No, this is not a joke. Conventional investing wisdom holds that you need to go to the US and Asia to find fast growing tech stocks. Conversely, Germany mostly offers cyclical autos, chemicals, machinery and financials, plus some engineering pearls. However, German information technology stocks are largely flying under the radar of global investors although they do offer strong growth in a low growth environment.
We asked conventional wisdom (CW) to interview us, the HanseaticHunter (HH):
CW: Germany has many global leaders in engineering, but not in information technology.
HH: Maybe we peaked early, but we have the global leader in enterprise software. Investors always think about SAP when they hear “German IT”. Rightly so, as this software behemoth has – from humble beginnings in the 70s - conquered the world over the last 40+ years. Now, it outpaces its arch rival Oracle due to its strong cloud product.
CW: OK, you have SAP, but beyond them Germany is an IT desert. Right?
HH: Far from it. We find many prospering information technology companies. Many of our global technology champions are hardware-related and accounted for in the industrial sector, which should not come as a surprise given our strong engineering background. However, what may surprise is the flourishing software & services sector in Germany.
CW: Define “flourishing”. Surely, growth rates lag those of US peers?
HH: First of all, besides the megacap SAP, there are well over 20 readily tradeable small/midcap software & services companies in Germany.
Secondly, this group of 25 software stocks is showing an accelerating growth curve while SAP’s growth momentum is waning. Despite its cloud success its growth curve is decelerating as both revenues and operating profit are expected to grow at less than 10% p.a. over the next 3 years. In contrast, our peer group is expected to grow an average of +13% p.a. in revenues and +20% in operating profits over the same period.
Finally, perhaps the biggest surprise, these growth prospects almost exactly match those of the top 10 US software & services stocks. On average, the latter are expected to grow +14% p.a. in revenues and +21% in operating profits over that period.
CW: OK, but the US top 10 are dominant global leaders. Can the same be said for your “group of 25”?
HH: Yes, the US top 10 are global leaders, but their largest exposure is still their home market. Within the German “group of 25” you will find global leaders in specific areas. For example, while the US has $45bn market cap WorkDay, Germany has the leader in connectivity platforms/staff collaboration, TeamViewer. We also have the leading construction software companies. This long neglected sector is now finally starting to go digital. Germany also has leaders in public traffic software, an area with growing focus as more and more cities turn “green”.
CW: Final point, how do valuations compare?
HH: The short answer is that they are no longer undiscovered, but still have a sizeable gap to the US top 10. Unlike the vast majority of the sellside which counts growth twice by taking a forward multiple and comparing it to forward growth, we use today’s valuation and compare it to future growth. This results in 4x EV/Sales, 18x EV/EBITDA and 46x PE for the German peer group, while the US top 10 is at 9x EV/Sales, 31x EV/EBITDA and 152x PE (or 62x excluding three barely profitable companies). Keep in mind that the top 10 US software & services companies are not universally fast growers like ServiceNow, but also include slow growers such as IBM and Oracle.
In conclusion, this chart summarizes the German opportunity:
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