Growth Plateau Software AG Meets Hard Reality

Growth at Germany's second-largest IT company has stagnated and the company may make acquisitions in cloud computing to halt falling sales.
The clouds are gathering over Software AG.

A focus on profitability. That was the key phrase Karl-Heinz Streibich, CEO of Software AG, used as he announced the 2014 revenue and sales figures of Germany's second-largest information technology company.

“Profitability before growth means that we won't engage in any unprofitable deals and projects,” he said, before quickly adding: “But of course we will also grow.”

The new focus on quality instead of quantity sounds good. But it is also an indirect admission by Mr. Streibich, 62, that his growth expectations for newly acquired sectors have not been fulfilled.

Software AG’s core business is data banks for large computers, a sector that has been declining for years. And once-promising undertakings have not grown as hoped. This means that in its current structure, Software AG can no longer achieve significant growth on its own. So the company is forced to make further acquisitions.

“Software AG still has gaps, above all in the cloud business,” said software analyst Knut Woller of the Munich investment institution Baader Bank. Cloud computing is a term for the provision of software and other services via the Internet.

“In that field, the company can't avoid making larger acquisitions if it wants to grow vigorously again,” added Mr. Woller.

Software AG still has gaps, above all in the cloud business. Knut Woller, Software analyst, Baader Bank

That is what has been lacking at Software AG, which is based in Darmstadt in central Germany. Since its sales peaked in 2010 at almost €1.12 billion ($1.27 billion), business has declined significantly to €860 million.

On the one hand, this was due to selling off sectors, such as the offloading last year of the IT advisory firm IDS Scheer Consulting. On the other hand, there has been trouble in the new business area of so-called integration software, which links various programs and computer systems with each other and was intended to become the new growth engine.

For a long time, Mr. Streibich managed to combine old and new business effectively. Software AG, founded in 1969, achieved its major growth spurt with a database program called ADABAS (Adaptable Data Base System). It runs on large IBM computers and can handle huge amounts of information.

This business is no longer growing because the market for large computers has stagnated for years. But the maintenance of the old ADABAS systems for existing customers in such fields as insurance or financial services keeps a good deal of money flowing in.

Software AG and SAP Revenue-01



“Right up to today, the sector continues to be the cash cow of the company,” said Mirko Maier, a stock analyst at LBBW bank in Stuttgart. In the fourth quarter of 2014 alone, the sector’s operational profit margin was 68 percent— more than twice as high as the margin for integration software (about 27 percent).

Mr. Streibich used the constant flow of revenues from the databank business to establish a second foothold.

He focused on software that connects different computer systems and programs with each other — so-called middleware. Most users don't notice these programs even exist. Such software acts, for example, as a bridge between a bank's large computer and its Internet site, making online banking possible.

In such fields, Mr. Streibich catapulted Software AG into the top global echelon with several acquisitions. Two in particular stood out. In 2007, Mr. Streibich acquired the U.S. software company WebMethods for about €400 million, and in 2009, the company bought IDS Scheer, at that time No. 3 in the German IT market, for about €482 million.

From these two companies, together with a few smaller acquisitions, Mr. Streibich built up a sector known internally as Business Process Excellence (BPE). It comprises various software packages for managing business processes.

120 Software AG-01



In the first years, Mr. Streibich's strategy went well: After taking the top job at Software AG in 2003, he raised the company's revenues from €420 million to more than €1 billion. According to Hamburg bank M.M. Warburg, Software AG is one of the world leaders in the fields of process optimization and system integration, with a market share of about 10 percent in each area.

But in mid-July 2014, Mr. Streibich had to renounce his plans for growth in this business sector. His explanation: Several customers had postponed or canceled large contracts. On the day of the announcement, the company's share price fell by 20 percent — a blow the stock is yet to recover from.

There are several reasons for the setback. One is that companies handle software products differently today compared to the past.

Instead of purchasing large packages for a hefty sum up front, many users now prefer to rent the software for more modest monthly fees, often via cloud computing.

Mr. Streibich never tires of emphasizing that his products are usually bought and not rented. But insiders close to the supervisory (non-executive) board acknowledge that the rush of customers into the cloud is also putting the brakes on business at Software AG. Moreover, Software AG seems to have had difficulties with its marketing.

A major acquisition would help to solve the problem of growth. Karl-Heinz Streibich, CEO, Software AG

“The company focused primarily on concluding extremely large contracts,” Mr. Woller says. “And at the same time, it neglected to build up a broad substructure of mid-sized deals.”

Insiders confirm this: “It is extremely difficult to bring aboard suitable marketing people who understand the complexity of our products and can present them effectively to customers,” said someone close to the supervisory board.

Mr. Streibich has already taken steps to remedy this problem. In October, he hired Eric Duffaut, a former manager at Software AG's larger German rival, SAP, as head of marketing. The move will mean a welcome shift towards the marketing of complete solutions rather than individual solutions, said Mr. Maier.

Many industry insiders see a problem with the head of the company himself, who has been at the top for almost 12 years. “Mr. Streibich acquitted himself extremely well in restructuring the firm up to 2011,” said one insider. “But then he wasn't really able to switch over to enduring growth with the new products.”

But the CEO is well entrenched, and has a powerful ally in the form of Software AG founder Peter Schnell.

A major acquisition would help to solve the problem of growth. According to a source close to the supervisory board, such an acquisition, especially in cloud computing, is a high priority.

Analysts are tight-lipped when it comes to naming possible candidates, but affordable takeover targets do exist, particularly among non-market-listed cloud providers in the United States.

 

This article originally appeared in weekly business magazine WirtschaftWoche. To contact the author: [email protected]