-term growth plan once its CCB backlog is cleared. But in the meantime, it has a steady revenue stream less available to other software players like U.S. group Salesforce CRM.N, which have already put more customers in the cloud. At around 24 times forward earnings, the group's current valuation better captures the potential perils of AI than the 45 times multiple it sported a year ago. It's also in line with SAP's 10-year average. Given its enduring moat, SAP investors should bear in the mind the risk of understating as well as overegging its position.

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CONTEXT NEWS

SAP said growth in its current cloud backlog (CCB) will decelerate this year after a 25% expansion in 2025. Management had previously guided for 26% full-year CCB growth at its third-quarter results.

SAP shares were down 14% to 169 euros as of 1015 GMT on January 29.

The software group reported total revenue of 9.7 billion euros ($11.6 billion) for the final quarter of last year, in line with a company-compiled consensus. It also announced a two-year buyback programme worth up to 10 billion euros.

(Editing by George Hay; Production by Streisand Neto)

((For previous columns by the author, Reuters customers can click on JOHNSON/Jennifer.Johnson@thomsonreuters.com))