SUMMARY. Risk Level *

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1 February 25, 2015 SAP AG Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Underperform Date of Last Change 12/28/2014 Current Price (02/24/15) $69.87 Target Price $ Week High $ Week Low $63.56 One-Year Return (%) Beta 1.25 Average Daily Volume (sh) 1,048,335 Shares Outstanding (mil) 1,229 Market Capitalization ($mil) $85,836 Short Interest Ratio (days) 4.07 Institutional Ownership (%) 4 Insider Ownership (%) N/A Annual Cash Dividend $0.99 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 9.3 Earnings Per Share (%) 10.7 Dividend (%) 20.2 P/E using TTM EPS 15.6 P/E using 2015 Estimate 19.8 P/E using 2016 Estimate 19.5 Zacks Rank *: Short Term 1 3 months outlook 4 - Sell * Definition / Disclosure on last page (SAP-NYSE) SUMMARY Continuing with its string of earnings beats, SAP s fourth-quarter 2014 earnings exceeded both the Zacks Consensus Estimate and the year-ago figure, riding on the SAP HANA growth platform. Moreover, SAP s Concur acquisition during the quarter promises bright growth prospects. Also, the company projects 7x growth in the cloud to achieve its revenue target of 28 billion by Additionally, new application innovations designed for different customer groups, associated with various business lines, promises strong growth prospects for SAP going forward. However, declining operating profit, weak professional services business and high competition in the IT services industry continue to be concerns for the company. Hence, our Neutral recommendation on the stock remains in place. Risk Level * Below Avg., Type of Stock Large-Blend Industry Comp-Software Zacks Industry Rank * 153 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) ,700 A 5,318 A 5,531 A 6,913 A 22,462 A ,112 A 5,623 A 5,399 A 6,830 A 22,964 A ,776 E 5,301 E 5,405 E 6,713 E 22,195 E ,348 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.75 A $0.93 A $1.00 A $1.62 A $4.30 A 2014 $0.77 A $1.01 A $1.07 A $1.64 A $4.49 A 2015 $0.54 E $0.76 E $0.84 E $1.39 E $3.53 E 2016 $3.58 E Projected EPS Growth - Next 5 Years % Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 OVERVIEW Headquartered in Walldorf, Germany, SAP AG is one of the largest independent software vendors in the world and the leading provider of enterprise resource planning (ERP) software. Its solutions are designed to cater to the needs of organizations, ranging from small and medium businesses to large, global enterprises. SAP s business suite solutions help clients improve customer relationships, enhance collaboration, and improve efficiencies across their supply chains and business operations. The company reports its revenue under two broad segments: Software and software-related service revenues: Software revenue represents fees earned from the sale or license of software to customers. Cloud subscriptions and support revenue relates to contracts which permit the customer to use specific SAP-hosted software functions during the contract period, and which impose significant contractual penalty if the customer cancels the contract or permanently uses the software on the customer s own systems. Support revenue represents fees earned from providing customers with technical support services and unspecified software upgrades, updates, and enhancements. Professional Services and Other Service Revenue: Professional services and other service revenue comprises primarily of consulting and other service revenue. The company generates most of its consulting revenue from the implementation of its software products. Other service revenue consists mainly of revenue from the messaging services acquired from Sybase, as well as training revenue from providing educational services to customers and partners on the use of the company s software products and related topics. SAP has also built a strong cloud portfolio with SAP HANA (High-Performance Analytic Appliance). SAP HANA cloud is a platform-as-a-service (PaaS) designed to help customers, independent software vendors (ISVs), and partners rapidly create innovative software applications to succeed in a world increasingly characterized by enterprise mobility, and social and collaborative business networks. The SAP HANA database is an in-memory database that combines transactional data processing, analytical data processing, and application logic processing functionality in memory. SAP HANA removes the limits of traditional database architecture that have severely constrained how business applications can be developed to support real-time business. SAP HANA is the core of the company s business as it seamlessly integrates all offerings by SAP into the cloud to give its customers a competitive edge over its peers. REASONS TO BUY SAP follows an open ecosystem strategy, which enables it to better leverage its innovation by extending it to the partners to drive additional customer value, based on their own domain expertise. The SAP partner ecosystem is a collaborative, innovative, and interactive network of partners, customers and individuals. Through its extensive global relationships, customers have a wide range of providers and resources to choose from for software-related services and support. These include some of the largest names in technology consulting and implementation sphere, as well as smaller firms that offer highly specialized applications and services. In turn, SAP supports its partners through continual co-innovation, expansion of routes to market (channels), and services capacity. SAP s new class of solutions that power the next generation of business applications SAP HANA (High- Performance Analytic Appliance) has been driving its growth momentum, since its introduction. The company s cloud offerings powered by SAP HANA are being embraced by an increasing number of clients as the HANA cloud subscription allows companies to leverage their businesses without any upfront capital expenditure. At the end of 2014, the company had over 5,800 HANA customers and more than 1,850 HANA Business Suite customers. In order to further boost the SAP HANA platform and Equity Research SAP Page 2

3 benefit its clients through new innovations, the company recently launched several business software such as SAP S/4HANA and SAP HANA Big Data Intelligence rapid-deployment solution. Moreover, SAP has been primarily concentrating on growing its cloud business to become one of the leading players in the category. SAP is the largest enterprise software company that is working on both core innovation and cloud transitioning successfully. Further, it has a competitive edge over its cloud competitors as its processes are designed to be industry specific and can be customized to meet the business requirements. Moreover, the Concur technologies make it the second largest cloud company. At the end of the reported quarter, the company had an enterprise cloud user base of around 70 million. Key players like Lockheed Martin, Johnson & Johnson, Kellogg, MetLife and Adidas are some of the companies that opted for SAP s cloud offerings in the quarter to enhance their businesses. Encouragingly, SAP projects 7x growth in the cloud to achieve its revenue target of 28 billion by SAP follows a systematic approach to expand and market its business. The company goes to market by region, customer segment and industry. In each region, the company concentrates its sales efforts on the fastest-growing markets with the most business and revenue potential. SAP primarily invests in its go-tomarket coverage model to effectively sell industry-specific solutions while increasing its engagement with customers in line-of-business functions (for example, human resources, sales, and marketing) and users of analytics. The corporate growth strategy is based on providing simple yet effective solutions for its customers. The company has previously made a number of innovative offerings like SAP HANA Customer Activity Repository rapid-deployment solution and SAP Business One application. Most recently, SAP has introduced a mobile solution, designed to simplify the Direct Store Delivery ( DSD ) method of consumer products companies. The company s continued focus on innovation and growth is likely to enhance its top line, going forward. SAP has the largest business network comprising of about 1.7 million businesses. The company remains focused on leveraging this huge network to enhance collaboration both within and among the companies. A strong enterprise value chain brings together all the elements of a successful business including people, systems and business processes, which will be significantly beneficial for its users. The Concur acquisition perfectly complements SAP s endeavors by enhancing and extending its existing network capabilities significantly, adding markets worth $1.2 trillion to the company s business. This apart, the earlier acquisitions of Ariba and Fieldglass networks have also augmented the company s business network to a great extent. All this is resulting in a continuous solidification of the company s position in the cloud-based corporate travel market. Equity Research SAP Page 3

4 REASONS TO SELL SAP is a global enterprise generating a substantial portion of revenue from countries outside the United States. Hence, as the company establishes its operations internationally; it is highly exposed to the negative impact of volatility in foreign currency. Also, competition is intense in the IT services industry. The company competes with large IT service providers with greater resources such as Accenture, Computer Sciences Corporation and IBM Global Services. The company s professional services business has been witnessing continued weakness owing to the demand shift towards the consulting services business. Also, SAP s business being spread across the globe is more prone to be impacted by the political and economical conditions. The prevailing macro uncertainties in regions like Latin America, especially in Brazil and Argentina are negatively affecting the company s business. SAP has grown its cloud business principally through acquisitions, which impacted its balance sheet in the form of a high level of goodwill and intangible assets. Further, the company s margins are expected to be under pressure and it expected to generate lower upfront revenue in the near term, as it refocuses on cloud-based software technology. RECENT NEWS SAP to Improve NHL's Visual, Back-Office Experience Feb 20, 2015 SAP and the National Hockey League ( NHL ) have entered into a strategic partnership to transform ice hockey through innovative technology. The tie-up between the two companies is also aimed at boosting the NHL s back-office operations with quality software, supporting an effective business administration. The partnership, likely to span multiple years, is expected to provide unparalleled customer experience for ice hockey fans. Currently, SAP HANA Enterprise Cloud service powers the renovated statistics platform of NHL.com. The latest deal is, practically, an effort to strengthen the statistics platform by leveraging the growing fan engagement and loyalty. Being the NHL s official cloud software provider, SAP had undertaken multiple design workshops to renovate its existing statistical platform, in order to provide an interactive and personalized experience for fans. The NHL s latest data platform uses the real-time competency of SAP, with the help of which the page has completely overcome the initial problem of being highly static. Moreover, visual appeal of the presentations of current and past ice hockey statistics will likely increase with the adaptation of SAP HANA Enterprise Cloud service. Redesigning of NHL.com/Stats is a rather lengthy process and will be completed over multiple phases. The first phase captures innovative design and enhanced statistics visualization experience. The following phases are expected to incorporate advanced filtering methods, playoff prediction tool, team power index and finally, the technique that will enable fans to effortlessly compare historical data related to the NHL, players and other facts. At the same time, NHL management plans to utilize a number of SAP technologies to simplify its business operations and improve overall administration. Services like SAP Cloud for Customer solution, the cloud edition of SAP Lumira software, SAP Predictive Analytics software and SAP Data Services software are likely to offer long-term benefits to the NHL. Equity Research SAP Page 4

5 SAP s latest venture with the NHL is part of its strategy to extend business in the sports arena through partnership deals. SAP is committed to improve league operations, team performance and fan engagement of sports organizations. By helping the NHL strengthen visual experience, SAP will provide meaningful insights into the game for both avid and casual fans. SAP's New Mobile Solution to Simplify Direct Store Delivery Feb 19, 2015 SAP came up with yet another innovative application, which can help improve the financial performance of its clients. SAP has introduced a mobile solution, designed to simplify Direct Store Delivery ( DSD ) method of consumer products companies. DSD, a key method of selling and distributing products for various consumer good manufactures, has always been a challenge due to its complexity. Of the issues faced by the companies, ineffective process optimization, improper route planning and lack of real-time data access are notable ones. Also, DSD is a quite multifaceted process as consumer product companies need to keep track of different retailer formats associated with price, promotion, order management and merchandizing. Coming as a positive for these companies, SAP s latest mobile solution aims to solve such issues, which have been weighing on the revenues and profitability of the companies. SAP s DSD mobile solution will significantly benefit consumer product companies by slashing costs and increasing profits. It integrates sales and logistics requirements of companies to simplify sales management. The software helps in coordinating cumbersome selling and distribution activities by incorporating direct selling at terminal points. Apart from this, DSD application is expected to help sales representatives by managing a host of activities like visit planning, pre-selling, van selling, taking sales orders and returns, among others. The most exclusive feature of SAP DSD is its agility in responding to diverse selling strategies of customers, channels and brands, through meticulous planning and execution of the complete sales process. Thus, implementation of the software would make the delivery process much simpler. With intensifying market competition, the companies need to improve their quality of service in order to maintain an edge over their peers. In this respect, SAP s innovative mobile solution marks a whole new era for DSD. As more and more companies will choose the software for simplifying their business processes, we believe SAP s future prospects will improve proportionately. SAP Introduces Futuristic Business Software SAP S/4HANA Feb 3, 2015 SAP launched its latest business software titled SAP S/4HANA. The new software is aimed at simplifying customers business operations several times. As per the company insiders, the idea to launch SAP S/4HANA can be traced back to the invention of SAP HANA by Hasso Plattner. The latest application, using SAP HANA s in-memory platform, has optimally utilized its real-time competence to aid networked business run on a real time basis. Strengthened by an impressive SAP Fiori user experience, SAP S/4HANA is appropriate for use in mobile devices, allowing customers to access business solutions on the go. The application brings with it a host of benefits, like easy churning of complex data, unmatched user experience and reduced operational costs. In a nutshell, the new software is likely to help in propelling innovation drive for business enterprises as they transcend borders and venture into newer territories. This is significant for any given business enterprise, as active customer engagement forms the core of sustainable growth. The latest offering from SAP HANA is expected to revolutionize the U.S. finance industry. Experts believe that SAP S/4HANA s ability to simplify the most complex financial data will enhance the decision-making process of the financial firms by analyzing both internal and external data. Equity Research SAP Page 5

6 The application can also expand the cloud solutions portfolio for SAP companies like SuccessFactors and Arbia. In addition, with the help of the new software, customers can avail tailor-made cloud solutions along with their existing SAP solutions. Companies in partnership with SAP will ensure that customers can easily switch to the latest application. SAP Launches SAP HANA Big Data Intelligence Rapid-Deployment Solution Jan 27, 2015 SAP introduced SAP HANA Big Data Intelligence rapid-deployment solution meant for simplifying and intensifying Big Data initiatives for business. The software will allow firms to acquire, analyze and present data swiftly from a variety of sources. The companies can optimize information processing across wide range of data types and scenarios. This will provide a cost-efficient procedure to the companies to cope with dynamic market environments and offer them an integrated platform for real-time analysis, aggregation and visualization of business-critical data. Also, the solution comprises templates for typical Big Data use cases, which can help users quickly commence the installation and study of such cases. SAP Q4 Earnings and Revenues Beat on SAP HANA Momentum Jan 20, 2015 SAP reported fourth-quarter non-ifrs earnings of 1.31 per share, increasing 2.3% from 1.28 per share in the prior-year quarter. In U.S. dollar terms, earnings came in at $1.64, easily surpassing the Zacks Consensus Estimate of $1.40 a share by 17.1%. For full-year 2014, non-ifrs earnings rose 4.5% year over year to SAP s flagship innovation, SAP HANA and its broader market adaptation in the cloud, have been a critical factors in driving growth. The company presently has over 5,800 HANA customers and more than 1,850 HANA Business Suite customers. Non-IFRS total revenues for the fourth-quarter 2014 amounted to 5.47 billion ($6.83 billion), up 4% year over year at constant currency and comfortably surpassed the Zacks Consensus Estimate of $6.62 billion. For full-year 2014, it increased 5% year over year to billion. However, SAP reported fourth-quarter 2014 non-ifrs operating profit of 2.13 billion ($2.66 billion). Q4 Revenues by Segments and Regions Cloud Subscriptions & Support: Non-IFRS revenues were 0.36 billion ($0.45 billion) in the quarter, up a robust 59% year over year at constant currency. Software & Support: Non-IFRS revenues came in at 4.37 billion ($5.46 billion), up 2% year over year at constant currency. Software and Software-Related Service: Non-IFRS revenues were 4.73 billion ($5.91 billion), up 5% year over year at constant currency. On the basis of regions, Europe, the Middle East and Africa ( EMEA ) region remained the strong performer in the fourth quarter, in spite of uncertainties in Russia and Ukraine. The region gained from the rise in software and software-related service revenue (5% year over year at constant currencies) and cloud subscriptions and support revenue (75% year over year at constant currencies). On the other hand, SAP reported sound performance in the Asia Pacific Japan ( APJ ) region, with strong revenue growth in cloud subscriptions and support segment (87% year over year at constant Equity Research SAP Page 6

7 currencies). Also, software and software-related service segment performed well (2% year over year at constant currencies), aided by double-digit software revenue growth in India. The Americas region posted a decent performance, with notable revenue growth in cloud subscriptions and support, and software and software-related service segments (50% and 6% year over year at constant currencies, respectively). However, unfavorable political and economic environment in Latin America remained a headwind. Liquidity For the year-ended Dec 31, 2014, SAP s operating cash flow decreased 7% year over year to 3.57 billion ($4.46 billion) and free cash flow declined 13% year over year to 2.84 billion ($3.55 billion). As on Dec 31, 2014, SAP had total group liquidity (includes cash and cash equivalents and short-term investments) of 3.42 billion and net debt of billion compared with billion as on Dec 31, Guidance SAP expects its 2015 non-ifrs cloud subscriptions and support revenue to be in a range of billion, with significant synergies expected from the acquired firms Concur and Fieldglass. On the other hand, the company projects its cloud & software revenue to rise by 8% 10% on a constant currency basis in this year. Also, the company expects its non-ifrs operating profit to be in a range of 5.6 billion billion for Note: 1 =$ (average for the period Oct 1, 2014 Dec 31, 2014) 1 SAP ADR = 1 ordinary share Equity Research SAP Page 7

8 VALUATION SAP s current trailing 12-month earnings multiple is 15.6x, compared with the 37.9x average for the peer group and 18.4x for the S&P 500. Over the last 5 years, SAP s shares have traded in a range of 13.5x to 24.8x trailing 12-months earnings. Our long-term Neutral recommendation on the stock indicates that it will perform in line with the broader U.S. equity market. Our target price is $73.00 or 20.7x 2015 EPS, which is well within the historical range. Key Indicators P/E F1 P/E F2 Est. 5-Yr EPS Gr% P/CF (TTM) P/E (TTM) P/E 5-Yr High (TTM) P/E 5-Yr Low (TTM) SAP AG (SAP) Industry Average S&P Oracle Corporation (ORCL) Microsoft Corporation (MSFT) Symantec Corporation (SYMC) Vmware Inc. (VMW) TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B P/B P/B ROE D/E Div Yield EV/EBITDA Last Qtr. 5-Yr High 5-Yr Low (TTM) Last Qtr. Last Qtr. (TTM) SAP AG (SAP) Industry Average S&P Equity Research SAP Page 8

9 Earnings Surprise and Estimate Revision History Equity Research SAP Page 9

10 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of SAP. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1126 companies covered: Outperform %, Neutral %, Underperform 8.1%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Coverage Team QCA Lead Analyst Analyst Copy Editor Content Ed. Reasons for Update 6B Supriyo Bose Lekha Gupta Lekha Gupta Ishani Mukherjee Lekha Gupta Q4 and 2014 Earnings Update Equity Research SAP Page 10