Eureka! Just occasionally, lightning strikes and something quite innocuous triggers a valuable insight into a new trend. This happened to me last week while I was enjoying a nice cappuccino with a colleague. My colleague commented that their company had just completed a procurement exercise to buy a new Enterprise Resource Planning (ERP) software system. Not surprisingly, the usual suspects cropped up on the list of bidders – big business software firms such as SAP, Sage and Oracle. But while these are undoubtedly well-respected firms, none of them are considered especially cheap. Then, late in the selection process, a new kid on the ERP block, Microsoft Dynamics, jumped into the fray.
Turkey of the week: Sage (SGE, 228p), tipped as a BUY by The Times, The Sunday Telegraph, Deutsche Bank
Microsoft has spent years developing this application to add to its traditional Windows and Office products. Microsoft Dynamics is aimed at medium to large corporations. It is a single application that can organise finance, supply chain, production, HR and customer relationship management. This is when we came to the ‘eureka’ moment. The business chose Microsoft Dynamics. But why? Well, the decision came down to price: Microsoft was substantially cheaper than the others. This struck me as important, because it could lead to considerable disruption in the ERP software market. In which case, who are the winners and losers likely to be?
The likes of SAP, Sage and Oracle will be hit hard on price, which in turn will damage profit margins. Typically, Microsoft does not invest in new areas unless it believes it can win. It has, for example, spent billions of dollars developing and launching its new Xbox 360, MSN web portal and mobile software. Indeed, to the detriment of its competitors, it tends to stick with its investments for the long term, even though they may require huge amounts of funding. However, SAP, Sage and Oracle, will not lie down and let Microsoft walk all over them. They will vociferously defend their client bases. And customers will be reluctant to replace their systems as the cost of switching ERP applications is substantial. Nevertheless, going forward, pricing will be squeezed. And with Microsoft on the attack, acquiring new customers will become far harder.
Sage is a global developer of finance, customer relationship management and ERP software for small and medium-sized firms. Although not affected as badly as SAP, Sage is still in Microsoft’s firing line, and Sage’s historically high growth rates are a thing of the past – since 2004, like-for-like sales have risen by just 5% a year.
Not surprisingly, Sage’s strategy has been to sell new products to its 325,000 existing customers while pursuing faster growth opportunities, sometimes outside of its core competencies. Last week, for example, it announced the acquisition of Emdeon Practise Services, which provides software for doctors’ surgeries and small clinics in America, for £297m. The application manages patients’ appointments, prescriptions and electronic health records across 20,000 surgeries. This is worrying as healthcare is a totally new area for Sage. I believe Emdeon is a much greater risk than past acquisitions, and could be a major drain on management resources – particularly while the threat from Microsoft remains to be dealt with.
Now let’s look at the valuation. At 218p, Sage’s shares trade on a toppy p/e of 17 and 15 times earnings for this year and next. So with pedestrian organic growth, higher acquisition risk and the entry of an aggressive new competitor into its core market, I recommend selling the shares.
Recommendation: SELL at 228p
See Paul Hill’s tip of the week for a share to capitalise on the Microsoft ERP trend. And to find out more about his specialist share-tipping service, ‘Precision guided Investments’, click on the link below: