Qualtrics Marks Stellar Debut Upon Separation From SAP SE

On January 28, 2021, shares of Qualtrics International, Inc. (NASDAQ NDAQ : XM; $45.50; Market Capitalization: $22.9 billion) started trading on the NASDAQ exchange, marking the separation of the customer experience management (CEM) platform previously owned by SAP SAP SE (NYSE: SAP; $130.44; Market Capitalization: $160.2 billion). XM attracted overwhelming interest from investors, following which the company’s shares were priced at $30.00, well above the initial price range of $20.00 – $24.00.

SAP sold about 51.7 million Class A shares of XM through the IPO and retains approximately 82.8% stake in XM through sole ownership of 423.2 million Class B shares. SAP initially announced its intention to carve-out XM on July 26, 2020, just two years after it acquired the platform in 2019. We note that the separation is expected to result in mild operational dis-synergies as XM is a key component of SAP’s overall offerings, especially after the company announced Sapphire integration in 2019. However, we believe that SAP’s strategic stake in XM post-IPO will enable both companies to benefit from platform synergies.

The separation has resulted in significant value unlock for shareholders as legacy IT players trade at a median valuation of about 12.0x forward cloud sales, whereas cloud companies with average sales growth of over 40% YoY, including Crowdstrike, Twilio TWLO , Okta, Veeva, and DocuSign DOCU , trade at a median of ~15.0x EV / FY21 Sales. We conservatively estimate that XM’s fair enterprise value is 16.0x FY25 cloud sales and initiate coverage on the company with a ‘Buy’ rating.

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Valuation and Recommendation

Using 14.0x EV/FY25e Cloud Sales, we estimate SAP’s market capitalization at $184.9 billion (including the value of 82.8% stake in XM) or $156.00 per share.

Using 16.0x EV/FY25e Cloud Sales, we estimate XM’s market capitalization at $26.5 billion or $52.00 per share.

Deal Overview

On July 26, 2020, SAP SE (NYSE: SAP) announced its intention to separate its survey and analytics platform, Qualtrics. XM filed its initial S-1 on December 28, 2020, followed by a first amendment on January 12, 2021. The IPO was initially priced in the range of $20.00 to $24.00 per share. On January 27, 2021, SAP priced XM shares at $30.00 driven by strong investor demand. SAP divested 17.2% of its stake in XM through an IPO that closed on January 28, 2021.

Deal Rationale

Qualtrics has begun a new chapter under SAP’s ownership, as evidenced by the robust top-line growth and platform integration for the experience management software maker. SAP is of the opinion that Qualtrics requires sufficient autonomy to scale further and retain its leadership in the survey and analytics software market. Perhaps, most investors are puzzled at the “why now” question since Qualtrics has operated under SAP’s ownership for less than two years. Significant acceleration in cloud adoption in the wake of COVID-19 is a factor that is likely to have driven SAP’s decision to float Qualtrics. However, SAP’s plans to retain at least three-fourths stake in Qualtrics after an IPO suggests that Qualtrics will still be able to leverage SAP’s management expertise, customer base and ERP platforms, with which Qualtrics XM enjoys high synergies. Under SAP, Qualtrics has achieved significant cross-selling to SAP’s ERP customers and the management has commented that Qualtrics has exceeded expectations on cloud and overall revenue growth.

Furthermore, the IPO represents an attractive monetization opportunity for SAP, whose cash flows have sputtered following acquisition of Callidus and Qualtrics. SAP will be wise to use the proceeds from the IPO to deleverage and meet its capex requirements to stabilize free cash flow margin.

SAP’s Acquisition of Qualtrics

On November 11, 2018, SAP announced its plans to acquire experience management private company, Qualtrics, in a $8 billion all-cash deal. Qualtrics was acquired four days before its planned listing in the U.S. At the time of the acquisition the company’s shares were oversubscribed 13 times valuing, the company around $5-$6 billion. SAP had financed the transaction with a $7.0 billion credit facility.

The primary rationale of the acquisition was to combine the experience data from Qualtrics and operational data from SAP to provide its customers with an end-to-end experience and operational management system. SAP’s global reach and Qualtrics solution would help the company pursue opportunities in the growing experience economy. SAP subsequently completed the acquisition on January 23, 2019. Chief executive officer of SAP at the time, Bill McDermott, faced flak from investors for overpaying for the company. Many investors felt that SAP was stretching its balance sheet by going after Qualtrics in a not-so-bolt-on acquisition.

Valuation

Our valuation of SAP hinges on the pace of cloud transformation the company is able to achieve over the next five years. Taking cues from the rather soft performance during 3Q20, we believe that SAP is aiming for an accelerated transition to cloud that will demand higher investments until 2024, which could keep the profitability suppressed. We forecast that SAP will significantly increase its “more predictable revenue” share to about 85% and continue to focus on bottom line efficiency. Sustainable double-digit operating profit growth is likely to kick in from 2023 to 2025 and beyond. The negative impact of COVID-19 on SAP’s cloud business is expected to ease by mid-2021, setting a stage for good recovery in key metrics such as non-IFRS cloud revenue, total revenue, and operating profit, by mid-2023.

While SAP has targeted to achieve €22 billion in non-IFRS cloud revenue by 2025, we believe that the journey is likely to be beset by multiple challenges that will have an impact on profitability and free cash flow as well. We conservatively estimate that SAP’s total cloud revenues in FY25 will be about $20.1 billion but is expected to constitute a higher proportion, at about 65%, of total sales. We expect non-cloud sources (such as software license, support, and services) to contribute about $10.8 billion. A significant deceleration in license revenues is expected to be offset by support and services revenues.

We estimate the respective enterprise values of XM and SAP Stub using median recurring sales multiples at which large cloud-centric European IT peers trade at. We expect XM to trade at a ~15% premium to legacy IT players, given its market dominance in the CEM space. Our sales estimates are based on the official guidance, which we discount back to 2021 using SAP’s estimated weighted average cost of capital of 6%.

Using 14.0x EV/FY25e Cloud Sales, we estimate SAP’s market capitalization at $184.9 billion (including the value of 82.8% stake in XM) or $156.00 per share.

Using 16.0x EV/FY25e Cloud Sales, we estimate XM’s market capitalization at $26.5 billion or $52.00 per share.

Company Description

SAP SE (Parent)

Founded in 1972, SAP is a global market leader in enterprise application software and also the leading experience management, analytics, and business intelligence company. SAP’s enterprise resource planning (ERP) software integrates back-office functions such as analytics, accounting, distribution and human resources, and comes in on-premises and cloud-linked forms. SAP offers most of its platforms on cloud computing and software-as-a-service with its flagship application suite S/4HANA as an alternative to its legacy SAP Business Suite. Besides enterprise software, SAP Concur provides expenses management and SAP Fieldglass provides external workforce management.

Qualtrics International, Inc. (Carve-out)

Qualtrics International, Inc. (XM) is the technology platform that organizations use to collect, manage, and act on experience data. The Qualtrics XM Platform™ is a system of action, used by teams, departments, and entire organizations to manage the four core experiences of business—customer, product, employee and brand—on one platform. Over 9,000 enterprises worldwide, including more than 75% of the Fortune 100 and 99 of the top 100 U.S. business schools, use Qualtrics. In 2019, the Qualtrics realized total revenue of €508 million.

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