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By Yan Taw (YT) Boon
The recent global IT outage underscores the abiding importance of the software sector – and the potentially attractive opportunities within it.
On July 19, CrowdStrike (CRWD), an American cybersecurity company, botched a software update and triggered a massive IT outage that turned computer screens blue around the globe. Roughly 8.5 million Microsoft Windows devices were affected, and within several days more than 7,000 flights were canceled or delayed, health services were interrupted, and payment systems came to a standstill, resulting in at least $5.4 billion in direct losses for Fortune 500 companies (excluding Microsoft).1
We believe this painful event underscores the abiding importance of the software sector – one that, in our view, has been relatively overlooked and undervalued in recent months.
While demand for remote work drove rapid digital advancement during the COVID-19 pandemic, the software industry’s growth has since normalized as many businesses have reduced IT spending due to tighter budgets and rising interest rates. Software company valuations saw substantial earnings-multiple compression, and growth efficiency – measured by the speed at which a company recovers its sales and marketing expenses through generating new revenue – has declined sharply, dropping roughly 50% between 2021 and 2023.2 Adding to these concerns: an influx of AI startups, representing a potentially paradigm-changing threat to established software players.
We believe the software sector continues to hold great promise given its increasingly foundational role in our daily lives. Yet not all software companies, in our view, are equally positioned to secure sustained competitive advantages. In this fast-evolving industry, selectivity matters.
Though the software sector overall has been suffering double-digit earnings deceleration (estimated from 2022 through 2026), we observe that particular companies have managed to achieve mid to high single-digit incremental earnings acceleration by adopting GenAI features that enhance product offerings and boost customer engagement. That’s why we believe that investors should seek out companies that not only generate solid free cash flows, but also maintain a flexible, forward-thinking approach.
In our view, companies that seek to embrace and harness new technologies, such as GenAI, are likely to emerge as leaders in the next phase of digital transformation, driving growth and delivering long-term value for shareholders.
Sources: (1) Parametrix, “CrowdStrike’s Impact on the Fortune 500, An Impact Analysis”, July 2024; (2) McKinsey, “How efficient growth can fuel enduring value creation in software” July 29, 2024.
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