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 large language model, or LLM, capabilities 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 for a variety of companies, reducing fair value estimates, and increasing uncertainty ratings for our immediate coverage.
The bottom line: We downgrade our moat ratings to narrow, from wide, for each of the following companies: Adobe, Descartes, Manhattan Associates, Salesforce, ServiceNow, and Shopify, based on lower confidence in the long-term return profile software companies may generate in the AI era.
- We lower our fair value estimates as follows: Adobe USD 380 (from USD 560); Descartes USD 90 (from USD 96) or CAD 123 (from CAD 132); Manhattan Associates USD 170 (from USD 215); Salesforce USD 280 (from USD 300); ServiceNow USD 165 (from USD 200); and Shopify USD 120 (from USD 160) or CAD 164 (from CAD 217).
- We raise our Uncertainty ratings as follows: Blackbaud Very High (from Medium); Descartes High (from Medium); Guidewire High (from Medium); HubSpot Very High (from High); Atlassian Very High (from High); Tyler High (from Medium); and Zoom 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 software carnage.
- Our top pick is wide-moat Microsoft, which has a fair value estimate of USD 600, 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.
