- Macro woes hit US IT investment
- AI applications a way off
It has been a tough couple of weeks for some of the biggest names in enterprise software. Sector darling Salesforce's (US:CRM) shares nosedive by as much as 20 per cent after it released a weaker-than-expected trading update last week. This negative feeling was then projected onto European peers SAP (DE:SAP) and Capgemini (FR:CAP) – which each fell around 5 per cent in the week to 5 June.
The UK’s SME-focused Sage Group (SGE) has also struggled, although the company’s share price woes have been driven by its perceived struggles. Investors turned bearish when they saw that guidance in Sage’s interim results last month implied full-year sales growth may come in slightly below the market’s prior expectations. The question now is whether this is an inevitable correction following a period of excitement, or whether the shine is coming off software-as-a-service (SaaS) stocks more permanently.
“US software earnings last week suggest that the macro environment remains challenging with expectations for a recovery pushed out marginally further,” said Stifel analyst Chandra Sriraman. “Given the scale and reach of the US peer group, there is a negative read-across for all European vendors.”
Salesforce’s chief operating officer, Brian Millham, attributed the group’s first-quarter slowdown to “elongated deal cycles, deal compression and high levels of budget scrutiny”. In other words, would-be customers are reluctant to invest in new software packages, given continued uncertainty over the path of inflation and interest rates. This seems particularly true in the US – the single-largest revenue contributor for most major SaaS groups, including Salesforce, SAP and Sage.
The latter saw US revenue growth moderate to 14 per cent in the first half, with sales growth at its Intacct accounting division falling to 27 per cent from 30 per cent at the end of FY2023. “The drop-off in percentage is simply the law of large numbers as the business gets bigger,” said Sage chief executive Stephen Hare.
It doesn’t help that organisations often buy new IT products on three-year contracts – meaning it's time to renew software purchased in 2021. “Lots of businesses used their pandemic windfalls/savings to buy products from B2B – mostly SaaS – vendors to help them operate better in a world forced online,” said Peel Hunt analyst Damindu Jayaweera. At the time, software groups were pricing their products for a more buoyant economy.
“If you think of business spend cycles as periods of overspend and underspend, we are in the midst of going into the latter from the former,” Jayaweera added. Put simply, companies such as Sage and SAP are inevitably going to be impacted by major changes to economic cycles. For now, management teams seem preoccupied with positioning their companies as leaders in the coming artificial intelligence (AI) revolution.
Salesforce’s chief executive Marc Benioff has taken to calling the group the world’s “number one AI CRM”, or provider of customer relationship management software. It’s a designation that hasn’t exactly been borne out in the group’s top line. Its data cloud business, which uses an AI model, was included in 25 per cent of $1mn-plus deals signed with customers in Q1. This is no greater than the prior quarter.
Meanwhile, Sage’s chief executive has been doing some AI boosterism of his own. In February, he said AI would change the nature of accounting – and that small businesses would soon be able to turn to the technology to balance their books. For its part, Sage has started offering an AI “co-pilot” tool to some of its customers, but if and when this will translate into new customer wins remains to be seen.
Analysts at Bloomberg Intelligence recently predicted that Microsoft (US:MSFT) would be the only large-cap software group to benefit from AI in the near term. Even so, the scale of the prize isn’t likely to be transformational at an operational level just yet. Jefferies has estimated that the group will make $10bn (£8bn) in annual recurring revenue from AI this year – or around 4 per cent of total sales.
“While it’s easier for existing vendors to demonstrate how this all works – think Microsoft or Sage’s AI demos – it’s not easy to get good usage,” said Jayaweera. “Adopting new functionality goes against our muscle memory.”
For now, many SaaS groups face an uphill battle to convince budget-conscious customers to invest more. Convincing them to become early adopters of new AI applications looks like a task for another day.
