Software developer SAP beat analyst expectations while reporting earnings for its latest quarter but disappointed investors by toning down its outlook for the rest of the year, sending its stock price down more than 3 percent in recent trading Thursday.

While SAP’s progress for this quarter has been better than its previous one, analysts are saying that the Walldorf, Germany-based company will have to change its M&A strategy if it wants to stay ahead in the business applications game against rival Oracle.

“SAP reiterated its preference for small, product-driven deals, instead of large, revenue-driven acquisitions,” said Cowen & Co. analyst Peter Goldmacher in a research note.

In its latest earnings call on Thursday, the business applications maker reported a 17 percent jump in software revenues to €691 million ($873 million) from €590 million ($871.8 million). Total revenues for the quarter were €2.2 billion ($2.8 billion), an increase of 11 percent over the year-ago quarter.

Net income for the quarter increased 16 percent from €334 million ($421.9 million) last year to €388 million ($490.1 million), or €1.27 per share ($1.60) this year. Analysts had expected the company to report earnings of €381 million ($481.3 million) on revenue of €2.23 billion ($2.82 billion).

Sticking to Strategy

Unlike its closest competitor Oracle, SAP has stuck to its organic growth strategy by making smaller “tuck-in” acquisitions rather than large sweeping ones. In the last two years, the company has bought smaller companies while Oracle has bought more than 20 companies for $20 billion—the largest being PeopleSoft for $10.3 billion.

That has allowed Oracle to significantly increase its earnings and market share. In its most recently reported quarter, Oracle blew past analyst expectations with a 30 percent increase in revenues (see Oracle Spree Pays Off).

On a conference call, SAP CEO Henning Kagermann reiterated his company’s strategy and said it will not change.

“Our continued strong results and share gains have been driven by our strategy to grow our company organically, instead of through massive acquisitions,” Mr. Kagermann said. “It has been key to our success. In a nutshell, our organic growth strategy has allowed us to win.

“I want to reiterate that our growth strategy has not changed,” he added. “We will continue to look primarily to organic growth, augmented with smaller technology and product acquisitions, and through co-innovation with partners.”

However, some analysts feel that SAP will have to resort to the larger acquisition strategy to keep up with the consolidating industry.

“We view M&A as an important core competence in software as the industry consolidates, and we are skeptical of SAP’s ability to achieve consistent top line growth of [more than 15 percent] without M&A, given the mature state of the applications market,” said Mr. Goldmacher.

He also named two other factors behind SAP’s slow growth—its lack of adoption of an SOA (software-oriented architecture) strategy, which is a recent industry trend, and its push into the mid-market, which will lower its margins.

“We believe it will need to grow its top and bottom lines materially faster, something we are skeptical about, due to shortcomings in its SOA strategy, unwillingness to make large acquisitions, and our anticipated margin pressure due to its push into the lower end of the market,” said Mr. Goldmacher.

Dim Outlook

Despite good earnings, SAP’s outlook for the rest of the year seemed dimmer than it had expected. During the previous earnings call, Mr. Kagermann stuck to his forecast of 15 to 17 percent software revenue growth for 2006 (see SAP Profits amid Slowdown).

This time around, he said the company expects full-year 2006 revenues to increase over a range of 13 to 15 percent compared to 2005, based on full-year software revenue growth of 15 to 17 percent, but it was unlikely to reach these goals.

“From today’s perspective, it appears less likely that product or software revenue growth will reach the upper end of the aforementioned ranges,” the company said in a statement.

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