Beyond the Software Scare – A Turnaround Story

Beyond the Software Scare – A Turnaround Story

Be fearful when others are greedy, and greedy when others are fearful – Warren Buffett

For the Layman

As investors view the emergence of AI-native research companies (like Anthropic and OpenAI) as a threat to the very foundation of the Software-as-a-Service (SaaS) model, since companies can now "vibe-code" their own in-house platforms. This has led to a wide sell-off in the SaaS space alone.

This is evident in the sell-off, which is seen only in the software space, as shown in the table above comparing the performance of the iShares Expanded Tech-Software Sector ETF (IGV) and the State Street Technology Select Sector SPDR ETF (XLK).

IGV has consistently underperformed the broader tech sector despite the AI rally.

Looking ahead, these firms are expected to see a turnaround, as large organisations run on complex, interconnected ERPs and legacy systems that are difficult and costly to replace. Furthermore, instead of rebuilding core software, firms prefer to use proven tools over the long term.

Stocks set to benefit:

Source: Bloomberg
*CMP as of closing prices on 9th February 2026

The Turnaround Opportunity

Enterprise Inertia

According to rating agency Fitch, large organisations do not run on a single app; they rely on integrated mainframes and ERPs, thereby creating a complex enterprise structure that is hard to replace. Furthermore, according to Nvidia CEO Jensen Huang’s screwdriver analogy, when faced with a task, firms use an existing screwdriver rather than invest resources in creating a new one. Similarly, instead of rebuilding fundamental software or infrastructure from scratch, companies would use established tools (such as Salesforce and ServiceNow), fostering efficiency rather than unnecessary disruption.

Build vs Use Economics

Additionally, many firms lack the internal bandwidth to build and maintain custom stacks, even though they could create in-house frameworks. Creating a model is one thing, while running and maintaining it is another. Hence, it's much more cost-efficient for firms to hire software firms that integrate AI, as it would not only reduce development costs but also maintenance costs for the platform.

Operational & Risk Efficiency

Finally, there is a risk of miscomputation, as firms would have to verify their own outputs, whereas previously they had trusted a vendor to guarantee compliance and security.

Hence, in this era of evolving business moats, only firms that can create a product with defensible alpha will benefit. Firms that follow the below would benefit greatly:

1. Proprietary Data: Guarded datasets that AI models cannot access for training or inference.
2. Workflow Integration: Being so profoundly embedded in a company’s operational fabric that extraction represents a catastrophic risk.

What Caused the Dip

The two key pillars of economic moats that were disrupted are:

Coding Framework

This is probably the most significant threat as it threatens the very existence of software firms. As mentioned earlier, with the rise in AI-native companies, the concept of “vibe-coding” rose. For instance, CNBC’s tech anchor, Deirdre Bosa, recently demonstrated this by recreating a functional version of Monday. com, complete with Gmail and calendar integrations in just one hour using an AI plugin.

In line with this, Y Combinator founder Chris Paharski noted that non-technical prospects are now building internal go-to-market workflows with platforms like Replit specifically to replace expensive SaaS subscriptions. When the barrier to creating custom, enterprise-grade tools falls to near zero, the premium for off-the-shelf software evaporates.

Per-Seat Pricing Model

For years, headcount has been a proxy for Saas revenues. For instance, Salesforce uses a per-user, per-month subscription model, typically billed annually, with costs scaling based on functionality, user count, and AI add-ons. As AI enables about 50 people to do the work of 100, a business model based on the user headcount would naturally see revenue decline as headcount falls.

How Can the SaaS Comeback be Played?

The top pick for the software sector's turnaround story is Microsoft (MSFT). Microsoft offers a massive portfolio of SaaS products, with Microsoft 365 being the primary example. The company is capacity-constrained in its Azure front, which might provide a solid runway through calendar 2026 to top consensus revenue as greater AI demand is recognised.

The strongest segment in the SaaS space is cybersecurity. Cybersecurity names such as CrowdStrike (CRWD) should hold up better than other software companies in the current selloff, as security tools rely on real-time system log data that AI models cannot learn from.

Finally, the third set of companies set to benefit are enterprise software providers Salesforce (CRM), ServiceNow (NOW) and SAP SE (SAP). These companies offer end-to-end enterprise management solutions, making switching costs often high for users. Furthermore, to tap into the AI space, these companies are including their own AI agents. For instance, CRM has Agentforce, NOW has Now Assist, and SAP has Joule. The inclusion of the Agentic Operating System is expected to benefit these firms by increasing sales.

For a diversified play in the sector, investors can use the iShares Expanded Tech-Software Sector ETF (IGV).