SAP's first-quarter results stabilized market sentiment, and Europe's software earnings season has not yet shown clear disruption

Overview

This report is Morgan Stanley's weekly Europe software and services note, centered on the stabilizing effect of SAP's 1Q26 results on market sentiment, while also covering Indian IT services providers' outlooks, legal AI hallucination incidents, legal tech M&A, and the European data sovereignty theme. The report believes that Europe's software first-quarter earnings have not yet shown clear demand or AI-related disruption overall, but visibility on demand and AI substitution pressure in IT services still warrants caution.

Core views

The core views include: first, SAP's cloud backlog growth, S/4 HANA demand, and comments on customer migration status were all relatively reassuring; second, first-quarter results from RELX, Dassault Systemes, and Temenos indicate that quarterly reporting risk for covered European software companies is manageable; third, the weak growth outlook from Indian IT services providers creates a negative reference point for covered European IT services names such as Capgemini; fourth, legal-sector AI hallucination incidents show that accuracy, completeness, and relevance remain key constraints on AI adoption in professional content; fifth, data sovereignty will create demand in specific regulatory and public-sector areas, but the base case remains continuity rather than disruption to the existing cloud landscape.

Analysis framework

The report combines weekly event tracking, company earnings reads, cross-company read-across, valuation charts, and summaries of company guidance to observe short-term earnings trends, AI-related impacts, and medium- to long-term thematic changes in the European software and services sector.

Methodology notes

• earnings_read_acrossEarnings read-across analysis

  Use results from SAP, RELX, Dassault Systemes, Temenos, and Indian IT services providers to assess subsequent earnings risk for the European software and services sector.

  This method focuses on the transmission relationship among company results, management guidance, orders or backlog, free cash flow, and sector sentiment.

• Valuation methodsNTM P/E relative valuation

  Observe the European software and information services sector's NTM P/E relative to the STOXX Europe 600 as well as its historical mean and standard deviation.

  The valuation charts are used to assess the sector's position relative to the market, but the report excerpt does not provide an explicit buy or sell conclusion.

• thematic_researchData sovereignty thematic framework

  Analyze European data sovereignty in the context of geopolitics, AI infrastructure, regulatory compliance, and capital constraints.

  The report believes sovereign cloud and data centers will see opportunities in specific workloads and regulated industries, but non-European cloud and data centers will still dominate.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• SAP SE

  Core positive read

  Strengths

  1Q26 current cloud backlog grew 25% cc y/y, and management reiterated S/4 HANA demand, customer migration status, and the operating leverage framework.

  Weaknesses

  The 2026 outlook was slightly lowered due to the impact from Iran and the services business outlook.

  Comparison

  Compared with prior market concerns, the results and narrative were more reassuring.

  Risks

  Whether AI changes the structure of enterprise software spending, a slowdown in the 2026 services business, and macro or geopolitical events.

• RELX

  A solid reference for European software and information services

  Strengths

  No major surprises in the first quarter, with strong new sales in key divisions.

  Weaknesses

  The report does not provide more detailed financial breakdowns.

  Comparison

  As a leader in data and analytics, its solid performance supports the view that the European software earnings season is relatively stable.

  Risks

  Competition between the accuracy of legal AI-generated content and the value of professional databases.

• Dassault Systemes

  European design and manufacturing software earnings read

  Strengths

  1Q26 was in line with expectations, and free cash flow was strong, prompting a relief rally.

  Weaknesses

  The quarter had a relatively pronounced backend-loaded profile.

  Comparison

  Like SAP and Temenos, it passed through the first quarter smoothly, reducing concerns about sector disruption.

  Risks

  Customer budgets, the manufacturing cycle, and execution risk in subsequent quarters.

• Temenos Group AG

  Banking software earnings read

  Strengths

  Both revenue and profit in 1Q26 beat expectations.

  Weaknesses

  The report does not provide a more detailed analysis of business quality.

  Comparison

  Performed well in the context of a backend-loaded quarter, supporting the view that European software quarterly reporting risk is manageable.

  Risks

  Bank IT budgets, project recognition timing, and sustainability in subsequent quarters.

• Indian IT Services vendors

  Negative read-across to European IT services

  Strengths

  Some companies still guided to low single-digit growth ranges.

  Weaknesses

  FY27 outlook did not show meaningful demand acceleration, and AI may compress spending on traditional enterprise IT services.

  Comparison

  Results from HCLTech, Infosys, and Tech Mahindra weighed on global IT services sentiment and were close to Capgemini's implied growth level.

  Risks

  AI substitution, shrinking client budgets, and prolonged weak growth.

• IONOS Group SE and European sovereign cloud

  Beneficiary watchlist for the data sovereignty theme

  Strengths

  There are opportunities for sovereign cloud in the public sector, regulated industries, and specific workloads.

  Weaknesses

  Large U.S. cloud vendors still dominate the European cloud market, and capital constraints limit expansion of European sovereign data centers.

  Comparison

  The report believes European data sovereignty is continuity rather than disruption, and non-European cloud and data centers will remain dominant.

  Risks

  High customer migration costs, limited choices, insufficient capital, and uncertainty around regulatory changes.

Key data

• SAP 1Q26 current cloud backlog growth25% cc y/yAbove the previously reduced expectation of 24%.
• SAP 2027 outlookYear-over-year growth expected to accelerateManagement does not believe AI will lead to a reset of the financial outlook and reiterated the operating leverage framework.
• HCLTech services revenue growth guidance1.5-4.5% cc y/yThe outlook from Indian IT services providers is weak, affecting global sector sentiment.
• Infosys group revenue growth guidance1.5-3.5% cc y/yDid not show meaningful demand acceleration.
• Capgemini FY26 implied organic growth estimateabout 1.5-4%The report compares it with the growth outlook of Indian IT services providers.
• Potential AI disruption to the IT services industry40% of industry spending faces risk of AI disruption and may contract at a 3%-5% CAGR over several yearsFrom comments by HCLTech's CEO.
• European cloud market concentrationThe three major U.S. hyperscalers account for about 85%Used to support the core view of data sovereignty as 'continuity rather than disruption.'
• EU sovereign cloud frameworkUp to €180m, term of 6 yearsThe consortium including OVH Groupe was selected by the European Commission to provide sovereign cloud services for EU institutions.

Impact & implications

For investors, the results from SAP and some European software companies help reduce systemic concerns around the first-quarter earnings season, especially concerns about S/4 HANA demand, cloud backlog, and execution in backend-loaded quarters. However, the IT services sector remains constrained by weak demand, AI substitution, and the lack of acceleration in FY27 growth. Data sovereignty, legal AI, and sovereign cloud may create structural opportunities, but in the short term they look more like localized themes than a full re-rating of the European cloud and software competitive landscape.

Risks

• AI substitution or compression of IT services outsourcing and enterprise software spending exceeds expectations.
• The weak outlook from Indian IT services providers is transmitted further to European IT services companies.
• SAP's 2026 services business outlook and geopolitical factors lead to further downward revisions in expectations.
• Legal AI hallucination incidents increase compliance and trust risks for professional content and legal tech products.
• Expansion of European sovereign cloud is constrained by capital, customer migration costs, and the established advantages of U.S. cloud vendors.
• Morgan Stanley has investment banking or other service relationships with multiple covered companies, and potential conflict-of-interest disclosures should be noted.

What to watch

• Whether first-quarter results from European software companies in the coming weeks continue to validate the view of 'no clear disruption.'
• Whether SAP's S/4 HANA demand, current cloud backlog growth, and expectation of accelerating growth into 2027 can be maintained.
• Orders, growth guidance, and AI impact commentary from European IT services companies such as Capgemini.
• The competitive positioning of RELX and Wolters Kluwer in legal AI content accuracy, expert databases, and AI-generated products.
• Contracts, regulatory changes, and progress in sovereign cloud projects by European vendors such as IONOS and OVH related to European data sovereignty.
• Upcoming events such as Microsoft 3Q26, Capgemini 1Q26, Nemetschek 1Q26, and Indra 1Q26.