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Thursday, October 19, 2006

SAP Fails to Let Results Speak for Themselves (SAP)(ORCL)

By William Trent, CFA of Stock Market Beat

We will be the first to admit that discussing enterprise class application software is about as fun as watching paint dry. Which is all the more reason to follow the ongoing rivalry between Oracle (ORCL) and SAP (SAP): each companies’ frequent snide remarks about the other turn a dull business into soap-opera-class entertainment. We can’t wait til the next time one of their executives moons the other again.Until then, however, we do have SAP’s earnings report - which was a good one.

SAP bounces back with 16% third-quarter profit growth - MarketWatch
SAP (SAP) said net income rose to 388 million euros ($486 million), or 1.27 euros a share, with revenue up 11% to 2.2 billion euros.

Software license revenue, a key barometer of future prospects as the company gains further revenue in the future off of maintenance and consulting, grew 17% to 691 million euros in the third quarter. Analysts had expected SAP to generate 14% growth.

License revenue had grown just 8% in the second quarter.“We reported a strong third quarter with an impressive win rate and double-digit software revenue growth in all regions,” said Henning Kagermann, chief executive, in a statement.

Oracle (ORCL) , SAP’s leading rival, reported a 19% profit rise in the quarter ended Aug. 31. SAP fared well in Oracle’s home market, with U.S. license revenue up 15%.“This long track record of outstanding performance can be largely attributed to our successful strategy of growing SAP organically. This disproves our major competitor’s claim,” Kagermann said in a clear reference to Oracle.

The problem with these snipes is that they effectively cause SAP to elevate Oracle to peer status before they have earned it. (Even after their multi-billion dollar acquisition spree Oracle has only half the application market share as SAP).

As Bloomberg reports:
Ellison, 62, is a master of applying Sun Tzu’s precepts to the modern-day warfare of business competition, say those who know him. One basic tenet notes a smaller force can beat a larger one by causing its rival to respond before thinking.

“Larry consistently executes `The Art of War’ better than any CEO,'’ CEO Marc Benioff, who has described Ellison as a mentor, said in an interview. “SAP never should have reacted to Oracle’s statements because it makes customers and investors view Oracle as a peer to SAP, when they aren’t.'’

Getting back to the boring side of things however, we will note that 15% growth in license revenue is quite good. As we have written before, license revenues are an imporant indicator of future growth for software companies. And while Oracle’s self-reported organic license growth was 47% in the latest quarter, some analysts have called that into question.

Oracle reported application license sales grew 80 percent in the first quarter. Stripping out sales from Siebel and other recent acquisitions, application license sales gained 47 percent, Oracle said.

Charles Di Bona, an analyst with Sanford C. Bernstein, disagrees with Oracle’s math. Factoring in Siebel Systems’ third quarter sales, before its acquisition, Di Bona estimates Oracle’s organic growth for the quarter at 2.2 percent.

Oracle “will be able at best to maintain market share against SAP in applications,'’ Di Bona wrote in his Sept. 21 investors note, and said Oracle “likely lost share in the most recent quarter.'’

We still think consolidating the application software market is the right strategy and will benefit all the players in the industry. And we look forward to the ongoing barbs as the two firms jockey for position.

The author may hold a position in the securities discussed. A current list of the author's holdings is available here.

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