INDEPENDENT RESEARCH UPDATE Software AG 19th July 2013 If you want a share of the action, go for it! IT Software & Services Fair Value EUR32 vs. EUR28 (price EUR25.82) BUY vs. SELL Bloomberg SOW GR We are raising our rating to Buy (vs. Sell) and our DCF-derived fair Reuters SOWG.DE value to EUR32 (vs. EUR28). Despite the volatile nature of growth, we 12-month High / Low (EUR) 35.1 / 22.5 think that strong trends in business process management and a more Market capitalisation (EURm) 2,244 Enterprise Value (BG estimates EURm) 2,245 favourable revenue mix lend credibility to a positive growth scenario Avg. 6m daily volume ('000 shares) 396.6 from Q4 2013 onwards, pending a higher EBIT margin in 2015. Buy Free Float 66.4% with your eyes wide open.... 3y EPS CAGR 1.0% Gearing (12/12) -5% Dividend yield (12/13e) 1.78% Continued momentum in business process management. With growth forecast at 16-22% in 2013, BPE (Business Process Excellence) YE December 12/12 12/13e 12/14e 12/15e Revenue (€m) 1,047 1,018 1,097 1,187 products (est. 45% of 2012 revenues), partly boosted by Terracotta (in- EBITA €m) 301.1 265.1 281.7 316.3 memory data management), should maintain vigorous momentum. These Op.Margin (%) 28.7 26.0 25.7 26.6 products are clawing back market share from rival Tibco, while Diluted EPS (€) 2.39 2.10 2.22 2.47 EV/Sales 2.1x 2.2x 1.9x 1.6x Software AG is improving its offer thanks to acquisitions that address EV/EBITDA 7.0x 8.1x 7.1x 5.8x new challenges in BPM (Cloud, Big Data, Mobility and social networks). EV/EBITA 7.3x 8.5x 7.5x 6.0x P/E 10.8x 12.3x 11.7x 10.5x ROCE 22.2 18.1 19.6 22.1 Return of organic growth foreseeable in Q4 2013. After eight quarters of negative growth, we think that Software AG will be capable of 19/7/13 150 restoring positive growth from Q4 2013: 1). BPE products are growing 140 strongly again; 2). Sales of ETS products are continuing to fall, but the 130 comparison base is becoming more supportive; and 3) the Consulting business has been repositioned. 120 110 Projected margin trends are priced in. Because of heavy sales and 100 marketing investment in the BPE division in 2013 and, to a lesser extent, 90 J A S O N D J F M A M J J SOFTWARE (XET) in 2014, we think EBIT margin is unlikely to improve before 2015. The STOXX EUROPE 600 E - PRICE INDEX Source: Thomson Reuters Datastream stock reacted negatively to the announcement of this plan, and we think this news has now been priced in. Attractive valuation. The stock is trading on EV/EBIT multiples of 8.5x 2013e and 7.5x 2014e, having suffered from: 1). Doubts about the execution of the 2018 Plan, which aims to generate revenues of EUR1bn in BPE; 2). The steep drop in revenues in the Consulting and ETS divisions in 2012; and 3). Question marks about the accounting recognition of licence revenues with staggered payments. Analyst: Gregory Ramirez 33(0) 1 56 68 75 91 [email protected] r r Software AG Simplified Profit & Loss Account (EURm) 2010 2011 2012 2013e 2014e 2015e Revenues 1,120 1,098 1,047 1,018 1,097 1,187 Change (%) 32.1% -1.9% -4.6% -2.8% 7.8% 8.2% lfl change (%) 0.6% -0.7% -8.1% -1.5% 6.8% 8.2% Adjusted EBITDA 331 321 314 279 296 331 Depreciation & amortisation (13.5) (13.4) (12.9) (13.6) (14.1) (14.6) Adjusted EBIT 317 308 301 265 282 316 EBIT 269 269 248 230 242 279 Change (%) 23.1% 0.2% -7.8% -7.4% 5.2% 15.3% Financial results (14.2) (9.9) (8.8) (8.5) (6.9) (5.0) Pre-Tax profits 254 259 240 221 235 274 Exceptionals 0.0 0.0 0.0 0.0 0.0 0.0 Tax (78.7) (82.1) (74.8) (72.0) (76.4) (90.4) Profits from associates 0.0 0.0 0.0 0.0 0.0 0.0 Minority interests 0.22 0.25 0.17 0.15 0.20 0.30 Net profit 175 177 165 149 158 183 Restated net profit 218 214 213 186 197 219 Change (%) 24.4% -1.8% -0.8% -12.4% 5.6% 11.5% Cash Flow Statement (EURm) Operating cash flows 225 182 214 199 210 233 Change in working capital 2.6 16.4 (29.9) 0.25 (13.5) (7.5) Capex, net (10.8) (12.5) (12.6) (14.0) (14.0) (14.0) Financial investments, net 1.1 1.5 (1.1) 0.35 0.0 0.0 Acquisitions, net (53.9) (59.2) (18.0) (78.7) 0.0 0.0 Dividends (32.8) (37.2) (40.1) (40.0) (40.0) (39.6) Other (214) 8.0 (16.2) (16.5) (21.9) 18.1 Net debt 167 60.9 (49.6) 0.78 (135) (340) Free Cash flow 217 186 172 185 183 212 Balance Sheet (EURm) Company description Tangible fixed assets 66.4 65.4 64.0 64.4 64.3 63.7 Founded in 1969, and listed on the Intangibles assets & goodwill 950 1,000 971 1,015 984 956 Investments 5.3 3.4 10.3 10.0 10.0 10.0 Frankfurt Stock Exchange since 1999, Deferred tax assets 21.5 18.7 16.7 16.7 16.7 16.7 Software AG markets enterprise Current assets 455 376 394 387 420 451 software addressing two specific Cash & equivalents 102 216 316 316 436 627 needs: 1). Business Process Total assets 1,601 1,681 1,772 1,808 1,932 2,124 Management/Analysis (55% of 2012 Shareholders' equity 769 951 1,060 1,054 1,172 1,356 Provisions 198 133 151 151 151 151 Product revenues, with the Deferred tax liabilities 47.4 36.7 26.8 26.8 26.8 26.8 webMethods product family, the ARIS L & ST Debt 270 277 266 316 301 286 platform, and the Terracotta in- Current liabilities 316 282 268 260 281 304 memory data management tool), Total Liabilities 1,601 1,681 1,772 1,808 1,932 2,124 Capital employed 937 1,012 1,010 1,054 1,037 1,015 enabling users to design business processes and integrate existing Ratios Operating margin 28.36 28.02 28.75 26.04 25.67 26.64 applications and data into new Tax rate 30.95 31.66 31.25 32.50 32.50 33.00 business processes; 2). Modernisation Net margin 15.67 16.11 15.71 14.67 14.43 15.44 of legacy IT systems (45% of 2012 ROE (after tax) 22.80 18.60 15.52 14.17 13.51 13.52 Product revenues, with an ETS ROCE (after tax) 25.10 22.02 22.17 18.09 19.61 22.10 Gearing 21.74 6.40 -4.68 0.07 -11.51 -25.10 product family, including its Adabas Pay out ratio 20.46 22.57 24.30 26.78 25.00 25.00 database management system and its Number of shares, diluted 86.15 88.79 88.77 88.77 88.77 88.77 Natural programming language), Data per Share (EUR) providing mission-critical mainframe EPS 2.04 2.04 1.89 1.72 1.82 2.11 applications with technologies Restated EPS 2.53 2.41 2.39 2.10 2.22 2.47 enhancing performance and opening % change 24.4% -4.7% -0.8% -12.4% 5.6% 11.5% EPS bef. GDW 2.53 2.41 2.39 2.10 2.22 2.47 new environments such as the Web BVPS 8.93 10.72 11.94 11.87 13.20 15.27 and e-business. Operating cash flows 2.61 2.05 2.42 2.24 2.37 2.63 FCF 2.52 2.10 1.94 2.09 2.06 2.39 Net dividend 0.42 0.46 0.46 0.46 0.46 0.53 Source: Company Data; Bryan, Garnier & Co ests. 2 Software AG 1. Upside potential after the fall 1.1. DCF model: EUR32 per share Our fair value of EUR32 Fig. 1: DCF assumptions is derived from a DCF Risk-free interest rate 3.0% model that incorporates Equity risk premium 6.1% an adj. EBIT margin of Beta 1.4 28% in the medium term Return expected on equity 11.5% Stock price (EUR) 25.82 Number of shares (m) 86.92 Market Capitalisation (EURm) 2,244 Net debt on 31/12/2013e (EURm) 1 Entreprise value (EURm) 2,245 Interest rate on debt 1.0% Tax rate 33.0% Sales growth rate to perpetuity 2.5% WACC 11.5% Source: Bryan, Garnier & Co ests. Fig. 2: Discounted FCF in EURm (FYE 31/12) 2012 2013e 2014e 2015e 2016e 2017e 2018e 2019e 2020e 2021e 2022e 2023e Sales 1,047.3 1,017.8 1,097.3 1,187.1 1,270.2 1,359.2 1,454.3 1,556.1 1,665.0 1,781.6 1,906.3 2,039.7 % chg -4.6% -2.8% 7.8% 8.2% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% Adj. EBIT 301.1 265.1 281.7 316.3 355.7 380.6 407.2 435.7 466.2 498.8 533.8 571.1 as a % of sales 28.7% 26.0% 25.7% 26.6% 28.0% 28.0% 28.0% 28.0% 28.0% 28.0% 28.0% 28.0% Theoretical tax rate 31.2% 32.5% 32.5% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0% Theoretical tax 94.1 86.1 91.5 104.4 117.4 125.6 134.4 143.8 153.8 164.6 176.1 188.5 NOPAT 207.0 178.9 190.1 211.9 238.3 255.0 272.8 291.9 312.4 334.2 357.6 382.7 Depreciation 12.9 13.6 14.1 14.6 14.0 15.0 16.0 17.1 18.3 19.6 21.0 22.4 as a % of sales 1.2% 1.3% 1.3% 1.2% 1.1% 1.1% 1.1% 1.1% 1.1% 1.1% 1.1% 1.1% Capex 13.3 14.0 14.0 14.0 14.0 15.0 16.0 17.1 18.3 19.6 21.0 22.4 as a % of sales 1.3% 1.4% 1.3% 1.2% 1.1% 1.1% 1.1% 1.1% 1.1% 1.1% 1.1% 1.1% WCR 126.5 126.3 139.7 147.2 152.4 163.1 174.5 186.7 199.8 213.8 228.8 244.8 as a % of sales 12.1% 12.4% 12.7% 12.4% 12.0% 12.0% 12.0% 12.0% 12.0% 12.0% 12.0% 12.0% Change in WCR 29.9 -0.3 13.5 7.5 5.2 10.7 11.4 12.2 13.1 14.0 15.0 16.0 Free cash flows 176.7 178.8 176.7 205.0 233.1 244.3 261.4 279.7 299.3 320.2 342.7 366.6 Discounted free cash flows 176.7 170.8 151.4 157.4 160.5 150.8 144.7 138.8 133.1 127.7 122.5 117.5 Sum of discounted FCF 1,457.8 Terminal value 1,360.7 Enterprise value 2,818.5 Fair value of associates 0.0 Fair value of financial assets 10.0 Provisions 151.0 Fair value minority interests 0.9 Dilution (s/o, warrants, conv bds) 44.7 NPV of tax credits 16.7 Net debt on 31/12/2012e 0.8 Equity value 2,737.2 Diluted nbr of shares (m) 84.80 Valuation per share (EUR) 32 Source: Company Data; Bryan, Garnier & Co ests.