All the chatter about AI "devouring" software might have some investors recanting their words, as highlighted in a recent report by Jefferies.
The past year has been rough for software stocks, being aptly dubbed "Saaspocalypse" last week with new agentic tools from Anthropic heightening fears of AI disrupting the software industry. The iShares Expanded Tech-Software Sector ETF (IGV), as a result, fell about 8% last week, leaving the fund down nearly 22% since the start of the year.
However, Jefferies analysts see the turbulence as a chance for investors comfortable with uncertainty. They noted that the negative sentiment is reaching its 2008 Global Financial Crisis levels.
There's been an uptick in optimism as regards to AI, giving stocks in the tech sector a boost over the past three years, except for occasional weakness in sectors such as software, which have less exposure to the booming AI data center.
The shift from AI development to application has brought about worries on the possible impact on entire industries. Post the market distress last week, over 40% of the software stocks in Jefferies' coverage are trading near historically low valuations. However, experts argue that death knells for software are "premature," saying, “incumbents who embrace the transition should emerge as long-term victors.”
The industry is plagued with fears that AI poses a threat on several fronts. AI agents and a new concept called "vibe coding" might potentially wipe out software companies' competitive advantage. A growing competition from AI-native startups like OpenAI and Anthropic could put a strain on industry margins. Furthermore, AI-powered efficiencies could lead to industry headcount reduction, destabilizing the industry's seating-based pricing model.
Activate in other parts of the tech sector is not helping the overall mood in the software space, as per Jefferies. Tech heavyweights, vying to build up computing power to train and run AI, are projected to spend roughly 60% more on infrastructure this year than in 2025.
A bulk of this capital is directed to semiconductor firms and data center hardware suppliers. In this regard, slower growing AI hardware suppliers like Advanced Micro Devices (AMD) are projected to increase revenue by over 30% this year, in contrast to Salesforce (CRM) and Intuit (INTU) who projected growth in the mid-teens.
Moreover, software enterprises are having a difficult time showing that AI is contributing to revenue growth. Jefferies estimates that AI made up no more than 3% of revenue at any of the application software companies under its coverage last year.
According to Jefferies, in the long run, current AI concerns will be disproved, and the benefits will accrue to nimble software providers who adjust to the realities of the AI transformation. They posit that the best-positioned companies are those with superior data access, established distribution networks, and deep entrenchment in enterprise workflows.
Lastly, the report states that clarity on the software ambitions of AI model providers like OpenAI and Anthropic could assist the industry. The answer to whether they want to replace software or enhance it could potentially lift the dark cloud currently hanging over the industry.