SNP Schneider-Neureither & Partner — Scaling up for global growth

Founded in 1994, with its headquarters in Heidelberg, Germany, SNP specialises in helping businesses tailor and improve their ERP landscapes. The group has two operational segments: Professional Services (83% of FY16 revenues), which offers consultancy and training; and Software (17% of FY16 revenues), which includes the only off-the-shelf transformation product in T-B. Launched in 2009, T-B automatically analyses and implements changes in IT systems in a standardised manner and has been developed on the back of c 5,000 projects. Customers include blue-chip names such as E-ON, Hewlett-Packard, Porsche, Siemens and ThyssenKrupp.

SNP is firmly back on track after the dip in 2013, which was partly due to the expiration of an agreement with SAP. Utilisation rates remain very high, and SNP has made acquisitions in the US, Germany, Asia and the UK to bring in new talent and to strengthen its global footprint. Further acquisitions are expected following the recent €30m equity and €40m debt financings. The main organic strategies are to drive high-margin software sales, both directly and via a partner network, and develop the any-to-any strategy (enabling the transfer of data between different ERP systems). Revenues jumped by 243% over FY13-16, and we forecast a further 50% growth over the next three years, with margins expanding due to the economies of scale and increased software sales.

Cost-reduction measures and investment freezes for IT projects by customers can lead to project delays and/or cancellations. Nevertheless, we note the resilience of the business in the years following the financial crisis, which partly reflects the ongoing requirement for transformation projects regardless of the economic backdrop. The success of SNP products and services has been linked to the success of SAP, though SNP is broadening its offerings to cover Oracle solutions and others. Software sales cycles can be long and lumpy. The loss of key personnel is a significant risk. Competition for skilled IT professionals could lead to shortages, as remains the case.

The stock trades on 36.3x our FY17 EPS, falling to 28.2x in FY18, based on our forecast operating margins of 11.0% and 12.0% in the respective years. However, the drive to push high-margin software suggests operating margins could rise to 20%+ in the medium term. Our DCF model (which assumes a conservative five-year CAGR of 9.1%, WACC of 10% and a long-term operating margin of 18.0%) values the shares at €46, slightly above the current share price. However, our DCF scenario analysis (see Exhibit 14) suggests significant upside potential.

SNP helps enterprises to tailor and optimise their ERP systems, through its proprietary software products and related consultancy services and training. The industry has historically largely relied on a manual approach, but SNP has developed its own specialist software, T-B, which automates the process. T-B is the world’s first software solution that automatically analyses changes in ERP systems and implements transformations in a standardised way. M&A activity is a driver, as ERP systems of acquired businesses will typically be integrated with the acquirer’s IT system, while data of disposed businesses need to be “carved out”. As ERP systems are highly complex with each installation customised for the user’s specific requirements, it is a highly complex process to combine or carve out these systems. The shifting by enterprises of their ERP systems to the cloud is also an important business driver. SNP’s software-based approach gives it a significant advantage over traditional manual methods in helping customers to meet tight deadlines, which is exemplified in M&A driven business. With more than 720 employees in the US, Europe and Asia, including c 500 consultants, SNP is able to support global companies in the selection, rollout and optimisation of their business applications and in company and IT transformations.

The business is divided into four categories:

Also referred to as “Business landscape transformation” (or BLT), this represents the change and adaptation of ERP systems and is the main area of the group’s activity. BLT comprises all aspects of software and consulting services in transformation projects. It covers business transformations such as mergers, carve-outs and disposals, and IT transformations, which includes consolidations, harmonisations and new technologies (cloud).

Also referred to as “Business landscape management” (or BLM), this represents a holistic consultancy approach for service and support processes in SAP and non-SAP system landscapes. SNP BLM structures the implementation of SAP Solution Manager with standardised consulting, best practices and finished enhancements. From 2015, SNP BLM has also been focusing on SAP architecture and technology consulting at an IT-decision-making level.

This includes traditional SAP consulting projects along with support and maintenance for regular customers. This area is supplemented with process consulting and software-based application developments. SAP module consulting constitutes the focus of consulting at RSP, which SNP acquired at the beginning of 2016.

Along with T-B, the group’s software portfolio also includes SNP Data Provisioning and Masking (DPM) along with SNP Dragoman. DPM software provides secure test data, which helps to accelerate software development for the transformation process, to automate quality assurance processes and to introduce new business functions successfully. DPM is also part of T-B. SNP Dragoman is a language translation tool, primarily targeted at internationally operating companies that must provide their SAP applications in the respective national language.

FY16 revenues grew by 43% to €80.7m (we forecast €77.0m), including benefits from the acquired Astrums and Hartung that were consolidated in the accounts from January and Harlex from September. EBIT rose by 62% to €6.9m (we forecast €8.0m). Management’s guidance is for FY17 revenues of €96-100m and EBIT margin of 9-11%. We have reduced our profits forecasts due to increased costs going into the business, including the creation of a third staff training centre in Berlin. SNP’s other two academies are in Magdeburg, Eastern Germany and Dallas, Texas in the US which is SNP’s primary delivery location in the US. There are also additional costs associated with the new corporate structure including the creation of SNP Transformations Deutschland to target the S4/HANA market in Europe. We forecast EBIT margins to rise by 150bp in FY17 and 100bp in FY18 and FY19, as the group benefits from its great global scale and increases its software sales. More details on our forecasts are provided in Exhibit 12.

ERP software provides an end-to-end information management solution for an enterprise, and can be used by all departments to manage the information. Solutions are typically modular, so that enterprises can purchase only the specific modules they require. Each ERP installation is normally highly customised and fundamentally unique, and hence any transformation project will be complex.

The worldwide ERP software market grew 3.8% to $25.4bn in 2013 (Gartner), from $24.4bn in 2012. SAP retained its market leadership position, with a 23.3% market share in 2015, while Oracle (which includes PeopleSoft, JD Edwards and Fusion brands) was second with an 11.2% market share. The market outlook for ERP remains solid, with Grand View Research forecasting the market to grow at 7% + pa over the 2015-22 period to reach $48.22bn by 2022, while Stratistics MRC forecasts a 7.6% CAGR over the same period, from $28.27bn in 2015 to $47.26bn in 2022. These numbers were prior to the UK referendum on the EU and the US presidential election.

There are two approaches to changing an IT landscape: so-called greenfield and brownfield approaches. The greenfield approach involves the implementation of one or more new ERP systems. The systems and processes are reconfigured and the business data of the existing systems are adopted. The brownfield approach involves the gradual migration of one or more ERP systems into a new ERP system. Clearly there are significant differences in technical and transformative migrations. Technical migrations are induced by M&A, carve-outs, disposals and organisational restructurings. Technical migrations include consolidations, harmonisations and new technologies (cloud). There are no market-sizing data available for data transformation. They are usually included in the data for IT system integration. However, SNP estimates that only one-third of the actual transformation work is outsourced, while approximately two-thirds of the work is done in-house. SNP argues that the age of new ERP implementation is over, ie, most firms that require ERP systems already have it. The future need regarding ERP systems is to transform, adapt and harmonise the existing data in the ERP systems – initiated by M&A activity, system consolidation, cloudification and simplification. In SNP’s experience, only a very small percentage of transformation expenditure is allocated to software-based tools, with the rest done manually.

M&A: M&A activity is clearly an important driver in ERP transformation, though we note there are other factors that can complicate an enterprise’s ERP landscape, such as organic expansion into new regions and business lines, while corporate restructurings and spinoffs can be common in any economic backdrop. Exhibit 4 shows that global M&A activity saw a cooling down in 2016 after a record 2015. There are uncertainties on the outlook for M&A relating to the Trump presidency, Brexit, EU/euro risks and potentially increasing protectionist politics.

SNP competes with a range of businesses, which we put in the following three categories:

In our view, the ongoing development of SNP’s T-B platform, combined with its strong domain knowledge of ERP systems gained through c 5,000 projects, significantly increases barriers to entry to the transformation software market. T-B is the only end-to-end tool that we are aware of and SNP’s competitors use higher levels of manual processes associated with the classic approach or they might well license the T-B platform.

One interesting aspect is that SAP itself is precluded from undertaking Oracle to SAP transformations following the Tomorrow Now legal case. Other iterations (eg, SAP to Oracle, or involving other ERP systems) will be added in due course.

Through both organic growth and acquisitions, SNP is building a global software-based IT services business providing support in transformation projects both at international and regional levels. The group has been winning increasingly larger deals, with a landmark $5m+ carve-out deal for Hewlett-Packard delivered in record time in 2015 and the group recently won a record $10m+ contract to combine the IT landscapes of two US chemical companies (we assume Dow Chemical and DuPont) that are merging. Another recent high-profile customer is Kellogg’s. These prestigious contract wins boost the group’s international profile and help it to win new business. The plan is to develop T-B into an industry standard, with the ability to handle any-to-any transformations. SNP has traditionally focused on the “DACH” German speaking region in Europe, which generated 100% of FY06 sales, which fell to 86% in FY13 and to 68% in FY16. The group has focused on SAP-to-SAP transformations, as c 80% of big companies in Europe use SAP systems. SNP is now seeking to expand geographically more aggressively, both organically and through acquisitions, to take advantage of the growing global transformation market.

Acquisition strategy

The group has made five significant acquisitions over the last four years, which have enabled SNP to become a provider of end-to end solutions, covering the entire value creation chain on the transformation market. SNP acquired GL Consulting in 2013, to accelerate the group’s entry into the US and a software-based approach to Oracle ERP transformations. SNP acquired RSP in early 2015 to expand the group’s range of strategy- and process-related consultancy services. SNP acquired Hartung Consult and Astrums in early 2016 to target the Asian market and to support customers in international rollout projects as well. SNP acquired UK-based Harlex in September 2016 to target and deliver new business in the UK. Consequently, SNP has a proven track record of successfully integrating companies on several occasions, which now contribute to an improved market penetration. Management is on the lookout for other selective acquisitions that add to the product offerings, tap new markets, enhance technical expertise or simply expand capacity.

Strategic partnership with SAP

In December 2014, SNP announced a new commercial agreement with SAP whereby SNP is now licencing SAP’s transformation product, SAP Landscape Transformation (SAP LT). SNP is now able to offer T-B with SAP LT. SNP T-B already significantly extends SAP LT functionality for SAP to SAP transformations. Furthermore, the move helps SNP to pursue its long-term plan to focus on enabling customers to migrate from any ERP system.

In 2015, SNP extended the partnership with SAP, and developed an exclusive partnership with SAP’s transformation business (SLO). This includes:

Each company has provided staff at SAP’s Walldorf headquarters to work on software development.

Strategic partnership with Huawei

In July 2016, SNP announced a strategic partnership with Huawei, a Chinese multinational networking, telecommunications equipment and services company. The aim of the strategic alliance is to provide companies undergoing a digital transformation a full range of hardware (based on Huawei FusionCube-servers), software (SNP Transformation Backbone), as well as implementation and migration consultancy services (SNP or third party) from a single source. The alliance allows businesses to harness SAP HANA technologies for digital transformation in a fast and efficient way. Huawei benefits from improving its access to the European markets. For SNP, this is another step to establish its software as an industry standard for transformation projects.

Growing companies accumulate ERP systems through acquisitions and expansion into new regions and business lines, and, over time, large corporations can find themselves burdened with some 15 to 20 ERP systems or even more. Hence, ERP landscapes can eventually become unmanageable and the nature of ERP projects from a consulting perspective naturally shifts from implementing new systems to landscape transformations. Transformation projects are among the most critical, complex and expensive programs that affect an organisation and its business processes. Transformations can be driven by business factors (mergers/acquisitions, disposals or restructurings) or technology (consolidation, upgrades/platform migration or data harmonisation).

Digitalisation and artificial intelligence might exponentially grow the amount of data modern enterprises will have to process. Today, often unseen by the public, but very transparent in the business world is the growth of ERP and related business process automation. This has been a trend for the last 25 years and will continue with the automisation of business and production processes. New digitally based process and business networks are about to drive productivity and force new levels of hyper-competition into the markets. At the same time, with every change to a business, a merger or a divestiture, a change in the organisation or process setup, the underlying systems have to be adapted and along with them the ever growing amount of data. Reorganising the data along with the required process changes driven by mandatory refitting of companies to their business environment is the market in which SNP wants to improve its position.

The launch of SAP HANA and SAP S/4HANA has started and will affect the markets over at least the next 10 years. If companies want to move to SAP S/4HANA, this change comes with the need to look at data structures – a core competency of SNP. In order to support SNP’s business model for SAP S/4HANA migrations, there may be the need for substantial investments in new products, depending on the overall ERP market development as well as SAP’s ability to provide the basis for migration tools. Depending on how fast customers are ready to adopt SAP S/4HANA, this new release of SAP has the potential to have a positive impact on SNP’s revenues.

European focus: Transitioning to SAP S/4HANA

A key driver for company transformations is the growing digitisation of business processes with SAP S/4HANA. In pilot projects, SNP is already working on migration paths to SAP S/4HANA that are as efficient as possible. At the moment, the switch to S/4HANA is the most urgent issue for many European companies. Here, the introduction of SAP S/4HANA means that a completely new technological architecture needs to be developed. For many companies, switching to this new product is associated with changes in business processes and necessitates fundamental strategic consideration prior to the introduction. SNP’s aim is to establish its software as an industry standard for transformations towards S/4 and play a key role in shaping this market via software-based solutions. In the past 18 months, SNP has expanded its already extensive knowledge about data and process transformations into SAP S/4HANA. In addition to the challenges associated with S/4HANA, SNP also sees cloud architectures, mobility, in memory and HANA as opportunities.

SNP Transformation Backbone with SAP Landscape Transformation software (T-B)

T-B takes the user right through the transformation process. A typical T-B project begins with SNP Systems Scan, which enables a systematic analysis of company structures to help to tailor the project. The next stage involves SNP Analysis, which analyses, compares and interprets the business processes, key configuration and components in order to plan the transformation. SNP Cockpits comes in at the design phase, guiding the user through the project. Finally, SNP Execution provides a speedy, automated, controlled and transparent generation and execution of the transformation program.

Predefined routines are available for a number of common scenarios such as system consolidation (mergers/acquisitions), carve outs (disposals), chart of accounts restructuring (data harmonisation), legacy migration (can require Dragoman for translation) and platform migration (ERP upgrade, can require Data Provisioning & Masking for scenario analysis).

A conventional or classic transformation

A classic transformation project will involve a large amount of manual processes and tailored programming and is typically based around MS Excel and MS Project. Consequently it will be less flexible and transparent than the standardised SNP software-based solution and with a greater risk of missing deadlines. While operational data (master data, open items and balances) are preserved, data history is typically lost. The classic approach can make use of tools that have been developed on previous projects or are available in the market such as SAP Data Services. Nevertheless, the approach typically requires significantly more consultant man days and time on tool development, while the software usage is much lower, and hence the project will take much longer and there is a greater risk of human error.

Key advantages of the SNP Transformation Backbone software

The precise benefits depend on the type of project; there is high variability.

In February 2015, SNP was commissioned to divide the global SAP system landscape of Hewlett-Packard (HP), in one of SNP’s biggest contracts to date with a value exceeding $5m. In November 2014, the US IT giant announced that it would split into two independent companies – Hewlett-Packard Enterprise (or HPE, a services-based technology solutions business) and HP Inc (a hardware-based provider of computers and printers along with related software and services) in what we understand was the largest corporate separation ever undertaken. As a result, the new companies needed to “carve out” their ERP systems and to achieve this in a very tight deadline, as the demerger was to take place on 1 November 2015. SNP won the contract against intense competition, including SAP, with HP opting for SNP’s software-based approach to benefit from the time and price efficiencies. HP already knew SNP very well, as HP is a re-seller of SNP’s software.

The mammoth project was completed in November according to plan. The T-B software developed by SNP ensured that the previous IT landscape was smoothly transformed into what are now separate ERP structures for company-wide resource planning without any significant impact on ongoing operations. The magnitude of this company split was unprecedented in terms of its size and complexity: project costs were estimated at c $2bn, involving 300k people and 786 legal entities across three continents. Overall, data volume of c 50 terabytes from 16 systems was transformed in just 14 days. The project demonstrated the advantages of a software-based transformation approach. In view of the significant cost and time savings, the use of SNP software ensured that the IT landscape could be transformed into two new, separate ERP structures without having any considerable effects on ongoing business operations or problems. The transformation of the IT landscape had to be completed in six months as the final quarter of the last joint fiscal year had to be depicted in two IT landscapes. SNP has subsequently won additional business in the merger of HPE Enterprise Services with Computer Sciences Corp (CSC).

The group sells its software both directly and through its partner programme (40+ partners). The business is typically H2 weighted, due to software sales in Q4.

The consultant utilisation rate dipped to c 60% at the low point in 2013, but more recently has been close to 100% due to strong demand for T-B and the group’s related professional services. Around 70% of consultancy work is done remotely. SNP makes use of freelancers when demand is high. There are three business models:

For projects, revenue recognition is based on the percentage of completion method. Two strategic objectives are to encourage customers to take a group licence and to accelerate software sales via the partner programme; SNP would like its partners to use T-B to transform all their customers.

As at 31 December, SNP had 62 sales people (FY15: 30). The sales process typically targets the IT department or CFO. The Dragoman translation product is a simple product with short sales cycles, sold via telesales, and helps to find higher-value transformation opportunities. The BPA analytics product is also intended to drive transformation opportunities. SNP attends a number of industry events and since 2014 it has held an annual customer conference in Heidelberg.

In addition to its own sales team, SNP works closely with independent partners in marketing its services and product portfolio. Following the launch of T-B in 2009, it initiated a partner and licensing programme, which has since been continuously expanded and developed, and in FY16 the group had 54 partners (c 12.5% of FY16 revenues, down from c 15.3% in FY15), which include several large enterprises (eg Accenture, Hewlett-Packard Enterprise and IBM) as well as a range of small players. Through its partners SNP aims to expand its core business both domestically and internationally, especially in regions where the group has no sales infrastructure.

New equity and debt financing

In July 2016, SNP raised a gross €31m (€30m net) in a rights issue of one new share at €25 for every three existing shares. The fund-raising shifted the group into a healthy net cash position (see Exhibit 9). Management and employees subscribed to new shares for a total of €4.77m. In wake of the €30m capital increase, Dr Andreas Schneider-Neureither saw his shareholding dip from c 20.6% to 18.3%, as he reserved some of his subscription rights for senior employees. He has recently lifted his shareholding back to 20.0% through on market purchases.

In February SNP issued a €40m loan note with investors, spread across fixed and variable tranches in terms of three to seven years. The initial average yield across all tranches is 1.41% pa. Due to the strong demand, the amount was increased by €10m to €40m. The issue was arranged by IKB Deutsche Industriebank AG. Additionally, SNP exercised an early call option on its outstanding 6.25% €10m bearer bond at 103% plus accrued interest effective on 27 March 2017.

At the time of the rights issue, SNP said it would use c 50% to 75% of the net proceeds to finance acquisitions. The balance of the rights issue was primarily to finance the increased working capital requirements due to an increase in the order backlog and the rising project sizes as well as to fund its training programmes in Germany and the US to educate young professionals.

FY16 revenues grew by 43% to c €80.7m (we forecast €77m) reflecting 26% organic growth and contributions from acquisitions (primarily Atrums and Hartung Consult, from 1 January). The adjusted operating profit rose by 62% to €6.9m, for an 8.5% operating margin. Along with a number of significant M&A-driven contract wins, including with the two merging chemicals companies, the shift of ERP systems to the cloud is the dominant transformation topic in the US, while the migration to SAP S/4HANA and the required transformation of old systems has been the focus in Europe.

Q4 revenues grew by 56% to c €23.1m, while operating profit more than doubled to €1.7m, for a margin of 7.2%. Incoming orders were slightly below Q3, though we note that Q3 benefited from the record $10m+ contract win that is scheduled to be delivered over the next c 18 months.

Management said it expects the group to generate revenues of €96-100m in FY17, upgraded from initial guidance of €95-100m given with the preliminary results on 31 January. The guidance is underpinned by the record €39.3m order backlog, which was 95% higher than a year earlier. Management expects an FY17 EBIT margin of between 9% and 11%. The guidance only includes organic growth, while fresh acquisitions are highly likely to be made in 2017. Given the group’s net cash position and debt refinancing SNP has considerable firepower to make acquisitions.

We have increased our revenue forecasts towards the middle of management guidance. However, we have reduced our profits forecasts due to increased costs going into the business, including the creation of a third staff training centre in Berlin, and costs associated with the new corporate structure. We now forecast group revenues to rise 21% to €97.5m in FY17, and then by 13% to €110.3m in FY18. We forecast adjusted operating margins to rise to 10.0% in FY17 and to 11.0% in FY18. We note that the company effectively unbundles projects in order to report professional services and software as separate divisions, and we have done the same in our forecasts.

Professional services revenues/margins: We assume that revenues rise by 21% in FY17 to €80.5m and by 14% in FY18 to €91.7m. This includes a modest amount of training revenues. We assume a 9.8% contribution margin in FY17, rising to 10.3% in FY18, and 12.0% in the long term. This is conservatively below the historical peak of 13.7% in FY09.

Software revenues/margins: We assume software revenues (licences and maintenance) rise by 21% in FY17 to €17.0m, and by 11% in FY18 to €18.9m. We assume a 27% contribution margin in FY17, rising to 30% in FY18, and towards 50% in the long term. The rise reflects the benefits from the relatively fixed R&D costs (€11m in FY16). We note that margins were above 60% in FY10/11.

Costs and tax: We assume “non-segment-related expenses” of €3.2m in FY17, rising to €3.4m FY18. We assume €0.5m of “other operating income & other taxes”, which relates to a wide range of minor factors including insurance, provision reversals and capital gains. We continue to assume an effective tax rate of 30% and cash tax rate of 28%.

SNP’s customers are mainly large corporations, often multinationals, and economic cycles have an effect on these businesses. Contracts can be lumpy and the three biggest customers generated c €15.4m or c 19% revenues in FY16, down from €13.0m or 23% in FY15 while the largest customer generated €6.4m or 7.9% of revenues (versus €7.0m and 12.4% in FY15). This shows that the increasing scale of the business is reducing the reliance on particular customers, despite the increasing size of contract wins. We note the resilience of the business in the years following the financial crisis, which partly reflects the ongoing requirement for transformation projects regardless of the economic backdrop. SNP has a reliance on SAP’s end-market, though SNP seeks to align its solutions to the ERP market as a whole. We note the following sensitivities:

While SNP’s shares look expensive on a P/E basis, our base DCF model suggests the shares are fairly valued. However, if the group can sustain current levels of organic growth (c 18-22%), drive margins higher and make additional value-enhancing acquisitions, we would expect the share price to continue to outperform. Exhibit 14 shows that if SNP can sustain the growth, the shares could double, even before making value-enhancing acquisitions. SNP’s growing track record in winning increasingly lucrative deals with some of the world’s largest enterprises underlines its strong positioning in the transformation market and has boosted its valuation. The group has a proven acquisition strategy in successfully integrating businesses. It has been buying smaller players that lack SNP’s software proposition and geographical reach at c 1x revenues, while SNP shares trade at more than 2x revenues, and this enables SNP to create value, as it broadens its position across the value chain and geographically. We highlight the following points on the group’s valuation: