josefkubes
josefkubes
The following segment was excerpted from this fund letter.
After following SAP for many years, we bought shares in the company in 2022. Since we have not covered SAP in much detail in prior communications, we will start with a little background. This Germany-based company boasts the leading global share in enterprise resource planning (ERP) software, or what one might consider the operating system for large businesses. This type of software performs critical functions for customers, related to bookkeeping, manufacturing, and supply chain. SAP also sells complementary modules that help customers manage human resources, procurement, and expenses. For multinational enterprises that make or move something in the physical world, SAP is just about the only game in town. As a result, SAP has retained many of its customers, particularly its biggest ones, for decades.
A handful of years ago, SAP set about transitioning its core ERP software product suite from one typically run by customers on their premises to a cloud version delivered directly by SAP. Because SAP is taking on a much higher degree of responsibility in addition to delivering an upgraded product, it stands to earn substantially more revenue per customer in the cloud. We believe the cloud transition of SAP's ERP business is likely to usher in a potentially decade- long sweep of accelerated revenue growth. Critically, because SAP's ERP software is so sticky, the migration to the cloud product is, in our view, much more a matter of when, not if, for a substantial portion of the company's installed base. We can think of few companies in the world whose products are more essential to their customers and/or have higher switching costs.
This transition is not without its challenges. SAP's software is so sticky and entrenched that customers even hesitate to upgrade from an old version to a new one. The company has developed programs and playbooks to help its customers navigate this shift and reduce the complexity of their SAP installations, but this whole effort has also required a large and sustained sales and education push across the entire SAP ecosystem, which includes not only tens of thousands of customers but also scores of technology consulting firms and third-party application developers.
In 2022, slowing ERP revenue growth and mounting temporary costs related to the ERP cloud transition gave some investors pause. Some members of the market were worried that while the software is "mission critical", the transition might also provide the once-in-a-generation opportunity for companies to reevaluate their ERP options, and in the process, SAP could see some client defect to other competitors. In our view, slowing ERP revenue growth was a predictable and temporary outcome of the transition's progress, as it takes time for the base of cloud subscription fees to offset the license sales they replace. As for the temporary transition-related costs, they related to specific initiatives we deemed necessary to the transition. Sensing an opportunity, we initiated our position in June 2022.
A year and a half later, we remain optimistic about SAP's prospects. We saw the ERP cloud transition gain momentum over the course of 2023, with cloud ERP revenue growing over 70%. We believe cloud ERP will help to drive high- single-digit growth in SAP's overall revenues this year and beyond. As last year also saw the completion of a cloud infrastructure renovation that had been weighing a bit on margins of late, we are anticipating significant double-digit earnings growth for 2023.
We believe SAP can, over time, earn significantly higher margins. The extent will depend on how exactly the ERP cloud transition progresses and on the particular pricing posture the company chooses to assume. Recent strength in the share price may have outpaced near-term earnings growth, but we remain comfortable at the current valuation because we see a clear path to enhanced profitability as the company works to extract greater value from its customer relationships. Along these lines, we are encouraged by what we have seen of SAP's new CFO. He joined last year and is already bringing welcome discipline around costs, especially stock-based compensation, as well as free cash flow generation and capital returns to shareholders.
| Disclosures Please consider the investment objectives, risks and charges and expenses of Sequoia Fund Inc. (the "Fund") carefully before investing. The Fund's prospectus and summary prospectus contain this and other information about the Fund and are available at Home - Sequoia Fund or by calling 1-800-686-6884. Please read the prospectus and summary prospectus carefully before investing. Shares of the Fund are distributed by Foreside Financial Services, LLC (Member FINRA).
* The Fund's holdings are subject to change and are not recommendations to buy or sell any security. The percentages are of total net assets. An investment in the Fund is not a deposit of a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Shares of the Fund may be offered only to persons in the United States and by way of a prospectus. Annual Fund Operating Expenses (expenses that you pay each year as a percentage of the value of your investment):
** It is the intention of Ruane, Cunniff & Goldfarb L.P. (the "Adviser") to ensure the Fund does not pay in excess of 1.00% in Net Annual Fund Operating Expenses. This reimbursement is a provision of the Adviser's investment advisory contract with the Fund and the reimbursement will be in effect only so long as that investment advisory contract is in effect. The expense ratio presented is from the Fund's prospectus dated May 1, 2023. For the year ended December 31, 2023, the Fund's annual operating expenses and investment advisory fee, net of such reimbursement, were 1.00% and 0.89%, respectively. The Fund is non-diversified, meaning that it invests its assets in a smaller number of companies than many other funds. As a result, an investment in the Fund has the risk that changes in the value of a single security may have a significant effect, either negative or positive, on the Fund's net asset value per share. The S&P 500 Index is an unmanaged capitalization-weighted index of the common stocks of 500 major US corporations. The Index does not incur expenses. It is not possible to invest directly in the Index. | ||||||||||||||||||||||||||||||||||
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