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Europe's Software Giant Takes a Step In the Right Direction

Alex Webb

(Bloomberg Opinion) -- With ambitious profitability goals, a business in flux and an activist investor hammering at the door, SAP SE Chief Executive Officer Bill McDermott’s time was up. His successors’ skill sets look better suited to meeting those challenges.

After nine years at the helm of Europe’s largest technology company – five as sole CEO, four as co-chief – the American manager stepped down on Thursday, replaced by two new co-CEOs: Chief Operating Officer Christian Klein and cloud chief Jennifer Morgan.

McDermott’s tenure was largely impressive. Through $31 billion of deals, SAP entered a string of new businesses, and generated good value for shareholders. Annual returns averaged 15% under his leadership, compared to the 12% average of European technology firms. Since he took sole control in 2014, the returns have been even higher, and the market capitalization has doubled to almost 140 billion euros ($155 billion).

Even with that growth, however, many still see the stock as undervalued: SAP trades at 21 times expected earnings, while new cloud software players such as ServiceNow Inc. trade at a multiple of 65 times. That’s partly because of some of McDermott’s operational shortcomings, not least a failure to integrate many of the acquisitions effectively and to get customers to buy into SAP’s cloud products fast enough.  

SAP’s clients feel they’re at a disadvantage in their digital transformation efforts to competitors who use products from SAP’s rivals, according to an industry body called the DSAG that represents SAP users in the German-speaking world. One major complaint is a failure of SAP to get its new offerings in the same coding language, creating additional work for their clients to get it all working together. As a result, only third of its 3,500 members trust the Walldorf, Germany-based company to accompany them well on the journey, the group told the Frankfurter Allgemeine Zeitung newspaper in September.

The road ahead looks rocky. In April Elliott Management Corp., the activist fund controlled by the billionaire Paul Singer, revealed it had built a 1% stake in the maker of enterprise software and demanded a halt to any new dealmaking. It’s targeting an increase in earnings per share that will likely require a buyback of as much as 10% of the stock. SAP simultaneously announced it intends to improve profitability by 5 percentage points through 2023, with a focus on a better gross margin at the cloud business.

The new CEOs therefore seem the logical picks. Klein is probably expected to bring the improved focus on operations needed to deliver the profit goal, and Morgan the cloud experience needed to accelerate the so far torpid adoption of its products in that market. Having been later than some U.S. competitors to pivot toward a cloud-based business, SAP is now migrating its customers away from software run on their own premises, and into its cloud offerings. Oracle Corp. sees the shift as an opportunity to steal customers from its German rival.

The push has come at the expense of SAP’s profitability, which lags the level of peers such as Oracle. McDermott already announced a major restructuring program that includes 4,000 job cuts. Another set of measures will be unveiled at an investor day in New York next month. The timing of the management change therefore gives shareholders a prime opportunity to meet the new team. They will need reassurance that Klein in particular, who at 39 will be the youngest chief executive officer in Germany’s benchmark DAX Index, can seamlessly manage the operational challenges such change inevitably poses. Cost-saving pushes can generate significant uncertainty.

McDermott’s departure does perhaps dispel any lingering doubt about who is really in charge at SAP: co-founder and Chairman Hasso Plattner. The 75-year-old looms large in the corridors of SAP’s headquarters in Walldorf. Thursday’s leadership picks mark the culmination of a wave of board changes which also saw former cloud chief Robert Enslin and digital services head Bernd Leukert depart in the past year. When, a few years ago, the company started developing its “digital boardroom,” a web portal that lets managers dig into the finest details of the company’s operations and evaluate earnings in real time, it was because Plattner asked for it, not McDermott.

As successful as McDermott was, his shortcomings also made the company more vulnerable to an activist approach. If Elliott were to push for SAP to be carved up, that would endanger Plattner’s legacy. Morgan and Klein now have to knuckle down on delivering that profitability goal. Their boss’s place in the history books is at stake.

To contact the author of this story: Alex Webb at awebb25@bloomberg.net

To contact the editor responsible for this story: Melissa Pozsgay at mpozsgay@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Alex Webb is a Bloomberg Opinion columnist covering Europe's technology, media and communications industries. He previously covered Apple and other technology companies for Bloomberg News in San Francisco.

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