The pace of change within the software industry has accelerated in recent months, leading to heightened uncertainty and prompting us to reassess moat ratings.
Why it matters: The capabilities of large language models are rapidly advancing and seem primed to cause at least some disruption within the industry, or at worst drive massive dislocation for many software firms.
- After an in-depth review of the software and services firms covered throughout Morningstar, we are downgrading moat ratings, reducing fair value estimates, and increasing uncertainty ratings for our immediate coverage of a variety of companies.
The bottom line: We downgrade our moat ratings from wide to narrow for these companies: Adobe, Descartes, Manhattan Associates, Salesforce, ServiceNow, and Shopify. This is based on lower confidence in the long-term return profile that software companies may generate in the AI era.
- We lower our fair value estimates as follows: Adobe to USD 380 per share from USD 560, Descartes to USD 90 from USD 96, Manhattan Associates to USD 170 from USD 215, Salesforce to USD 280 from USD 300, ServiceNow to USD 165 from USD 200, and Shopify to USD 120 from USD 160.
- We raise our Uncertainty Ratings as follows: Blackbaud to Very High from Medium, Descartes to High from Medium, Guidewire to High from Medium, HubSpot to Very High from High, Atlassian to Very High from High, Tyler to High from Medium, and Zoom to High from Medium.
Big picture: We have seen multiple “software is dead” episodes over the last 26 years and do not share the view that software moats have evaporated overnight. We therefore conclude there will be winners and losers in the AI era, and that patient investors can find value within the carnage.
- Our top pick is wide-moat Microsoft, which has a fair value estimate of USD 600 per share, as we think the firm should thrive regardless of AI. However, we think it is hard to recommend any software stock in this environment due to the extreme uncertainty.
