B2B Software on a Tear (SAP)

For a German translation by Vanessa Krauth, click here.

Software can be a high-margin business for companies with popular products. Microsoft is a perfect example. Their balance sheet gave them the capital to work with Yahoo and spend $100 million advertising their new search engine Bing. Google is also a software company – albeit of the media variety. But these aren’t the only companies worth considering.

German software company SAP (SAP) is proving to be a global powerhouse yet again. This business-to-business giant designs and distributes software for supply chain management, product and customer relationship management. SAP weathered some tough times to rebound with a second-quarter profit that exceeded expectations. What is behind the success?

For one, profit margins are looking up – mainly from cost-cutting efforts. SAP cut 2,800 jobs in the first half of this year. According to CEO Leo Apotheker in a recent interview, “We will continue to be a very disciplined company… In the last few quarters we’ve used this opportunity to become a leaner and more agile company.”

This is just the sort of thing you might expect from an old-school German business. Figures back up his claims. SAP improved its full-year outlook for operating profit margin from a range of 24.5% – 25.5% in April to 25.5% – 27%. When the economy roars back this operating leverage will works in their favor, as the lean machine will see profits soar.

Others are taking notice. Merrill Lynch recently upgraded SAP shares to buy from neutral, the second upgrade within two days for SAP. That’s a big coup for any company. Oppenheimer analyst Brad Reback added “SAP is in a solid position with a good product lineup and customers who like them. The big question is how much they’ll give back to investors when things turn around.”

Another vote of confidence came from research firm IDC. In a recent market analysis, IDC found that SAP has the leading market share and highest share gain of any vendor. The report also highlighted that SAP’s market share is approximately twice as large as its nearest competitor. In addition, growth in 2008 was 17.8 percent – almost double overall market growth.

SAP Germany says these figures represent a selling environment that is still tough. Optimism remains high, however. Bill McDermott, executive board member and head of field operations, said SAP expects the sales climate to improve as the year continues. “There is a steadily improving pipeline in all regions of the world, and in all industries, in fact.”

The company’s optimism can be seen in recent acquisitions. SAP said it would pay $90.6 million to purchase SAF Simulation, a Swiss software maker. SAP feels that this deal will give them a stronger product base for their customers.

Peeking at the chart, SAP has been on a tear since early July. The strong uptrend is firmly in place. We understand the desire to wait for a pullback in this low-volume market. But now could be an opportunity to get in while the rest of Wall Street vacations at the beach.

To go with a solid play in the B2B software space, buy SAP.