SAP Comes on Strong

The headline-grabbing brouhaha over Oracle's ( ORCL) attempted takeover of PeopleSoft ( PSFT) has diverted attention away from enterprise software's rising star -- SAP ( SAP).

In the last few months, the German giant has made significant gains across a number of product lines in North America, and is now poised to become the leader of the market for customer relationship management (CRM) software.

Even more significantly for the long run, SAP is moving beyond its roots as a provider of applications and becoming a platform company with the capacity to compete against the likes of IBM ( IBM) and Oracle.

Granted, SAP probably isn't a great short-term play because it trades well above its peers on a price-to-earnings basis and other valuation metrics. The stock strongly outperformed the Goldman Sachs Software Index in the past year, rising 80% vs. 35% for the index, and has held up better than most of its peers this year.

But even if the short term proves unexciting, "most of us think it's the best stock in its group" for the long term, said Richard Parower, manager of the ( SHGTX) Seligman Global Technology fund, which owns SAP shares. "It's more expensive than its peers, but its earnings growth is strong enough to sustain the valuation," he said.

Never known for modesty, SAP executives exude confidence these days. Asked about the strength of the competition, SAP Senior Vice President Peter Graf said during an interview: "I judge them by the job applications I get, and right now I'm getting them from engineers at Oracle, and CRM guys at Siebel ( SEBL)."

Bumptious or not, Graf has a point. Siebel Systems, which has tenaciously clung to its lead in the CRM market, is within a whisker of being overtaken by SAP, according to a soon-to-be-released report from market researcher AMR Research.

AMR Research director David O'Brien said SAP's CRM revenue is likely to grow by 5% to 10% in 2004 vs. less than 5% for Siebel. Given that Siebel's CRM revenue was about $1.3 billion in 2003 while SAP's was about $1.25 billion, the German company will be No. 1 by year-end, O'Brien said, although currency effects account for some of SAP's gain.

Market share numbers are always controversial, partly because different vendors and researchers often define product categories differently and count revenue in different ways. Putting it less politely, Siebel Executive Vice President David Schmaier said that "one of these companies SAP or Siebel is not telling the truth."

Schmaier accuses SAP of cooking the sales numbers it reports to industry analysts by including CRM software that is bundled with other SAP products but neither paid for nor used. He claims that Siebel's sales force, which is involved in most potential CRM deals, only sees SAP 11% of the time. "How could they be even close to us?" he asked with some agitation. "This is one of the greatest marketing jobs ever done."

Other major research organizations, including the highly respected Gartner/Dataquest, said they have not yet completed tallies for 2003 or projections for 2004. A Gartner analyst did say that Siebel's CRM share in 2002 was 24.9% vs. 15.9% for SAP, a much smaller lead than it enjoyed the year before. In 2001, Siebel led SAP with 28.5% of the total CRM market vs. 10.9%.

Meanwhile, SAP continues to hold a strong lead in its core franchise of enterprise resource planning (ERP) software.

Weaving a Platform

ERP software is used to manage critical back-office business functions, including human resources, financials, planning and supply chains. CRM applications are generally used to manage customer and sales data, although the line between the two sectors has been blurring.

In 2003, SAP's share of the $21 billion ERP market was roughly 37%, while PeopleSoft (including J.D. Edwards) was second at 13% and Oracle was third with 11%, according to AMR. The next closest competitor was British-owned Best Software at 4%.

Right now, it doesn't look like anyone is even close to catching up.

"We believe SAP has experienced the biggest uptick in demand vs. any other software names in our universe in the past two months," ThinkEquity analyst Yun Kim wrote in a note upgrading the firm Monday. "SAP is benefiting from its de facto standard status in the ERP space, which is why it is seeing accelerating demand and increasing deal size relative to its two closest ERP competitors," Kim added. (ThinkEquity is seeking investment banking business with SAP.)

Other reasons for the uptick: The battle between PeopleSoft and Oracle, which has frightened some of their customers into the arms of SAP, said Seligman's Parower. Also, SAP has been able to expand its leadership in serving manufacturers in the hotly contested small- and medium-sized business (SMB) market.

Piper Jaffray analyst Tad Piper recently surveyed dozens of executives at the National Manufacturing Week conference and found "SAP already has a meaningful position in the SMB manufacturing sector."

Long term, however, the biggest change in SAP is one that probably won't generate large amounts of revenue right away. "SAP is changing fundamentally," said Ruediger Spies, who follows software for the Meta Group from Germany. "It's expanding its reach from the applications to the technology platform."

Earlier this month, SAP released a new version of NetWeaver, software that includes an application server that will compete with offerings from IBM, BEA Systems ( BEAS) and Oracle; integration capabilities that compete directly with specialized companies like Tibco ( TIBX); as well as business intelligence functions and a portal server.

Although that may sound a bit like a Swiss Army knife, NetWeaver is more than a collection of software. In industry parlance, it is a platform, which is what IBM, for example, offers its customers.

NetWeaver is a structure that a company can use to develop and manage its business software, including applications from rival companies. And that's another change. "In the past we haven't been known as a very open company," said Graf.

Open software is designed to industry standards and is interoperable with other software. By becoming more open, SAP can sell its software to companies that have no intention of abandoning existing software from other vendors.

Still, SAP's target audience for NetWeaver in the next year is its massive installed base -- about 20,000 customers worldwide, said Graf. "Right now, it's an upsell opportunity." By 2005, however, SAP will be pushing beyond its base.

"In the short run, NetWeaver isn't what the stock market is looking at," said Wells Fargo analyst Eric Upin. Margin expansion, share gain and a new-product cycle are all of more immediate interest. (Wells Fargo does not have a current banking relationship with SAP.)

Judged by those standards, SAP "is a solid story," he said. "I don't see a major growth catalyst in the next few quarters, but the longer picture is very robust," a conclusion many on Wall Street have reached of late.

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