Software & Services Report Interpretation

Overview

The report assesses the fundamentals and valuation of the European software and services industry following the “SaaS apocalypse”-style sell-off in early 2026. Morgan Stanley believes that second-quarter results, CIO budgets, and evidence of AI commercialization indicate a meaningful pause in the industry downtrend. However, uncertainty remains around model capabilities, the competitive structure, and whether incumbents can preserve value, making it more appropriate to select individual stocks supported by moats and growth rather than taking a broadly bullish view of the industry.

Core views

The central issue in the first half of 2026 was not an imminent collapse in earnings, but investors' reassessment of the long-term value of software companies. The AI-related sell-off began in the summer of 2025 and intensified in the first quarter of 2026 amid advances in agentic capabilities and business workflow plug-ins. Market debate centered on five risks: whether enterprises would develop more software themselves, whether AI-native start-ups would capture market share, whether per-seat pricing would come under pressure, whether agents would demote application software to back-end systems of record, and whether AI software could maintain traditional software gross margins given higher compute costs. Selling by long-only funds and a shift in valuation frameworks toward price-to-earnings or free cash flow after deducting stock-based compensation made it harder for the industry to establish a valuation floor; the trough for the European sector broadly corresponded to approximately 1x PEG after stock-based compensation. A decomposition of prices and earnings shows that the sell-off was driven primarily by a higher risk premium. By mid-February, the average share price of covered European companies had fallen by approximately 20% at one point. Current year-to-date total returns are approximately -6% for covered companies and approximately -8% for the industry overall. The median NTM P/E of covered companies has compressed by approximately 18% year to date; average compression for software, information services, and IT services was 20%, 18%, and 13%, respectively. IT services data were influenced by an approximately 14% company-specific rerating of IONOS; excluding it, the average NTM P/E declined by approximately 22%. During the same period, aggregate consensus NTM adjusted EPS rose by approximately 9%, of which roughly 8 percentage points came from the valuation window mechanically rolling forward to FY2027 and approximately 0.5 percentage points came from estimate upgrades. This indicates that underlying earnings revisions were broadly neutral and that share-price weakness mainly reflected the market assigning a lower valuation to the durability of long-term profits. Clear divergence has already emerged within the industry. Using July 31, 2025 as the baseline, data infrastructure software was down only approximately 9% at its February 2026 trough and is now more than 40% above the starting point, as AI increases demand for data, compute, observability, and orchestration. Cybersecurity software fell by approximately 38% at one point, then recovered to approximately 3% above the starting point as AI-related security demand became clearer. Application software, information services, and IT services continue to lag: vertical software is down 28% year to date, horizontal software is down 10%, IT services is down 14%, and information services is down 16%. Application software faces a long-term value debate over pricing, moats, and ownership of agentic workflows, while IT services simultaneously faces pricing compression, investment in service-model transformation, and weak industry growth. The start of the second half of 2026 has improved markedly. Since the end of June, the median return among covered companies has been approximately 16%, versus approximately 1% for the STOXX Europe 600; SAP, Sage, and Dassault Systèmes have risen by approximately 39%, 31%, and 25%, respectively. Part of the rise reflects technical factors: the correlation coefficient between software and services and semiconductors recently fell to approximately -0.7 at one point and is currently approximately -0.4, far below the roughly ten-year average of +0.54. Following market concerns about excessive compute investment, capital rotated from crowded AI infrastructure trades into previously lagging software stocks. Fundamentals also provided catalysts, as second-quarter results generally exceeded low expectations: SAP's leading indicator of current cloud backlog beat expectations, with no slowdown in organic trends year to date; RELX's STM and legal businesses both delivered better-than-expected growth; Capgemini's second-quarter organic revenue growth exceeded expectations and it raised full-year guidance; and Sage's organic growth accelerated further in the third fiscal quarter. AI commercialization is beginning to shift from road maps toward observable pricing and revenue. Sage has tied features such as Copilot to higher-priced plans, raising the price of the Plus plan for Sage Accounting in the UK by approximately 25% to 30%. Annual pricing contribution in FY25 and 1H26 was approximately 5.5%, 0.5 to 1.5 percentage points above the historical average, while NRR continued to rise above 100%. RELX's legal business accelerated organic revenue growth from 9% in FY25 to 10% in 1H26, with adjusted operating profit up 13% and margin expanding by approximately 80 basis points to 21.7%; approximately 90% of new LexisNexis business now comes from AI-related products. SAP reseller surveys indicate that approximately 33% of partners' customers have paid to adopt Business AI or Joule, approximately 10% have observed broad deployment, 87% expect AI to increase customer spending on SAP over the next 12 months, and 80% believe AI migration tools will strengthen customers' willingness to move to S/4HANA. Since its launch in November 2025, IONOS's AI receptionist has completed approximately 15,000 services, while second-quarter ARPU for the customer cohort exceeded €70, compared with an overall customer average of approximately €17. The report expects products such as AI App and SiteBuilder to continue supporting ARPU growth in FY27. The foundation model market is becoming increasingly multi-model, reducing the likelihood that value will be concentrated among only a few model vendors. Surveys show that 63% of enterprises will use both open-weight and closed-source models. Closed-source frontier models are currently better suited to complex reasoning and agentic tasks, while open-weight models are used more often for high-frequency, cost-sensitive, or domain-specific scenarios. However, competition will lower the cost of intelligence and expand the enterprise workflows in which AI can be used. On this basis, the report believes infrastructure and cybersecurity software will benefit from demand for routing, orchestration, observability, security, and governance. Application software and information service providers with proprietary data, industry context, distribution channels, and embedded workflows may also retain a larger share of the value chain. This impact will not occur evenly. The report cites the “jagged frontier of capabilities” to explain that large language models perform strongly in tasks such as programming, drafting, and content generation, putting products that rely on simple features or user interfaces as their moat at greater risk. In tasks requiring professional context, judgment, strict compliance, governance, or cross-process integration, model reliability is weaker, and the data, rules, and workflows provided by incumbent platforms remain irreplaceable. The report therefore expects greater vendor divergence rather than wholesale disintermediation of application software. The key question is which companies can translate model advances into better products, broader usage, and incremental revenue. There is not yet evidence on the demand side that AI is broadly crowding out software budgets. The AlphaWise CIO survey forecasts IT budget growth of approximately 3.8% in 2026, slightly above 3.7% in 2025 but still below the pre-pandemic average of approximately 4.1%; 30% of CIOs expect budgets to increase, while 25% expect them to decline. Software is the fastest-growing major spending category at approximately 4.1% and the only major category expected to grow faster in 2026 than in 2025. SaaS spending is expected to increase by approximately 4.9%, and ERP applications remain among the most defensive areas. However, AI is not entirely incremental spending: 40% of CIOs fund AI by reallocating other budgets, concentrating pressure on deferrable service projects. IT services spending is expected to grow by only approximately 1.8%, supporting the report's preference for software and information services and its cautious stance toward diversified IT services. M&A and investor sentiment also provide marginal support. Europe has recorded 12 transactions year to date in 2026 with consideration of approximately $500 million or more and involving a European buyer or target. All but one were initiated by strategic buyers, reflecting a recovery in strategic M&A from the second to the third quarter. Private equity take-private transactions remain affected by tight credit and AI uncertainty. Surveys also show that most investors expect industry divergence to widen further, indicating a more balanced stance than the nearly one-sided pessimism seen at the beginning of the year. Valuations have rebounded from their lows but still embed considerable skepticism about medium- to long-term growth. The long-standing listed coverage group trades at an average NTM adjusted P/E of approximately 15.8x, below 24x roughly a year ago and also below the valuation ranges that provided support during the COVID drawdown and the 2022 rate-hiking cycle. The covered software and information services group trades at approximately 1.4x PEG, slightly below the screened STOXX Europe 600 at approximately 1.6x. Morgan Stanley believes the market was not entirely wrong to reduce industry valuations previously, and the recent rebound should not be extrapolated to a valuation significantly above the market. Stock selection should focus on companies with strong or improving growth, defensible competitive positions, the ability to benefit from AI, and remaining upside on a growth-adjusted valuation basis. The report maintains Overweight ratings on SAP, IONOS, Informa, Sage, and Amadeus and Underweight ratings on Netcompany, Temenos, and Tieto, while raising the price targets for SAPG.DE, SAP.N, and Sage from €190, $222, and 1,140p to €215, $251, and 1,245p, respectively.

Analysis framework

The report first reviews the AI debate since the summer of 2025 and share-price performance in the first half of 2026, then decomposes returns into earnings revisions, valuation compression, and calendar roll-forward to determine whether the sell-off was driven by near-term performance or a higher long-term risk premium. It then compares divergence across data infrastructure, cybersecurity, application software, information services, and IT services, combining second-quarter results, CIO budget surveys, reseller surveys, and company-specific AI pricing and adoption data to validate fundamentals. Finally, the report uses PEG and NTM adjusted P/E to map industry valuations relative to the market and forms stock preferences based on moats, growth momentum, AI opportunities, execution quality, and growth-adjusted valuation.

Methodology notes

• Valuation MethodologyP/E and PEG Valuation

  Comparison of NTM adjusted P/E and growth-adjusted PEG

  The report uses the next-12-month adjusted P/E to measure the valuation the market assigns to near-term earnings and uses PEG to match P/E with expected earnings growth. It then compares these measures with historical ranges and the screened STOXX Europe 600 to assess the potential for an industry valuation recovery.

• Industry/Sector Analysis FrameworkPrice-Volume Decomposition

  Earnings and valuation decomposition of share-price performance

  The report decomposes share-price changes into changes in earnings estimates, calendar roll-forward, and valuation multiples. It finds that the increase in NTM EPS mainly resulted from the rolling window, while actual estimate revisions were close to neutral, meaning the year-to-date decline was driven primarily by valuation compression.

• Competition and Strategy FrameworkMoat / competitive advantage

  Software moats formed by data, industry context, workflows, and distribution capabilities

  By assessing whether vendors possess proprietary data, mission-critical workflows, customer distribution, and governance capabilities, the report distinguishes companies that can use AI to enhance their products from those whose simple functionality can be readily replaced by models.

• Industry/Sector Analysis Framework

  Jevons Paradox

  The report believes that cheaper and more widely available models will reduce the cost of intelligence and increase AI usage, thereby expanding the potential enterprise AI market rather than merely lowering the prices of existing products.

• Competition and Strategy Framework

  Jagged Frontier of Capabilities

  This approach emphasizes that large language models have uneven capabilities across different knowledge tasks. The report uses it to explain why standardized content and coding tools face greater pressure, while software dependent on professional judgment, compliance, and complex processes may retain its value.

• Event-Driven Strategy and Behavioral FinanceFund Flows/Positioning Analysis

  Technology-sector rotation and crowded trades between software and semiconductors

  Using the sharp turn to a negative correlation between software and semiconductors and capital flows from AI infrastructure into lagging software stocks, the report concludes that the early second-half rebound was supported by earnings but also included technical position covering.

Asset mapping & comparison

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

• SAP SE (SAPG.DE, SAP.N)

  The report maintains its Overweight rating and raises the respective price targets to €215 and $251; resilience in the cloud business and AI-driven bundling of data products and S/4HANA migration are the main pillars of the thesis.

  Strengths

  Current cloud backlog exceeded expectations; 33% of resellers see customers paying to adopt Business AI or Joule, and 87% expect customer spending to increase over the next 12 months.

  Weaknesses

  AI has not yet become a major standalone growth driver, with its near-term contribution relying more on product bundling and migration acceleration.

  Comparison

  One of the report's preferred companies combining growth, a moat, AI opportunities, and valuation upside.

  Risks

  Model evolution, intensifying competition, and S/4HANA conversion or AI product adoption falling short of expectations.

• IONOS Group (IOSn.DE)

  The report reiterates its recent upgrade to Overweight and expects the company to enter 2027 supported by new customer acquisition, price increases, AI contributions, and cloud business growth.

  Strengths

  The AI receptionist has completed approximately 15,000 services, and second-quarter ARPU for the customer cohort exceeded €70, significantly above the overall customer average of €17.

  Weaknesses

  AI products remain at an early stage of commercialization.

  Comparison

  Its approximately 14% positive rerating during the year is highly company-specific and does not represent an overall improvement in the diversified IT services sector.

  Risks

  New customer acquisition, cloud growth, price increases, or initial AI contributions falling short of the report's expectations.

• Sage (SGE.L)

  The report maintains its Overweight rating and raises the price target from 1,140p to 1,245p, highlighting early evidence of commercialization through the combination of AI features and price increases.

  Strengths

  The UK Plus plan was repriced by approximately 25% to 30% through the bundling of Copilot; annual pricing contribution is approximately 5.5%, while NRR remains above 100%, with no material increase in churn.

  Weaknesses

  The magnitude of price increases varies across products, plans, and regions, while usage-based pricing for workflow agents remains under exploration.

  Comparison

  One of the leading companies in the early second-half rebound, returning approximately 31% since the end of June.

  Risks

  Acceptance of price increases, customer retention, or AI workflow commercialization falling short of expectations.

• Informa

  The report maintains its Overweight rating and includes it among preferred companies offering growth, a defensible position, AI opportunities, or attractive growth-adjusted valuation.

  Strengths

  The report believes its risk-reward profile meets the preferred criteria.

  Comparison

  It is included in the Overweight preference list alongside SAP, IONOS, Sage, and Amadeus.

  Risks

  Industry-wide uncertainty surrounding AI competition and model evolution.

• Amadeus IT Holdings (AMA.MC)

  The report maintains its Overweight rating and identifies it as one of its main preferences for the second half of 2026.

  Strengths

  The report believes it offers a combination of strong or improving growth, a defensible position, AI opportunities, or attractive growth-adjusted valuation.

  Comparison

  It is preferred alongside the other Overweight names over diversified IT services companies rated Underweight.

  Risks

  Industry growth, AI competition, and execution uncertainty.

• RELX

  The report cites it as evidence that AI products have translated into improved growth and profitability.

  Strengths

  The legal business delivered 10% organic revenue growth and 13% adjusted operating profit growth in 1H26, with margin rising to 21.7%; AI-related products account for approximately 90% of new LexisNexis business.

  Weaknesses

  Information services cover a broad range of products, and investors still find it difficult to assess the AI competitiveness of individual companies.

  Comparison

  Its legal and STM businesses both demonstrated better-than-feared resilience in the second quarter.

  Risks

  Rapidly innovating new entrants may create competition in adjacent markets.

• Netcompany Group (NETCG.CO)

  The report maintains its Underweight rating, believing that its risk-reward profile is affected by earnings quality, growth durability, or execution issues.

  Weaknesses

  Earnings quality, growth durability, or execution keep the report cautious.

  Comparison

  Its risk-reward profile is weaker than those of the report's preferred software and information services companies.

  Risks

  Weak IT services spending, AI-related pricing pressure, and transformation execution risk.

• Temenos Group (TEMN.S)

  The report maintains its Underweight rating.

  Weaknesses

  An insufficient risk-reward profile due to earnings quality, growth durability, or execution.

  Comparison

  It is not included among the report's preferred combination of moat, growth, and valuation.

  Risks

  AI competition, growth durability, and execution risk.

• Tieto (TIETO.HE)

  The report maintains its Underweight rating and continues to take a cautious stance toward the IT services sector.

  Weaknesses

  IT services spending is expected to grow by only approximately 1.8%, while pricing competition and service-model transformation create considerable pressure.

  Comparison

  Relative to software and information services, the report does not recommend chasing a recovery rally in IT services stocks.

  Risks

  Budget crowding-out, pricing compression, weak growth, and execution risk.

Key data

• YTD trough performance of covered companiesApproximately -20%Average share-price decline as of mid-February 2026
• Returns of covered companies since the start of the second halfApproximately 16%Median return since the end of June, versus approximately 1% for the STOXX Europe 600 over the same period
• NTM P/E compressionApproximately 18%Year-to-date decline in the median multiple of covered companies
• Change in NTM adjusted EPSApproximately +9%Approximately 8 percentage points came from calendar roll-forward and approximately 0.5 percentage points from estimate upgrades
• NTM adjusted P/E of the coverage groupApproximately 15.8x24x approximately one year ago
• Software and information services PEG1.4xApproximately 1.6x for the screened STOXX Europe 600
• Software-semiconductor correlation coefficientRecent low of approximately -0.7, currently approximately -0.4Approximately +0.54 ten-year average
• Expected IT budget growth in 2026Approximately 3.8%Approximately 3.7% in 2025 and a pre-pandemic average of approximately 4.1%
• Expected software spending growth in 2026Approximately 4.1%Fastest growth among major IT spending categories
• Expected SaaS spending growth in 2026Approximately 4.9%CIO survey result
• Expected IT services spending growth in 2026Approximately 1.8%Significantly weaker than software spending
• Percentage of CIOs funding AI through budget reallocation40%Indicates that AI spending does not come entirely from incremental budgets
• Percentage of enterprises using both open-weight and closed-source models63%Supports the view that enterprise AI is moving toward hybrid, multi-model architectures
• Sage annual pricing contributionApproximately 5.5%FY25 and 1H26 level, 0.5 to 1.5 percentage points above the historical average
• RELX legal business growth in 1H26Revenue 10%, adjusted operating profit 13%Margin expanded by approximately 80 basis points to 21.7%
• SAP paid AI adoptionApproximately 33%Resellers report that customers have paid to adopt Business AI or Joule, with approximately 10% seeing broad deployment
• IONOS AI receptionist usageApproximately 15,000 servicesSecond-quarter ARPU for the customer cohort exceeded €70, versus an overall customer average of approximately €17
• Large European software and services M&A transactions12 transactionsEach had consideration of approximately $500 million or more year to date in 2026, and all but one were initiated by strategic buyers

Impact & implications

The report believes the European software and services industry has shifted from indiscriminate risk reduction in early 2026 toward a phase that places greater emphasis on fundamentals and company-specific differences. AI has not broadly damaged software demand in the near term and has instead begun creating pricing, adoption, and revenue opportunities for some vendors. However, the benefits will not be distributed evenly, and companies with proprietary data, mission-critical workflows, distribution, and governance capabilities are more likely to preserve value. IT services face relatively greater pressure from deferrable budgets, pricing competition, and transformation investment, while near-term industry valuations also should not rise significantly above the market.

Risks

• Foundation model capabilities continue to evolve rapidly, making it difficult to determine the final form of the technology stack and the competitive positions of incumbent vendors.
• In-house enterprise development, AI-native competitors, pressure on per-seat pricing, agents controlling the user interface, and higher compute costs could still weaken the long-term economic value of traditional software.
• Point solutions with simple functionality or moats primarily derived from the user interface are more vulnerable to improvements in model capabilities.
• Forty percent of CIOs fund AI by reallocating budgets, potentially crowding out deferrable IT services and other non-core projects.
• The early second-half rebound includes technical factors such as technology-sector rotation and the covering of crowded positions, and it remains too early to conclude whether the negative correlation between software and semiconductors has ended.
• Valuations have already rebounded recently, and the industry still lacks a sufficient basis for trading significantly above the market.
• Earnings quality, growth durability, or execution at Underweight-rated companies may continue to pressure their risk-reward profiles.

What to watch

• Use the “growth cracks” screen to track whether companies' revenue and earnings trajectories are beginning to deteriorate materially.
• Compare industry PEG and NTM adjusted P/E with the STOXX Europe 600 to assess whether valuations exceed the level fundamentals can support.
• Track whether AI adoption, pricing, ARPU, and revenue contributions at Sage, RELX, SAP, and IONOS can expand further in FY27.
• Monitor CIO budgets for software, SaaS, and IT services, as well as the extent to which AI funding shifts from incremental budgets toward reallocation.
• Observe whether competition between open-weight and closed-source models continues to create multi-model architectures and how value is distributed among the model, infrastructure, and application layers.
• Monitor the negative correlation between European software and semiconductors and whether sector rotation persists.
• Track whether industry divergence widens, particularly the relative performance of vendors with proprietary data and mission-critical workflows versus simple point tools.
• Monitor whether the recovery in strategic M&A can continue and whether credit conditions and AI uncertainty continue to constrain private equity transactions.