Software Giant SAP Is Spending Money to Make Money

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SAPSAP (SAP) recently announced its first quarter 2011 earnings results, in which it showed a healthy revenue growth of 26% compared to the same quarter last year. However, operating profits increased by only 7%, meaning that SAP's operating margins declined to 19.7% from 22.2% during the same period.

We believe the dip in margins could be temporary, as SAP's core business remains robust. SAP competes with Oracle (ORCL), Microsoft (MSFT), (CRM) and IBM (IBM) in the applications software market.

We currently have a $64.16 price estimate for SAP stock, roughly in line with market price.

SAP's Expenses Increase Could Be a Minor Blip

In the past few quarters, SAP has introduced a few new and innovative products. These innovations have come through higher spending on selling, general & administrative expenses and R&D. These expenses constitute a larger portion of the company's gross profits, and hence play an important role in the overall valuation of the company. For example, SG&A as a percentage of gross profits was around 35% as of 2010, and we expect it to increase to 37% in 2011.

Although we expect the expense growth to moderate over the long-term, SAP could benefit if it is able to further control its operating expenses.

SAP's Focus on Long-Term Growth

These expenses are made by the company with a view to grow long-term business prospects. Some of the innovations that the company has brought in the recent past are the introduction of products like HANA (High Performance Analytic Appliance) and Business ByDesign. HANA leverages in-memory technology, which speeds up data storage and retrieval. See our earlier note on HANA titled SAP's In-Memory Technology to Shake Up Database Market, in which we discussed how HANA could benefit SAP and compete with Oracle's Exadata machines.

Business ByDesign is on-demand software from SAP, and its features have a few advantages over products offered by competitors. Other players typically provide a piecemeal solution while SAP's offering is an integrated solution. We discussed Business ByDesign's growth prospects in our earlier note titled Optimistic Outlook for SAP's On-Demand Market Prospects.

See our complete analysis for SAP stock here

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