SNP Schneider-Neureither & Partner — Attractive business drivers are sustained

H1 revenue grew by 35% to €65.0m, including 2% organic growth, along with €16.0m from the acquisitions of Innoplexia, SNP Poland and Adepcon. The group swung to an EBITDA loss of €1.7m from positive EBITDA of €1.3m in H117 (SNP’s methodology). On our methodology calculations, these numbers were a €2.1m loss and a €1.2m profit respectively. The loss was due to a poor performance in the US, and included €1.8m of restructuring expenses, while the DACH region generated moderate profits and other areas delivered normal levels of profitability.

These numbers were below the expectations affirmed at the time of the Q1 results in late April, and in late July SNP issued preliminary results and cut its FY18 revenue guidance to €135-140m from €150-155m, with a slightly negative EBIT margin (previous guidance was mid-single digits). The EBIT margin in H2 is expected to be “positive, single digit” while FY18 EBITDA is expected to be in the lower to mid-single digit millions of euros. SNP is very confident that there will be a rebound in proprietary software sales in H2 and has implemented a price increase. Management remains committed to its “over-riding medium-term target for structural profitability growth”.

The primary reason for the expectations miss was the deferral of many S/4HANA projects, as a result of lengthening planning and proof-of-concept (POC) phases. This resulted in lower capacity utilisation for Professional Services, which was exacerbated by heavy recruitment in late 2017, along with reduced proprietary software licence revenue. H1 utilisation rates were c 73-74% against a normal level of c 80%. Revenues from the M&A-driven side (eg mergers, carve-outs) also disappointed, which we believe reflects the lumpiness of deals as well as the senior-level changes in the sales team. Additionally, the company said that pipeline conversion rates have been lower than normal at c 40%, from 50%, which was due to the current high level of market engagement.

The S/4HANA project deferrals related to the complexity of SAP S/4HANA and clients choosing to wait for a greater “maturity level” of S/4HANA before planning a full transition. In light of feedback from its customers, SNP is confident that this is now happening and many customers are close to proceeding. SNP estimates that there are c 50,000 enterprises that need to transition to S/4HANA and believes that a tsunami of transformations is building up.

SAP S/4HANA was launched in 2015, and while SAP has had great success with its new fourth-generation Enterprise Resource Planning (ERP) suite, with more than 8,900 customers, up 41% over the year. Nevertheless, we understand that most of these are small customers that are not in SNP’s targeted market. SNP has not yet booked, nor is it aware of any competing large-scale S/4HANA transformations. However, some of SNP’s largest customers are looking to transition to S/4HANA using SNP’s T-B software and SNP says it is currently engaged in more than 20 SAP S/4HANA POCs that relate to large enterprise customers. Consequently, SNP expects the average deal size to rise significantly over the next 12 months. SNP says the number of POCs has been growing strongly. It estimates that a typical large-scale transformation to SAP S/4HANA would take around five years to implement, and believes it can reduce the project duration to around two to three years through using its highly automated Bluefield template-based approach.

Measures have been taken to improve the efficiency of the business, including cost reductions, working capital improvements and targeting customers at a higher management level. A key goal is to improve the value proposition and, in wake of the landmark $6m Hewlett-Packard carve-out, seek to take a higher share of M&A project costs. At the lower end, SNP is working on a strategy to target SMEs using a partner model. The US business had not been meeting expectations and hence 25 jobs were eliminated in Q1, leaving c 75 jobs in the US. The group had 1,350 employees at end-June, up from 1,341 at year end, but down from 1,363 as at end March. Further headcount reductions are not anticipated, as skilled employees are hard to recruit, and the company highlights that it has a revenue problem rather than a cost problem.

All regions, except for the US, grew significantly. The share of revenues from DACH (Germany Austria and Switzerland) countries slipped from 61% to 50%, with the increase predominantly due to the acquisitions in Poland and South America. The UK grew revenues by 20%, while Asia was flat, and the US fell by 8%. The South American business, which was acquired in mid-2017, is in good health, and this business is now being adapted to sell SNP’s proprietary software and transformation consultancy. China and South-East Asia are growing. However, SNP is cautious about selling its software in Asia due to potential piracy reasons, and it highlights the primary focus regions as Germany, the UK, US and Switzerland.

Software sales grew by 31% organically, while professional services declined by 6% on this basis. Software sales included €4.2m of low-margin software resales (€0.5m in H117). Licence sales grew by 59% to €7.6m, but excluding resales, SNP’s proprietary software licence sales fell by 21% to €3.4m. Also included in the software category was €1.0 of cloud services, which came to SNP with the BCC acquisition, and maintenance revenues, which more than doubled to €4.2m. The S/4HANA project delays were reflected in the 6% organic decline in professional services and the 21% decline in the proprietary software sales. Transformation Backbone revenues rose by 32%, including maintenance revenues, while Data Provisioning & Masking jumped by 54% and Interface Scanner rose by 13%.

Management is bullish on its global alliance with IBM Services, which is targeting the SAP S/4HANA transformation market. The alliance is targeting IBM’s huge customer base and SNP emphasises that due to the huge number of S/4HANA projects, these can only be achieved using an automated approach. SNP has already trained the IBM Services sales team on the SNP Bluefield approach and it says the pipeline is growing by the week. SNP has already received c €1m of orders and a €45m pipeline is in place (of which half is licences and half consultancy). Initially, SNP will be handing the services work, but over time it will train IBM’s staff while booking the software revenue.

Henry Göttler, head of Asian operations, left the business in April. David Kenneson resigned from his position as chief revenue officer in July after joining in January. The group is switching back to an MD model and is seeking a CEO in the US and a chief operating officer for the group. Dr Uwe Schwellbach was appointed chief financial officer in July. Dr Schwellbach is responsible for finance and HR.

The group continues to maintain healthy cash balances following its capital-raising last year. SNP recently amended the presentation of its accounts, with financial liabilities now including acquisition liabilities (see our previous update note). The H1 operating cash outflow was €5.3m (implying a €0.6m outflow in Q2) and, after net capex of €2.0m, the free cash outflow was €7.1m. The group paid €7.0m in acquisition payments during the half. Group’s net debt increased by €3.2m over the quarter to €35.8m. There is also a small pension deficit that we have included in our DCF valuation.

We have cut our revenue forecasts by 9% in FY18 to €137.9m and 7% in FY19 and FY20 to €153.4m and €166.6m respectively. We forecast the group to generate a small profit in H218, mainly due to a strong rebound in proprietary software sales and benefits from the restructuring programme, but to be loss-making overall in FY18. Given the growing number of S/4HANA POCs, we would expect revenues from these projects to start flowing from FY19. Our adjusted EPS forecasts come back by 56% in FY19 and by 34% in FY20. Our dividend forecasts shift back by one year and we now forecast no dividend in FY18 (previously 30c), 30c in FY19 (40c) and 40c in FY20 (50c). We now forecast the group to end FY18 with net debt of €42.8m (previously €35.9m), which eases to €40.9m (€30.8m) at end-FY19 and falls to €34.9m (€21.5m) at end-FY20.