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Standing at the edge of a secular shift

The value of guiding a customer from a legacy on-premise offering into a cloud solution, is not a simple dollar-for-dollar exchange. In fact, the migration usually results in the customer spending 2-3x more with that vendor, but saving 20-50% overall as it is able to shed significant ancillary costs.

– Amit Nath

It is increasingly clear that in the post-pandemic world, digital transformations are being prioritized and accelerated across enterprise companies. As the need to navigate an entirely new business environment is born, multiple opportunities are also created. This was the topic of our recent whitepaper that the team at Montaka Global authored, which readers can find here

While transitioning to the cloud is central to most digital transformations, it is often overlooked just how material the shift can be for businesses facilitating the move. While collaborative tools, Customer Relationship Management (CRM) and Human Capital Management (HCM) have already achieved significant cloud penetration (~70%+), Enterprise Resource Planning (ERP) and Supply Chain Management (SCM) are right at the start of their journey (~15-40% penetration). 

Cloud Penetration by Software Application

Source: Bloomberg

While there are many definitions around what constitutes ERP and SCM software, the areas that are likely to see the most significant functional shift from on-premises (i.e. customer managed hardware and software) to cloud (i.e. vendor managed), are in manufacturing systems, production lines, inventory management, supply chain planning and procurement. 

The reason these types of software applications have remained internally managed by customers (on-premises) is due to the high level of customization required, their mission critical nature to the business and the length of the sales cycle. As a rule of thumb, companies generally review their CRM tools after 3-5 years, HCM product after 5-7 years, while ERP / SCM solutions are reviewed with a 10+ year gap. This is largely the reason why ERP / SCM have among the lowest customer attrition in all of software and we stand at the edge of a once in a decade cloud transition, as vendors look to lock-in customers, retain market share as new entrants look to disrupt them.

It is worth noting the value of guiding a customer from a legacy, on-premise offering, into a cloud solution, is not a simple dollar-for-dollar exchange for an incumbent vendor. In fact, when a business moves from on-premise software to a cloud solution, the pick-up in revenue is actually 2-3x what it was previously. The reason there is such a massive pick-up in revenue for the vendor is because the customer is no longer paying for the hardware to host the software, internal IT staff to manage it or a consultancy to implement it. In fact the customer will usually see a net saving of 20-50% with a cloud migration, despite paying the vendor 2-3x more as it is able to shed so many ancillary costs. This seemingly magical situation is due to the cloud vendor being able to provide a fully hosted solution, driven by economies of scale and specialization.

Within the ERP market, German software business, SAP has the largest piece of the market with ~22% share. Given only ~40% of these workloads are in the cloud, the remaining ~60% could see a 2-3x revenue pickup for SAP as customers migrate.

ERP Market Share by Revenue

Source: Gartner, IDC, Bernstein

Additionally, SAP is the market leader in SCM software as well, which is very favorably positioned in a post pandemic world as companies and countries look to diversify and internalize supply chains, as tensions particularity with China, spurs demand across the world. 

SCM Market Share by Revenue

Source: Financial Times

It is estimated that ERP and SCM represent more than 50% of SAP’s total revenue according to Bernstein. Given ~70% of these revenues are on-premises, implies that as these workloads migrate to the cloud, SAP could pick-up 2-3x the amount of revenue customers are currently paying. If this were to happen it would result in SAP’s entire revenue base doubling, without factoring in any price increases or additional services sold into the customer base. 

This may sound astounding but it is not the first time we have stood at the edge a secular shift to the cloud, in fact Adobe and Microsoft have been going through this transition for several years. More interestingly however, is the number of times the market fails to understand the enormous, structural, revenue growth tailwind on-premises to cloud drives and severely underestimates it.

In fact, as the migration kicks off, revenue often decelerates as the vendor exchanges large, lumpy, upfront license sales, for high quality, recurring revenue streams, which can lead to proclamations that the vendor is losing market share and failing. Ultimately however, for a successful execution, the market heuristic is proved incorrect and the company is ascribed a significantly higher multiple. Additionally, as we have observed with Adobe and Microsoft, the long-term, structural cloud growth underlying the businesses, repeatedly confounds the market which consistently underestimates it, creating a further value inflection.

At Montaka Global, we believe in owning the long-term winners in attractive markets, while they remain undervalued. We believe both SAP and Microsoft clear these hurdles comfortably and look forward to carefully monitoring their trajectory for many years to come.

Montaka owns shares in SAP and Microsoft.

Amit Nath is a Senior Research Analyst with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.

Our Montaka Active Extension strategy strives for maximised return over the long-term. Owning the Montaka long portfolio typically scaled up to approximately 130 percent - and the Montaka short portfolio typically scaled down to approximately 30 percent – this strategy results in a net market exposure of approximately 100 percent most of the time.

Our Montaka variable net strategy strives for significant downside protection – but with minimal upside reduction. Focused on owning the world’s great and growing businesses when they are undervalued, while managing a portfolio of short positions in businesses that are deteriorating, misperceived, and overvalued, this strategy is our flagship long-short

Our Montgomery Global strategy strives to act as a core, high conviction, global portfolio holding. Consistent with the long portfolios in our Montaka strategies, this offering is focused on owning the world’s high quality, undervalued businesses – and cash when appropriate – to outperform its benchmark. Branded as “Montgomery Global” in Australia to reflect a key.

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Strategies

Our Strategies

Our Montaka Active Extension strategy strives for maximised return over the long-term. Owning the Montaka long portfolio typically scaled up to approximately 130 percent - and the Montaka short portfolio typically scaled down to approximately 30 percent – this strategy results in a net market exposure of approximately 100 percent most of the time.

Our Montaka variable net strategy strives for significant downside protection – but with minimal upside reduction. Focused on owning the world’s great and growing businesses when they are undervalued, while managing a portfolio of short positions in businesses that are deteriorating, misperceived, and overvalued, this strategy is our flagship long-short

Our Montgomery Global strategy strives to act as a core, high conviction, global portfolio holding. Consistent with the long portfolios in our Montaka strategies, this offering is focused on owning the world’s high quality, undervalued businesses – and cash when appropriate – to outperform its benchmark. Branded as “Montgomery Global” in Australia to reflect a key.