S&P: German Enterprise Software Co. SAP Outlook Revised To Pos On Stronger Credit Metrics, Solid Performance; Affirmed At 'A'
At the same time, we affirmed our 'A' long-term corporate credit rating on SAP and the 'A' issue rating on the group's senior unsecured debt.
The outlook revision reflects our expectation that SAP's credit ratios will continue to strengthen in the next 24 months thanks to strong discretionary cash flow (DCF) generation and our expectation of revenue growth of more than 5% in 2016-2018. This is primarily owing to a continued surge in cloud subscription revenues and modest growth in traditional software and support revenues.
SAP has a track record of deleveraging after large acquisitions, and its credit ratios have been gradually strengthening since it acquired Concur in late 2014. After peaking at 1.6x in 2014, we expect adjusted debt to EBITDA to decline to about 0.8x-0.9x in 2016, 0.6x-0.7x in 2017, and below 0.5x in 2018. We are mindful that SAP may continue to participate in industry consolidation in the next few years. However, we expect that the ongoing deleveraging and increasing DCF generation will give SAP more headroom to make large debt-financed acquisitions without significantly impairing its balance sheet.
SAP revenues have grown steadily in recent quarters, underpinned by fast-growing cloud revenues. We think SAP's Hana cloud platform and S/4 HANA, SAP's most recent suite of core business applications, which was launched in February 2015, could support further revenue growth. We understand that S/4 HANA provides SAP with some competitive advantages, offering customers the possibility to run on a real-time in-memory computing platform for analytics and applications and is relatively simple to integrate into customers' core business processes. As a result, we think its adoption will continue to increase. We think SAP's Hana cloud platform and S/4 HANA will support solid cloud subscriptions (+32% in the first six months of 2016) and support consolidated revenue growth (+5%). This should also result in a higher portion of recurring support revenues or cloud subscription revenues, from 60% of SAP's total revenues in 2015, to above 70% by 2020. Following the restructuring program in 2015, which resulted in the adjusted EBITDA margin temporary weakening below 30%, we expect margins will rebound in 2016 to above 30%, a level we consider above the industry average.
SAP's business risk profile remains supported by the group's world-leading market positions in the enterprise application software market, meaningful barriers to entry, high renewal rates from customers, good revenue visibility, growth opportunities, and strong profitability. SAP is the largest global supplier of enterprise application software. It ranks first in the markets for applications (automation of enterprise-critical business processes throughout the entire value chain, such as finance, supply chain, sales, and marketing segments) and analytics (collection and use of massive amounts of data). It ranks fourth in the technology platform market (platform to run and interact an application with the rest of an enterprise's IT), well behind the dominant market leader Oracle, as well as IBM and Microsoft, ranking second and third, respectively. SAP benefits from meaningful barriers to entry, given high switching costs. It provides customers with mission-critical software and enjoys extremely high renewal rates. In its major segment--software and support--the group achieves renewal rates of about 96%-97%.
These strengths are partly offset by the stiff competition from large software companies previously mentioned, as well as from smaller, faster-growing providers of software as a service, such as Salesforce. com or Workday. In addition, the software industry continues to evolve and innovate rapidly in areas like cloud computing, mobile applications, and "Big Data".
Our assessment of SAP's financial risk profile reflects SAP's strong balance sheet and strong DCF generation, thanks to a high cash conversion and low capital expenditure needs. In addition, SAP has demonstrated a conservative dividend policy, with a track record of moderate dividend payouts of about 30%-40% of net income. These strengths are partly offset by a history of large acquisitions.
In addition, SAP may pursue further larger acquisitions (such as the acquisition of Concur in December 2014 with an enterprise value of US$8.3 billion) than we foresee in our base-case assumptions for 2016-2018, which could result in a temporary weakening of its core ratios outside the thresholds for the current rating, including the adjusted debt-to-EBITDA and funds from operations (FFO)-to-debt ratios of 1.5x and 60%, respectively.
Furthermore, the rating on SAP reflects our view that higher-rated peers--such as Oracle, IBM, Microsoft, and Google--have even stronger profit margins, more dominant competitive positions, and larger scale, and are much more diversified in terms of business lines. Moreover, many of SAP's peers also command stronger financial risk profiles, with many having no adjusted debt and much larger cash balances than SAP does, which gives them greater strategic and financial flexibility.
The positive outlook on SAP reflects the possibility that we could upgrade SAP by one notch in the next 24 months if its credit ratios continue to strengthen accompanied by continued revenues growth and an EBITDA margin, as adjusted by S&P Global Ratings, above 30%.
We could raise our rating on SAP if the adjusted debt-to-EBITDA ratio declines to about or below 0.5x due to continued EBITDA growth and debt reduction through free cash flow, which we think will happen within two years in the absence of major acquisitions. In addition, continued revenue growth in line with the industry and an adjusted EBITDA margin above 30% would support an upgrade.
We could revise the outlook to stable if the group's revenue growth trajectory significantly slowed as a result of stronger competition from existing or new competitors, coupled with adjusted EBITDA margins below 30%, or if adjusted debt to EBITDA weakened and remained between 1.0x and 1.5x.
Although we do not expect it, we could lower the rating if SAP altered its financial policy in a way that resulted in adjusted debt-to-EBITDA and FFO-to-debt ratios sustainably above 1.5x and below 60%, respectively. This could be caused by significant debt-funded acquisitions and significantly weaker than expected revenues and margins.