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SAP says big margin gains to wait until 2020, shares down 10%

By Douglas Busvine
FILE PHOTO: The logo of German software group SAP is pictured at its headquarters in Walldorf

By Douglas Busvine

FRANKFURT (Reuters) - SAP told investors not to expect a major improvement in margins before next year as the German business software group reported a 21% decline in second-quarter operating profit on Thursday, sending its shares sharply lower.

Europe's most valuable tech firm reiterated its forward guidance and CEO Bill McDermott expressed his "absolute commitment" to meeting a strategic goal of expanding margins by 5 percentage points through 2023.

Shares fell 10% at the open as revenue and operating profit came in below expectations, weighed down by one-off costs and weakness in Asian markets. That hurt broader sentiment after weak results overnight from streaming service Netflix .

Knut Woller at brokerage Baader Helvea said growth momentum had cooled after a strong start to the year. But, in a flash note, he said he still saw SAP on track to meet its yearly targets - as long as economic conditions don't deteriorate further.

Investors, including U.S. activist fund Elliott, had driven SAP's shares to all-time highs after management launched an efficiency drive in April, and are keen to see evidence that it is starting to pay off.

They also anticipate major share buybacks, to be announced at a capital markets day in November, with JPMorgan seeing potential to return between 11 billion and 20 billion euros ($12-$22.5 billion) to shareholders over four years.


LICENCE REVENUE SLOWS

The spring quarter was, however, marked by a 5% decline in licence revenue, the result of trade tensions that took their toll on Asian markets in particular.

Until now, software companies have suffered less from the escalating trade dispute between the United States and China than companies in the semiconductor and auto industries that have issued a slew of profit warnings.

Software licences and support, SAP's legacy business, still account for more than half of its revenue and the bulk of its profit. But because most revenue on new deals is recognised up front, it is more volatile than the company's smaller, but faster-growing cloud business.

In the cloud, a 4-point expansion in gross margins and a fourth consecutive quarter of 40% growth, showed that SAP's operational performance was on track, McDermott said in an interview: "We're very happy with the direction this is moving."

That trend is being supported by SAP's growing partnerships with 'hyperscale' cloud computing giants Amazon, Microsoft and Google.

Such remotely hosted services are subscription based, making them easier to forecast than "lumpier" software licences. That, in turn, helped SAP lift its share of predictable revenue by 3 percentage points to 69% in the quarter.

It targets a 71% share next year and 75% in 2023, part of a drive to make the business, based in the Rhineland town of Walldorf, a safer long-term bet for investors.

McDermott, 57, said he was not unduly concerned by the dip in licence fees. Experience showed that clients in wait-and-see mode often come back with bigger orders later as they reconfigure supply chains in response to changing conditions.

"As people see the need to reorient supply chains, or think differently about the regulatory environment, they tend to broaden the spectrum of what they buy from us," he said, adding that such deals "tend to get bigger".

ONE-OFFS WEIGH

Operating profit of 827 million euros was hit by charges from a restructuring that will see more than 4,000 staff leave SAP, the $8 billion acquisition of customer sentiment tracking firm Qualtrics and cash-settled staff bonuses.

Year-on-year comparisons would become more favourable in the second half of the year, CFO Luka Mucic said, adding that he expected a "very meaningful step upwards" in profitability from next year.

SAP competes in areas such as finance and logistics, known as Enterprise Resource Management, with Oracle, which recently reported stronger-than-expected earnings. It competes with Salesforce in Customer Relationship Management.

After adjusting for one-offs, SAP's operating profit at constant currencies rose 8% in the second quarter - in line with revenue growth but below Eikon Refinitiv estimates. Adjusted operating margins were flat at 27.3 percent.

SAP reiterated its guidance for adjusted operating profit to grow by between 9.5% and 12.5% this year.


(Reporting by Douglas Busvine; editing by Michelle Martin and Jason Neely)