GrowthSpotting: The Art of Global Investing
This series cuts through market noise to explore a handful of what we believe are the most relevant and inevitable global trends for investors seeking growth.
These powerful subthemes take a closer look at what we think is a valuable framework for understanding growth drivers worldwide—our “MANTRA” (Mass Affluence, New Technology, Restructuring and Aging).
Today’s post focuses on Paradoxes in Austerity: Efficiency Driven Growth.
Growth in the developed world could well be described as “slow and fragile.” As it appears today, a cyclical recovery in the U.S. will be modest, while Japan continues, in my view, to misallocate capital. Across Europe there remains a long runway of deleveraging and restructuring to do. However, there are things to invest in, even in this gloomy environment.
Whilst the tepid global economic environment is causing weak top line growth for many companies, it is driving a lot of growth among a select number of industries. I see businesses facing significant revenue headwinds investing in goods and services that enable them to boost efficiency and productivity. If this trend continues, enterprise software applications would clearly benefit.
SAP, the software company based in Germany, provides a good example of this trend. SAP is a provider of enterprise resource planning (ERP) software, in other words, it provides to other companies the computer programs they need in order to do their business. The software packages that SAP licenses to end users—and then helps to install and run—cover everything from accounting to human resources, purchasing to delivery. It also enables all of these systems to interact with each other. Hence the ads we see in airports stating that “such-and-such a company runs SAP.”
With a 25% market share, SAP is tops in ERP, and therefore massively advantaged.1 These are complex, expensive installations, so once a company has begun using SAP software, the cost of switching to or integrating with other providers can be prohibitively high. Its customers also return for maintenance and lucrative upgrades. SAP’s revenues grew at over 15% annually in the last two years, faster than any time since 2001, and its operating margins are higher than ever before.2
Microsoft is riding this trend as well. Revenue and earnings at Microsoft during the quarter ended in March were ahead of expectations, largely on the back of business division revenue.3 In 2011, Microsoft’s business division became the firm’s largest and most profitable segment, fuelled by its Office suite and associated products.
The ubiquity of Outlook, Word and Excel is a key competitive advantage that is hard to erode. Great software? No, probably not. However, an easy way for many businesses to improve productivity is to upgrade their Office software. Over the past two years, many have chosen to do just that. Since launching their upgrade Office 2010 in June 2010, Microsoft has been selling roughly one copy per second, while tens of millions of users access it through the web as well.
These companies are compelling for two other reasons. First, their huge free cash flow and low operating leverage allows both companies to fund their own growth, which allows them to enhance competitive advantages and seize growth opportunities. Second, prospects look promising if the global economy finally does pick up. Whether it’s high switching costs or limited alternatives, I believe companies are unlikely to abandon SAP or Microsoft anytime soon. In fact, as companies add workers, demand should remain strong, potentially fueling strong long-term growth for both companies.
1. Gartner, 4/24/2012
2. Bloomberg, 6/5/2012
3. Bloomberg, 6/5/2012
Read more from the series GrowthSpotting: The Art of Global Investing at http://blog.oppenheimerfunds.com/tag/growthspotting/
The mention of specific companies does not constitute a recommendation by any Oppenheimer fund or by OppenheimerFunds, Inc. Certain Oppenheimer funds may hold the securities of those companies mentioned