SAP is forecasting that its cloud subscription revenue will exceed sales of on-premise software licenses in 2018, company executives said Tuesday. But the company's cloud growth is coming at the expense of profit margins and the company has reduced its profit outlook for 2017.
That news sent the price of SAP's stock tumbling more than 5 percent in early trading Tuesday.
SAP – a longtime leader in selling on-premise ERP, CRM and other business applications – is transitioning to selling cloud applications. The company reported last week that cloud subscription and support revenue grew 56 percent in 2014 and 68 percent in the fourth quarter, pushing the Walldorf, Germany-based company's annual cloud application revenue over 1 billion euros for the first time.
On Tuesday, the company said it was targeting 7x growth in its cloud business, pushing annual revenue to reach €28 billion ($39.5 billion) by 2020. Last year SAP's sales were €17.6 billion, or approximately $24.9 billion.
SAP's fourth-quarter results show how complex the company's cloud transition is. While cloud subscription revenue soared, sales of the vendor's traditional – and higher-margin – software products declined 2 percent to €1.87 billion. That resulted in a 3 percent decline in the company's operating profit to €1.75 billion.
Tuesday, SAP said it expects 2017 operating profit (excluding special items) to be in the range of €6.3 billion to €7 billion on revenue between €21 billion and €22 billion. Earlier, the company had forecast an operating profit of €7.7 billion in 2017.
SAP expects profit margins to eventually grow as the company's cloud operations scale up.
"We expect cloud subscriptions to exceed software licence revenue in 2018," said SAP CFO Luka Mucic in statement Tuesday. "At that time, SAP expects to reach a scale in its cloud business that will clear the way for accelerated operating profit expansion."
In an interview on CNBC Europe's "Squawk Box" on Tuesday, CEO Bill McDermott said: "What you find with the cloud is that once you get the size, scale and reach in the cloud, the operating margins increase over time. That's why we gave a 2017 and 2020 view on how we nearly double profits by 2020."
But McDermott added: "I think we're doing the right transition; we're a growth company and this is what the investor wants."