Friends,
Between January 7th and early April, the iShares Tech-Software ETF (IGV) was down 30%. This fund includes some of the biggest industry names, including Microsoft, Salesforce, Adobe, Intuit, and ServiceNow.
We've already talked about the culprit in past newsletters: Anthropic's never-ending stream of Cowork solutions for specific industries.
We've also talked about what types of SaaS companies can actually benefit from the Era of Agentic AI:
- Hardware / Software: If a SaaS company has a hardware component (like Axon), it's less likely to be replaced by AI.
- Usage-based: If the company charges based on the amount of work done instead of the number of humans with access (like Datadog), it won't need to undergo a massive business model re-do.
- Proprietary Data: If a company has access to data that AI cannot synthetically create (CrowdStrike), it still holds the keys.
But there are tons of software names that don't have these advantages. They are working hard to transition their business to a usage-based model.
Salesforce and ServiceNow are prime examples. They are both transitioning users to AI tools (Agentforce and Now Assist, respectively). And with earnings season starting, we are likely to hear a lot about such tools. While the growth numbers for tools like this will no doubt be impressive, there are three key questions every investor should consider:
- Needle-moving: While the growth of AI tools is great, it may not be needle-moving. Agentforce, for instance, is growing 169%. But it accounts for less than 2% of overall revenue.
- Margin profile: Because AI requires computing costs, the margins are lower. Investors need to see how much lower that is.
- Making up for losses: If these AI tools are effective, many customers will renew fewer seat subscriptions. Will the gross profit (see above margin question) of AI tools make up for losses in seats?
We aren't saying that traditional SaaS is doomed. We are saying that there are a lot of moving pieces. Keeping an eye on how these pieces fit together will give investors a better idea for where the industry is headed.
Wishing you investing luck in the months ahead,
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Brian Feroldi, Brian Stoffel, & Brian Withers
Long-Term Mindset
PS - Join Stoffel in a webinar later today on this topic: The 5 Moats You Must Master - How AI Is Changing SaaS Moats. Click here to register.
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