Read the below article written by Michal Katz, Head of Investment & Corporate Banking, Mizuho Americas:
The selloff in software has raised existential concerns for the industry and the future of software as a service (SaaS) players amid the innovations and advancements in (Artificial Intelligence (AI). While the impact of AI on the software sector is undeniable, to paraphrase Mark Twain, I believe that reports of its demise are greatly exaggerated. Software is the DNA powering our world - cars, appliances, communication, collaboration, robotics, and so much more. And while AI can automate and optimize rote and rudimentary functions, true systems of record which house proprietary and confidential data cannot be readily replaced or populated onto open instances of Large Language Models (LLM) that lack enterprise grade security, governance and guardrails. Yes, software is under attack, but do not count it out just yet.
Uneven Impacts Across Sector
Native AI companies are disrupting the existing tech world order and defining a new era in software. The recent release of a dedicated legal agent by Anthropic designed to automate legal tasks and workflows such as contract reviews, non-disclosure agreements (NDAs) and other legal briefings highlight the threats and opportunities by this changing of the guard. But the impact of AI will be uneven across the software sector.
First to feel the pain of innovation were companies providing customer call center technology, code writers and content creators. But the contagion applies to companies whose workflows and processes can be automated and lack moats, compared to those serving as systems of record, containing critical IP, sensitive data, national security information, or deep domain knowledge and experience applied at scale.
Keep Your Seatbelts Fastened
But as business models evolve from pricing by seats to consumption or value based, investors are right to question the Total Addressable Market (TAM), projected growth and appropriate metrics of valuations. AI’s promise of productivity and efficiency will impact the number of users, and the price customers are willing to pay. This is playing out real time through equity valuations. Equal weight software indexes (IGV) are down 25% over the past 45 trading days (vs. a 6% decline in the NASDAQ and a 1% decline in the S&P over the same period), the lowest multiples since April 2017 when the sector transitioned to SaaS. To compound matters, venture capital and private equity firms are grappling with the need to monetize portfolio companies they acquired in 2020-2021 with valuations exceeding what investors are willing to pay today.
While the technology superhighway is littered with legacy companies that failed to embrace change, software has proven resilient from the evolution of on premises and client server to cloud. While it is unclear how long this dislocation will last, it sure feels like we are near the bottom. The journey may be bumpy, but I wouldn’t throw software out with the bath water.