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STRATEGIC ACQUISITIONS MAY BE SOFTWARE STOCKS' LIFELINE AMID AI FEARS

For all the concern around U.S. Big Tec's massive AI-related CapEx budgets, the same goal of protecting competitive advantage is also driving M&A activity at many of the “non-hyperscalers”.

Jessica Rabe, co-founder of DataTrek Research, notes that the four largest public-company acquirers of seed- and venture-backed startups over the last three years – since ChatGPT launched in November 2022 – are all U.S. software companies.

Rabe cites data from Crunchbase showing that the businesses with six or more such deals are Salesforce, OpenAI, Snowflake, IBM, ServiceNow, and Stripe.

"Some of the large public companies most exposed to AI-driven disruption are also the ones most aggressively acquiring emerging competitors or businesses with complementary offerings to defend and/or possibly expand their competitive moats," writes Rabe in a note.

She adds, "These enterprise software companies don't have the same scale of cash flow as the hyperscalers to fund massive in-house AI investment, so they are increasingly turning to strategic acquisitions."

As Rabe sees it, enterprise software incumbents are proactively buying critical layers of the AI stack to strengthen their existing platforms and limit competitive threats from emerging players.

According to Rabe, investor concerns around AI CapEx are reasonable, but they miss a key piece of the puzzle: there's also a tranche of companies funneling significant capital into M&A to protect their competitive positions.

While she cautions that acquiring companies rarely cover their cost of capital in M&A transactions, she believes this path for enterprise software may ultimately demand more corporate cost discipline than the hyperscalers' open-ended CapEx commitments.

U.S. large-cap software stocks have been under heavy price pressure this year due to worries about AI-driven disruption. (The S&P 500 Software & Services Index .SPLRCIS is down about 21% year-to-date.)

However, DataTrek thinks, "Their focus on strategic acquisitions may prove to be their lifeline back to better returns if they can show the utility of these investments in the coming quarters."

(Terence Gabriel)

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