The FTSE 100’s tech staple Sage Group (LSE: SGE) was recently downgraded to ‘sell’ by Goldman Sachs. This triggered a 5% slide in Sage shares yesterday from 741p to 706p.
The software company has been on my watchlist for a while now. Here I look at the possible reasons for the downgrade and also analyse its recent finances and business strategy to see if it is still a buy for my portfolio.
Reason for the downgrade
Analysts at Goldman Sachs moved Sage shares from neutral to sell, with a price target of 700p. The reason cited is the lack of “margin expansion” from the UK financial software company. Taking into account the dynamic software and cloud computing space, Sage Group’s focus on revenue generation over margin expansion is a concern for the banker.
I think there is validity to this assessment. While Sage’s model of recurring revenue through software subscriptions looks attractive, I feel like this affects innovation. The focus on customer retention and acquisitions for existing products could affect the company’s ability to expand to newer revenue streams in the industry, in my opinion.
Competition and innovation
Sage currently provides automated invoicing/accounting software, HR management systems, and asset management software. Interestingly, Goldman Sachs uses Amazon Web Services (AWS), which is a competitor to Sage Group.
Comparison with AWS is important here because of Sage’s expansion to the US. Although Sage grew recurring revenue in the region by 7%, I think that AWS already has a strong hold over the space. Adding in other competitors like Microsoft (Azure), Google, and IBM, and Sage could be overshadowed by these industry giants.
Also, AWS offers a range of customisable, sector-specific solutions. It facilitates software building, machine learning, and analytics along with traditional accounting and cloud services. Sage focuses on medium and small businesses and has fewer targeted tools. I think this is a roadblock to Sage’s margin expansion efforts, as highlighted by Goldman Sachs.
Would I invest in Sage shares?
Sage has carved a niche for itself in Europe and America. Its subscription model has over 90% customer retention figures. Financials look strong and the company has a good history of revenue generation. In the first nine months of 2021, recurring revenue increased by 5% to £1.2bn, supported by software subscription growth of 11% to £920m. The 7% growth in North America was primarily due to Sage Intacct, its construction-focused accounting software. This again tells me that sector-oriented products work better in foreign markets. This is an area I see as Sage’s primary weakness.
Looking at investor returns, the Sage share price has risen 17.5% in the last six months. But, over the last five years, returns stand at a dismal -3.3%. The UK tech company is a defensive option. Its focus on strengthening its existing product line and customer service is commendable. But is it a prudent strategy in the innovation-driven software sphere? I don’t think so.
I am optimistic about the UK’s tech industry as a whole. But there are other companies in the space that look like much better investments for my portfolio at the moment. I would prefer long-term investments in BAE Systems and BATM Advanced Communications over Sage shares today.
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Suraj Radhakrishnan has no position in any of the shares mentioned. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Microsoft. The Motley Fool UK has recommended Sage Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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