While the overall analyst commentary generally has been pretty constructive and supportive of SAP’s $3.4 Billion bid for SuccessFactors, Inc., many questions remain.  Although many analysts believe SAP is overpaying for SuccessFactors (SFSF), in our view, the valuation is not unreasonable and is not the critical factor in assessing this deal.

The more important point, is that we believe SAP is throwing in the towel, and admitting that its ByDesign SaaS initiative, which has cost SAP material amounts of time and money, has not met expectations and that a buy, rather than a build, approach is needed to meet market requirements.   This is a big shift for SAP, in that SAP has not participated substantively in the broader consolidation of the industry and raises a number of questions, concerns and risks.

We raise these concerns to provide the much needed balance to the generally optimistic views represented by current research commentary.  It remains to be seen how well SAP and SFSF address these issues.  We will be doing additional work to provide greater depth and detail with respect to these concerns.

1. SAP’s culture of “not invented here.”  SAP has a track record of organ rejection of ideas/technology coming from Silicon Valley (witness the ejection of Shai Agassi and the TopTier team).  Will SAP, and its engineers in Walldorf, Germany be able to embrace a high profile senior executive and development team based in California?
   
   
2. SAP's co-CEOs are betting that acquired, rather than internally developed, technology will yield a higher return. This deal is an outcome of a strategic internal review of SAP’s HCM offerings.  The morale of SAP's internal HCM R&D teams is likely to sag.   Conversely, now that SAP is de-emphasizing its own, dated HCM offering, will the SAP channel pick up on SuccessFactors, and sell several billion dollars worth of talent management and e-learning product?
   
   
3. The acquisition of SFSF may undermine SAP’s long standing positioning of its tightly integrated ERP offering. Combined, SAP and SFSF have over six distinct SaaS offerings – and lack a coherent single architectural foundation. By trying to make a bold acquisitive move, SAP may have inadvertently shot itself in the foot with this deal.   Is SAP’s long-standing argument for tighter integration from a single vendor is now past its sell-by date?

Winners

• SFSF shareholders and SaaS vendors across the market.  SAP is setting a high bar for price premiums.     The valuation of the SFSF deal fits our model that we published is our SaaS Valuation note “What Price is Right?”   The valuation multiple is also consistent with what our model predicted for RightNow which is being acquired by Oracle.    In addition, the valuation of IBM’s announced deal to acquire DemandTec is also very much in line with what the MGI SaaS valuation model predicted.

Losers

• Legacy on-premise vendors without a credible SaaS offering are now exposed as the tide recedes, the market will see all who are not wearing shorts.  The pool of SaaS companies with proven offerings is actually quite small in a given application market segment (e.g., HCM, manufacturing, financials).  On premise vendors planning to acquire a SaaS solution need to move quickly, as the number of potential targets shrinks. To date, the build strategy has proven to be inadequate – witness recent actions of SAP and Oracle, the two companies with the largest resources to build their own SaaS offerings who have reversed course and acquired a solution.