SAP's New Activist Investor Appears to Have Done Its Homework
German software giant SAP ( SAP) rose more than 12% Wednesday after beating Q1 estimates (revenue rose 12% annually in constant currency, thanks in part to acquisitions) and hiking its 2019 and 2020 operating profit guidance. The company lowered its full-year, euro-based, revenue guidance due to currency swings, but maintained constant currency revenue guidance for its cloud and traditional software businesses.Notably, SAP also set a goal of growing its non-IFRS operating margin, which was at 29% last year, by an average of 1% per year over the next five years. And around the same time that SAP released its Q1 report, activist Elliott Management disclosed a 1% stake in the company, while giving a thumbs-up to the company's margin expansion goal. Elliott also suggested it wants SAP, which plans to host a Capital Markets Day on Nov. 12th, to start repurchasing shares, and argued the company can produce €8.50 ($9.47) in EPS in 2023, up from a 2018 level of $4.97.
Though only time will tell whether SAP hits Elliott's EPS target, a comparison of the company's margin profile with that of Oracle (ORCL) and Microsoft (MSFT) suggests SAP has a fair amount of room to improve its cost structure.
Whereas SAP had a 23% IFRS and 29% non-IFRS operating margin in 2018, Oracle had a 34% GAAP and 44% non-GAAP operating margin in its fiscal 2018, which ended last May. To be fair, SAP has been growing faster than Oracle, and making an all-out push to approach Oracle's profit margins would likely hurt its top line. But there might be a middle ground.
Microsoft (MSFT) , meanwhile, reported a 36% GAAP operating margin in its fiscal 2018 (it ended last June) for its Productivity and Business Processes segment, which covers sales of its Office productivity suite and Dynamics business apps. It also reported a 36% GAAP operating margin for its Intelligent Cloud segment, which covers revenue from traditional server software as well as the Azure cloud platform. These margins were posted even though Microsoft has seen a major shift in its sales mix towards cloud revenue streams that carry lower margins than traditional software sales, and also in spite of Microsoft's willingness to up its sales and R&D spend in order to drive cloud growth.
Elliott tends to do its homework before taking a stake in a company and calling for operational changes. And from the looks of things, its decision to buy a stake in SAP is no exception.Snap Still Needs to Show More Bottom-Line Improvement
There are several positives within Snap's Q1 report: Revenue of $320 million (up 39% annually) beat consensus by $14 million, Q2 revenue guidance of $335 million to $360 million (possibly conservative, given Snap's guidance history) is slightly favorable to a $345.5 million consensus at its midpoint and free cash flow (FCF) of negative $78 million was much better than a consensus estimate of negative $142 million, not to mention much better than any FCF figure reported in 2018.And though Snap's daily active user (DAU) count fell by one million annually to 190 million, it beat a consensus estimate of 187 million. While Instagram Stories and (to a lesser extent) other Facebook (FB) clones of Snapchat services are still clearly weighing on Snap's user growth, the company has held onto much of its core base of younger North American and European consumers.
Nonetheless, shares are down over 5% post-earnings. Higher expectations undoubtedly have much to do with the selloff: Snap's heavily-shorted shares had risen 70% since the company delivered a better-than-expected Q4 report in early February.
But it's also worth keeping in mind that Snap's last two earnings reports haven't exactly quelled concerns about the long-term profitability of a company that now sports a $15 billion market cap. Though FCF improved meaningfully in Q1, the company still burned $78 million in cash on revenue of $320 million.
Moreover, even after backing out $163 million in stock compensation expenses, Snap still had a Q1 net loss of $148 million. Snap's FCF would have been closer to its adjusted net loss if not for some favorable quarterly swings in line items such as accounts receivable and accounts payable, as well as a major drop in capital expenses that might not repeat itself.
In addition, both Snap's FCF and net loss benefited from the fact that its cloud infrastructure expenses fell by $3 million annually to $136 million -- that's still equal to 43% of revenue -- and that (thanks to lower R&D and sales and marketing spend) its operating expenses fell 4% to $248 million. On the earnings call, interim CFO Lara Sweet mentioned that recent usage trends could boost Snap's infrastructure expenses in Q2, and that investments in marketing, engineering, sales and content will boost its operating expenses.
Given the resources of its biggest rival, it's not realistic to expect Snap's R&D and sales/marketing spend to keep trending lower over the long run. Throw in the fact that the company hasn't exactly put to rest concerns about infrastructure expenses and long-term user growth, or about how well it can compete against Facebook as Mark Zuckerberg's firm gets serious about growing ad sales for its stories services, and that $15 billion market cap looks fairly steep.Chip Stock Investors Should Note TI's Reluctance to Call a Bottom
Texas Instruments ( TXN) and STMicroelectronics ( STM) are both trading moderately higher post-earnings, and in the process are helping the Philadelphia Semiconductor Index once more make new 52-week highs. Better-than-expected guidance from smaller peer Silicon Labs ( SLAB) , which is up 14% post-earnings, might also be helping.
Neither TI nor STMicro's numbers qualify as stellar. TI beat Q1 estimates with the help of growing analog chip sales to telecom equipment makers (5G infrastructure ramps are helping) and its trademark strong financial execution. However, TI's sales were still down 5% annually, and at its midpoint, the company's Q2 revenue guidance is a little below consensus and implies a 10% annual sales decline.
STMicro missed Q1 estimates while reporting a 7% annual sales decline. And at its midpoint, the company's Q2 sales outlook is below consensus and implies a 6% annual drop. However, the company also issued full-year revenue guidance that roughly matched consensus estimates at its midpoint. And with the midpoint of the guidance range also implying sales will be roughly flat relative to 2018, STMicro's full-year guidance suggests it expects meaningful second-half revenue growth.
On its earnings call, TI maintained a cautious view of near-term demand trends. Though declining to predict when it expects the current chip industry down-cycle to end, the company noted Q1 was the second quarter in which it saw an annual revenue decline, and that cycles typically "have four to five quarters of year-on-year declines before year-on-year growth resumes."
However, echoing recent comments from Taiwan Semiconductor (TSM) , Skyworks (SWKS) , Broadcom (AVGO) , Micron (MU) , Silicon Labs and a slew of other industry players, STMicro expressed optimism about a second-half recovery on its call. The company noted that while its industrial chip sales remained pressured in Q1, it saw improved end-market and distributor sales in March and April, and expects China's stimulus program to provide a boost going forward. Likewise, though STMicro has begun seeing its automotive sales (up in Q1 thanks in part to electric car-related design wins) hurt by softer Chinese demand, the company thinks this trend is likely to reverse itself soon.
Judging by how chip stocks are moving today, markets don't seem bothered by TI's unwillingness to predict a second-half recovery, and (with STMicro and Silicon Labs not saying anything that would shake this view) remain confident that industry demand will be a lot better in Q3 and Q4. It's quite possible that this view will be affirmed in time, but there are some variables -- from Chinese macro pressures to soft smartphone demand to memory price declines -- that could spoil the fun, or at least cause the recovery to be more gradual than anticipated.
TI likely has this in mind while declining to predict when the chip industry will return to growth. And considering how much chip stocks have rallied since December, that's a good argument for investing more selectively in the space for the time being. While I felt chip stocks in general were pricing in too much bad news in late 2018, the story today is more complicated, with some names offering much better margins of safety than others.To see Tech Check coverage from the previous trading day, click here.
