SAP – One of Europe’s Best Businesses is on Sale
When short-term fear creates long-term opportunity in a mission-critical software giant
German software giant SAP is one of the highest-quality businesses in Europe, operating a mission-critical software backbone that powers the core processes across finance, supply chains, procurement, and HR for the world’s largest enterprises.
It is deeply embedded, highly sticky, and nearly impossible to replace, making SAP one of the most resilient businesses in Europe; even in downturns, it is among the very last line items a CIO would ever cut.
And this company is firing on all cylinders right now, with cloud revenues compounding, margins expanding, backlog building, and free cash flow accelerating. This company is likely looking better than ever, with the migration to the cloud rapidly expanding its TAM and revenue opportunity, and AI integration propelling this opportunity even further, with SAP a perfect foundational IT/data layer within the enterprise on which Agentic AI can run. Add to that the fact that SAP is the prime candidate to benefit from Europe’s push away from U.S. software and focus on sovereign cloud options.
Truly, the backdrop for SAP over the next 5-10 years is sublime.
Yet, its shares have been decimated in recent weeks. Shares are down 17% YTD, 29% over the last year, and 35% away from their July 2025 all-time highs, which is also when I last covered this company here on InvestInsights in a thorough Deep Dive.
Back then, I concluded that SAP was a brilliant long-term hold, given a compelling backdrop for the decade ahead and a high level of reliability for investors, but that the growth prospects for the next 3-5 years were already well priced in at those highs.
So, I think it’s due time I updated my stance on the company by re-assessing recent performance, its financials, and underlying developments to ultimately update my thesis, financial forecast, and fair value estimate.
Let’s delve in!
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An underappreciated quarter
SAP released its latest financial results on January 29 and delivered what I view as a very strong quarterly report, showing excellent business momentum across the board, delivering strong growth and healthy margin expansion. Furthermore, the company surpassed its 5-year cloud targets and its 2025 profit and FCF guidance, while growing its cloud backlog to record levels and maintaining strong top-line growth.
However, that still couldn’t please investors, who stumbled over a single number that missed guidance, sending shares down 15% in the following session and to a new 12-month low. In my opinion, this is as ridiculous as overreactions come, especially since it was a very minor miss and one that management easily justified.
What we really saw there was an overreaction to a minor miss fueled by weak sentiment, driven by the prevailing narrative that AI is a threat to these enterprise software giants, which is outright false. However, it is putting investors on edge, and any minor miss fuels fear. However, this also means the sell-off hardly reflects fundamentals and simply lowers the multiple investors need to pay to buy shares in this best-in-class European SaaS giant.
But I’ll address those subjects later on. First, let’s break down the Q4 numbers, starting at the top.
SAP reported total Q4 revenue of €9.68 billion, missing consensus estimates by €80 million and reflecting constant currency growth of 9% YoY (or 3% reported including FX headwinds). Notably, this is a deceleration from low-double-digit growth in prior quarters, but it is simply due to contract timing and does not reflect business momentum, so don’t place too much value on it.
This brought FY25 revenue to a record $37 billion, up a healthy 11% YoY.
The primary driver of growth remains cloud revenue, as SAP continues to migrate its large customer base from on-premises contracts to cloud-based ones. Crucially, when a customer makes this transition, SAP can, on average, sign a contract with a 2-3x higher contract value than the previous software-based one, due to much improved cross-selling capabilities and higher-value services, so this transition is giving it significant revenue upside. In practice, by transitioning its entire customer base, it can double or triple pre-migration revenue without acquiring customers.
As a result, combined with a strong customer acquisition engine, SAP delivered 26% growth in cloud revenue in Q4, now accounting for 58% of total revenue. As highlighted below, this is a minor deceleration from prior quarters, driven by the same dynamics affecting total revenue.
Cloud revenue for 2025 was also up 26% YoY, driven by a strong performance in cloud ERP, with revenue up 32% YoY and accounting for 86% of total cloud revenue. ERP remains SAP’s core offering; the transition to the cloud is just expanding the revenue opportunity.
Notably, this means SAP outperformed the cloud market by 10 percentage points in 2025.
Meanwhile, as cloud revenues grew from the transition, software license revenue fell 27% YoY, but the net result remains strong: combined revenue (cloud + software) was up 10% YoY in Q4.
Then, on to the cloud backlog, which is arguably the most important metric for investors to watch, most certainly the most valued one, given that it provides the most visibility into real current demand, business momentum, and future revenue. And this is where the company reported a slight hiccup.
SAP reported a current cloud backlog, referring to cloud revenue to be realized over the next 12 months, of €21 billion, up 25% YoY and with that falling short of the 26% management has guided for in Q3, which was a negative surprise, suggesting that the company is not just seeing growth slow down, but even more than expected.
Obviously, that number on its own isn’t great. 25% current backlog growth is the weakest in over 2 years and a notably 400 bps slowdown from the 29% growth reported in Q1, so clearly momentum is easing, right? Well, it isn’t actually that straightforward, and simply looking at the number completely misses the underlying business dynamics.
Management gave two very logical reasons for the one-percentage-point miss in the growth rate. First, the company closed a higher share of very large deals in Q4 compared to prior quarters. Crucially, it is obviously very favorable for total cloud backlog growth but a drag on the current backlog. Why? Because these large customers very often don’t move their mission-critical ERP in the first year, as transitioning mission-critical systems to a completely new infrastructure takes time – an issue that occurs way more often for larger customers than smaller customers.
As a result, while the actual backlog growth was significant due to these large contracts, this larger share of the total is a drag on the amount of cloud revenue to be realized over the next 12 months, with these contracts more back-loaded. This means the shortfall says very little about actual business performance.
Second, the company closed a higher share of government deals, which include a termination for convenience by law. Therefore, SAP does not include these deals in its CCB (Current Cloud Backlog). Again, the result is a CCB growth number that does not fully reflect actual business momentum.
When considering the actual booking performance, management indicated it outperformed, with results ahead of plan rather than falling short. Customer retention was strong, and churn, contract duration, and discount rates were stable.
As a result, the total cloud backlog grew 30% YoY to €77 billion, with growth well exceeding CCB. This included notable customer wins in Q4, including Adidas, H&M Group, Deloitte, RTX, the U.S. Navy, Toyota, Daimler Truck, Nokia, and Lockheed Martin.
Also, the company is seeing new demand driven by geopolitical tensions, with greater emphasis on exploring sovereign SaaS options. In other words, businesses, particularly in Europe, are increasingly seeking to reduce their dependence on U.S. software, and SAP is well-positioned to benefit. These deals take longer to negotiate, given their complexity and the fact that many are state-owned, so we are likely to see this turn into a stronger tailwind later in 2026 and into 2027.
Even more important, when it comes to cloud revenue and backlog, AI is becoming a significant tailwind for SAP, not a risk.
As I explained in my ServiceNow analysis, AI is probabilistic, meaning it produces outputs based on likelihood rather than certainty. This in itself makes it unusable for large enterprises, which require structured, governed, and predictable execution. This is exactly why, especially in the age of AI, workflow orchestration is critical, as it is deterministic and predictable.
As SAP management pointed out during the Q4 earnings call, enterprises have nothing to gain by developing multiple custom AI agents or by applying commodity large language models on top of transactional business applications, given their probabilistic nature. In order to actually “boost process automation and efficiency, AI agents must be embedded in business processes and trained with context-rich business data that is not available to large language model providers,” to quote management.
In other words, deeply integrated enterprise software platforms are the gateway to Agentic or functional AI for enterprises, functioning as the execution and control layer that allows AI agents to operate across systems, workflows, and departments in a governed, predictable, and scalable way – SAP sits on the world’s largest volume of business data and is in the position to directly integrate Agentic AI into the most mission-critical business processes of a company.
This puts it in the perfect spot to benefit from AI adoption rather than be disrupted by it.
As a result, SAP is actually seeing great traction in its SAP Business AI module, which is SAP’s portfolio of artificial intelligence capabilities that are built directly into its enterprise software to help businesses automate processes, gain insights, and boost productivity.
Over 2/3 of its cloud deals signed in Q4 included Business AI, up more than 20 percentage points from Q3, and usage of its AI CoPilot (one of the best given the data access) has exploded over the last year, growing ninefold, signaling very strong demand traction for these AI features. For reference, management indicated that 60% of customers already use AI features through SAP, with another 20% actively exploring the opportunities.
Furthermore, 90% of the top 50 deals signed in Q4 included AI or SAP Business Data Cloud (BDC), a unified, cloud-native data platform that brings together all of an organization’s enterprise data (from SAP systems and third-party sources) into a single, semantically rich, governable data foundation. BDC harmonizes data with consistent business meaning, removes the need for costly extracts and motioning between systems, and enables real-time analytics, planning, reporting, and AI-driven decision-making. It essentially prepares and organizes trustworthy business data that can fuel advanced analytics and SAP’s enterprise AI capabilities across the organization.
SAP’s BDC has already secured €2 billion in contract value in less than a year since its launch, underscoring the strength of demand for these overarching data and AI solutions. SAP, being very deeply integrated in the enterprise software stack, is simply in the perfect position to offer these kinds of next-gen solutions, and it is driving significant long-term value, especially considering it has a customer base exceeding 440,000 across 180 countries to cross-sell these features to, which will significantly increase contract value per customer over time.
The opportunity here for SAP is massive, and the risk of disruption is minimal.
To quote management:
“So to make this very clear, we are winning deals because of AI. We are not losing deals because of AI. And definitely, these deals are actually now leveraging AI to increase the win rate in Q4.”
With that, let’s jump to the P&L results!
SAP reported a Q4 gross margin of 74.1%, roughly flat YoY, but still showing steady progress, helped by a strong cloud gross margin, which was up 160 bps for the year.
Further down the line, SAP is able to deliver healthy operating leverage, as high costs from recent years ease with the peak investments in its cloud transition now largely behind it. For reference, Q4 R&D expense growth was limited to just 1%, sales and marketing was down 8%, offset slightly by 23% growth in G&A, but restructuring costs were near €0, down from just over €300 million last year.
With the gross margin flat and operating costs well under control. SAP delivered strong growth in operating profit, up 21% YoY to €2.8 billion, despite a lasting €100 million headwind from a 2025 workforce transformation, as reflected in high G&A costs.
This reflects an operating margin of 29.2%, up 770 bps YoY and 90 bps sequentially.
This brought the full-year operating profit to €10.4 billion
This translated into a Q4 EPS of €1.62, beating the consensus by €0.11 and up 16% YoY.
Finally, SAP delivered a FY25 FCF of €8.2 billion, which sat at the high end of its guided range and was up 44% YoY, the highest levels since 2020, driven by higher profitability and lower payments for restructuring and share-based compensation, which were elevated in recent years due to the cloud transitions and heightened investments in the business. Furthermore, this reflects an FCF margin of 22%, up 500 bps YoY.
Given these excellent cash flows, improving ahead of schedule, management announced a new 2-year share repurchase program of up to €10 billion, starting in February, allowing it to retire another 5% of its outstanding shares at current prices. And this comes on top of a solid dividend. SAP shares now yield 1.4%.
Also supporting this is a very healthy balance sheet. SAP ended Q4 with a net cash position of just under €2 billion, including nearly €10 billion in cash. This is a massive improvement from over €10 billion in net debt as of 2020, putting the company in an excellent position to invest in the business and be opportunistic with repurchases at favorable prices.
On a final note, SAP’s reinvestment metrics are excellent as well. Its TTM ROIC is just over 16%, the highest level since 2018, and its ROE is just over 16%, suggesting SAP can generate healthy returns on investment.
Ultimately, I am quite pleased with this quarter. The company is showing strong top-line results and momentum, and continues to expand margins and improve cash flows. In my view, this was a fairly decent quarter, largely as expected.
On that note, let’s get to the outlook.
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Outlook & Valuation
As always, let’s start with management’s guidance.
