SAP SE (FWB: SAP) – market cap as of 23/11/2018: €109.7bn ($124.5bn)
Introduction
On November 10th, 2018, enterprise software giant SAP announced that it would acquire Qualtrics, one of cloud computing’s rising ‘unicorns’, for $8bn in cash. The announcement was made shortly before the much anticipated Qualtrics IPO, which had been under preparation for months. The deal marks SAP’s second biggest acquisition ever, the first being the $8.3bn acquisition of travel and expense software company Concur. The Qualtrics acquisition also marks the latest in the recent wave of acquisitions by enterprise software companies, from the $34bn IBM-Red Hat deal to the $7.5bn Microsoft-Github deal. The all-cash SAP-Qualtrics deal indicates a rather heavy implied premium offered by SAP, as Qualtrics was valued at $2.7bn post its latest round of private funding in 2017 and the most optimistic estimates for the IPO valued the company no more than $5bn.
About SAP SE
SAP SE (Systems, Applications & Products in Data Processing) is the developer of an enterprise resource planning (ERP) cloud software. Founded in 1972 and headquartered in Germany, SAP is the largest software group in Europe and the global market leader in enterprise application software. SAP’s business solutions are adopted by over 13,500 companies around the world in numerous industries such as electronics, utilities, banking and pharmaceuticals, to name a few. Additionally, 77% of the world’s transaction revenue involves an SAP system. SAP markets its services in software consulting, training and support services in more than 120 countries through its 76 international subsidiaries, under SAP America, its U.S. subsidiary. SAP is listed on both the NYSE and the FWB, the Frankfurt Stock Exchange. It is the largest German company by market capitalization and it’s a component of both the DAX index and the Euro Stoxx 50.
SAP generates its revenues from two divisions – Cloud Segment and On Premise. While the Cloud Segment includes marketing and selling of subscriptions to cloud software offerings developed by SAP, the On-Premise Services segment provides implementation and educational services on the use of software products. This division focuses on what’s called Operational data (“O”) and supports with software the functioning of every information technology-linked aspect of the firm.
On a year-to-date basis, SAP revenues were up 4% from $16.6bn to $17.3bn, mainly driven by the Cloud segment in which the Cloud Subscription revenues increased by a significant 29% to $3.6bn, but the more profitable software license segment, in which enterprises pay not on a periodic basis but una tantum for a piece of software, was down 9% to $2.6bn. The operating profits are very solid with an increase of 13% from $2.9bn to $3.3bn from Q1 to Q3. To give an idea of the yearly results in 2017, revenues were $23.5bn and operating profits were $4.9bn. With an accelerating number of companies adopting cloud services and with SAP’s recent expansion in the space of Internet of Things (IoT), there is potential for a consequent phase of revenue growth for SAP
About Qualtrics
Qualtrics is a software-as-a-service company (SaaS) that started off as a survey research tool for academia and went on to become and a leader in experience management. Experience Management (XM) is the process of monitoring every interaction people experience with a company in order to spot opportunities for improvement. Founded in 2002 as a family-owned tech company and headquartered in Utah, US, Qualtrics focuses on user experience data (also known as X data) that focuses on business experiences of the customer (through customer experience or CX), product (PX), employee (EX) and brand (BX). It also has business operations in the segment of Research on Demand and a predictive intelligence engine called iQ. Qualtrics platform has a host of smart features such as sentiment analysis and statistical regression techniques to predict the highest priority actions a person might take next. Over 8,500 business enterprises across the world, from 75 of the Fortune 100 to 99 of the top 100 US business schools are clients of Qualtrics, whose single system of record for all experience data enables them to consistently strengthen customer loyalty by optimizing customer experience.
Qualtrics has remained cash flow positive every year since its onset, with all the primary capital raised to date having stayed intact on its balance sheet. The organization recorded a revenue of $289.9m in 2017, up 52% year-on-year and recorded $184.2m in the first 6 months of 2018, up 41.7% year-on-year. 75% of Qualtrics revenue is subscription-based, and the company had recorded an implied annual recurring revenue (ARR) of $288.1m by the last quarter, indicating a growth of 42% year-on-year. It also recently marked its profits, with a net income of $2.6m in 2017 compared to its loss of $12m in 2016.
The company, prior to its planned IPO that aimed to raise $200m, raised $180m from venture funding in 2017. Backed by top tier venture capital firms such as Sequoia Capital, Accel and Insight Venture Partners, Qualtrics was valued at $2.5bn after this last raise.
Industry overview
The CRM (short for Customer Relationship Management) software combines all information available to the company to give one, holistic view of each customer in real time. This allows a company to improve in areas such as sales, marketing and customer support by making quick and more informed decisions. It is therefore not a surprise that this market is booming with estimated total revenues of $39.5bn in 2017, according to a Gartner research, and estimated CAGR of 16% from 2017 to 2022. The major market players, with the notable exception of Salesforce, are mainly sub-branches of big tech conglomerates such as Oracle (through Oracle Siebel), SAP, IBM, and Microsoft (through Microsoft Dynamics). But there are many other challengers in the industry, mostly startups of different sizes that are able to dominate a niche of the market. Two particularly relevant names are Qualtrics with its $289.9m in revenues in 2017 and SVMK (official name of SurveyMonkey) that went public on the Nasdaq in late September and with revenues for 2017 around $210mn.
The industry leader is Salesforce: an established tech company with $91.6bn in market cap and $8.3bn in revenues in 2017, capturing almost a quarter of the entire industry, which has been able to grow its revenues at an impressive average rate of 25% over the past 4 years.
A further distinction needs to be made: the incumbent tech giants offer services mainly on a single hardware system or device. This means that it is hard to use that technology to operate cross-platforms and to easily move the files using online databases. This is the reason why many smaller cloud-based services like Qualtrics managed to survive and thrive in the first place, but now the incumbents realize that, being unable to internally develop those systems quickly enough to surpass competition, they have to turn to M&A to implement those cloud solutions and stay relevant in the business. But a strong pressure is put on them, as they have to hurry up before these new unicorns turn to profit and their valuations skyrocket.
Deal structure
With the deal announced on Sunday, SAP agreed to acquire the entirety of Qualtrics’ outstanding shares in exchange for an $8bn cash consideration. The deal came out of a dual track process, therefore securing Qualtrics much more bargaining power if compared to a traditional M&A deal. In fact, SAP stepped in while the American technology platform’s first day of public negotiations was already planned for November 15th. In order to convince Qualtrics to take down the IPO to exercise the M&A exit clause, SAP had to offer quite a high price – evaluating its target company at 20x year-to-date revenues – therefore successfully turning a potential $6bn oversubscribed IPO into a private sale. The transaction is expected to be closed by 1H 2019.
From a financial perspective, acquisition costs – which included unvested employee incentive compensation – were covered through existing cash and a newly raised $7bn loan. However, since SAP is a sound and cash-flow rich company, generating over $3bn in FCF before acquisitions per year and expected to keep that pace for the future as well, the considerable size of the deal does not seem to be an issue. In fact, even under the hypothesis of doubling net debt to reach approx. $7bn, it would take only a couple years for the German software giant to pay down the whole amount, without considering the results generated by Qualtrics’ extra-business.
From an operational standpoint, instead, since the deal takes on the typical traits of an acquihire, Qualtrics will maintain both its headquarters, personnel, branding and culture.
Deal Rationale
The deal embodies SAP’s shift from traditional, on-premises enterprise software services to the ever-growing world of the cloud, in the attempt of proposing to the market as a one-stop-shop encompassing all digital offerings.
From a series of recent public statements, the deal can be seen as a response to the longstanding rivalry with Salesforce to crown the best-in-class enterprise cloud services company worldwide. In fact, both CEOs were publicly making promises of beating the rival, not just on the basis of Client Relationship Management – Salesforce’s core business for almost two decades, therefore setting the US company in advantage vis-à-vis the European competitor – but referring to the whole business. With this deal, SAP is trying to move from its mostly operational software (“O”) used to practically run a company to a front-end solution that provides also data driven decisional technology, offering a comprehensive service that no other company could provide.
More specifically, SAP’s revolution builds upon the strengthening of the new Experience Management (“XM”) category, in which SAP was already a top player, by betting strong and buying one among the other main providers in the industry. The combination of the German software house’s outstanding capabilities in managing what is called Operational data and the US platform’s Experience data, the newly created company would be first in line in the offer of a unique, immediately globally scalable, end-to-end tool to empower organizations. The deal represents a revolutionary transformation on the same lines as the previous game-changing market-driven industry transformations such as the shift towards personal operating systems, smart devices and social networks.
Since Qualtrics is absent outside the American market, while SAP already touches upon 77% of worldwide transactions, the geographically complementary network of the latter would constitute for Qualtrics an opportunity to rapidly grow scale and start business with a like-minded, globally renowned partner, owning all that is needed in order to introduce experience management to millions of customers worldwide well before Qualtrics best estimates.
Market reaction
The tech sector experienced a huge fall in prices during October, therefore the market reaction must be read in a context of nervousness in the markets. SAP stock was hit particularly hard, losing as much as 17.5% of its value from late September. The acquisition, despite the strategic fit was not enough to make the stock rebound. Indeed, on Monday 12th, the first opening after the announcement, the stock closed at $130.5, down 5% from $136.9 of Friday, and kept going down over the following days reaching $121.1 a week after. The most probable interpretation is that, despite a solid 30 to 40 percent top line growth estimated for Qualtrics, its overall impact on SAP’s profit remains very distant in the future and the uncertainty over the tech industry as a whole probably affected the willingness of investors to put their money on this bet. As for Qualtrics it was probably set up to have an IPO less brilliant than its competitor MonkeySurvey, despite overall better financial figures, due to unfavorable market conditions.
Financial Advisors
Qualtrics was advised on the transaction by Qatalyst Partners and Goodwin Procter, LLP. , while J.P. Morgan acted as financial advisor and Jones Day acted as legal advisor to SAP.
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