The advancement of artificial intelligence, coupled with the widespread adoption of cloud computing, has sparked a revival among some of the tech industry’s stalwarts. This resurgence is exemplified by the transformation of IBM through its WatsonX AI platform, propelling its stock to a 20% gain this year and a remarkable 50% surge over the past 12 months. Similarly, Salesforce, a cloud software pioneer, has experienced a surge in its shares, with a 16% increase this year and a notable 66% rise from a year ago, driven by optimism surrounding its AI initiatives.
Hewlett Packard Enterprise has seen its shares rally by over 20% in the past week, fueled by high expectations for its AI server business. Dell Technologies has also witnessed a significant uptick, with its shares spiking by 55% this year, buoyed by similar prospects in the AI sector. These examples underscore the transformative impact of AI across the industry.
Consider SAP, the German software giant synonymous with traditional data center-centric corporate computing. SAP has long dominated the market for enterprise resource planning (ERP) software, vital for critical corporate functions such as accounting, compliance, and supply chain management. Traditionally, implementing an ERP system was a daunting task, fraught with complexity, requiring substantial time and capital investments, and carrying a significant risk of business disruption.
In a recent interview, SAP CEO Christian Klein revealed that there was a time when customers would spend $300 on consulting services for every dollar spent on the software itself. Not long ago, companies often faced earnings declines due to unexpectedly complex ERP system installations, leading to disputes and lawsuits. However, SAP’s embrace of AI signals a shift towards innovation and adaptability, reflecting the broader trend reshaping the tech landscape.
Klein highlights the significant shift away from the old SAP approach, which involved excessive customization, heavy spending on services rather than innovation, and ultimately, being left with outdated software after just a few years. However, this outdated model is largely a thing of the past.
Nearly three years ago, there was a notable shift in SAP’s strategy towards migrating customers to cloud-based versions of its enterprise software. This transition, promising greater profitability for SAP and enhanced effectiveness for customers, has unfolded as anticipated. Investors are beginning to recognize this transformation, with SAP shares rallying by 24% this year and experiencing a remarkable 60% surge over the past 12 months. Yet, there remains a perception gap in the market regarding the profound differences between the old and new SAP, with investors potentially undervaluing the company’s leverage from the cloud, compounded now by AI integration.
SAP’s revenue stream reflects this evolution, with over 80% of its revenue generated from cloud-based subscription services and maintenance revenue for legacy software versions. Notably, the cloud backlog exceeds $44 billion, underscoring the growing importance of cloud-based offerings to SAP’s business model. In contrast, revenue from traditional software sold to data centers now accounts for less than 20% of SAP’s total revenue, signaling a fundamental shift towards cloud-centric operations under Klein’s leadership.
SAP’s revised guidance in January has instilled confidence in investors, with anticipated growth in cloud revenue of up to 27% adjusted for currency, overall revenue expected to rise by 8% to 10%, and adjusted net income projected to increase by 17% to 21%. J.P. Morgan analyst Toby Ogg sees SAP in a favorable position, characterized by accelerating growth, expanding margins, and improved cash generation. Ogg predicts that SAP can achieve earnings and free cash flow growth rates of over 20% annually through 2027, setting a price target of 205 euros ($224), representing a 15% premium over the current stock price.
As SAP transitions to the cloud, it has embraced a philosophy akin to Mark Zuckerberg’s “year of efficiency,” evidenced by recent cost-cutting measures including the reduction of 8,000 jobs. Additionally, SAP is doubling down on AI with its Joule co-pilot, integrating AI capabilities across its software portfolio to enhance effectiveness and usability.
CEO Christian Klein sees AI as the next frontier in SAP’s evolution. While competitors like Microsoft and Salesforce offer their own AI solutions, Klein believes SAP has a unique advantage due to its access to vast amounts of corporate data spanning finances, supply chains, and human resources. Over 30,000 customers have granted SAP consent to anonymize their business data for AI model refinement, enabling the company to leverage large language models for the benefit of all customers.
Klein emphasizes that SAP is leading by example in AI adoption, with AI tools driving margin improvement and boosting productivity by 30% to 40% among SAP engineers. Leveraging AI will enable SAP to maintain a flat headcount while accelerating cloud revenue growth. Klein underscores SAP’s commitment to scaling businesses with generative AI, citing the company’s success as its own best reference.