Committed some capital to software stocks amid selloff, says First Eagle's Matt McLennan

Key Concepts

• Revenue Multiples: A valuation metric comparing a company's enterprise value to its annual revenue.
• Mission-Critical Software: Software essential to the core operations of a business, where failure is not an option.
• Proprietary Databases: Unique, internal data sets owned by a company that provide a competitive advantage, particularly in training AI models.
• Operating Efficiency: The shift from "growth at all costs" to prioritizing profitability and margin expansion.
• AI Disruption: The market fear that Artificial Intelligence will render existing software business models obsolete.

Investment Thesis on Software

Matt McLennan, Head of First Eagle’s Global Value Team, explains that his firm has been actively committing capital to the software sector. The core argument is that valuations have corrected significantly, moving from the high multiples seen during periods of "torrid" growth to more reasonable levels.

• Valuation Correction: Software stocks are now trading at revenue multiples in the "three range." McLennan notes this is roughly half of what private market transactions were in recent years and a small fraction of the valuations these companies commanded when growth rates were higher.
• Margin of Safety: McLennan argues that at current revenue multiples, if these companies stopped growing and reduced expenses, they would trade at "quite modest" earnings multiples. This provides a fundamental floor for the investment.
• Efficiency Shift: Companies like Workday and Salesforce are now balancing 10% revenue growth with a newfound focus on operational efficiency.

AI: From Threat to Opportunity

A primary concern in the market has been that AI would disrupt established software players. McLennan counters this by highlighting the strategic advantages of incumbent firms:

• Data Moats: Large software companies possess massive proprietary databases (e.g., HR systems, sales/marketing data) that are essential for training and deploying effective AI solutions.
• Market Expansion: Rather than being "victims" of AI, these companies are positioned to expand their Total Addressable Market (TAM) by integrating AI into their existing, deeply embedded enterprise platforms.

Portfolio Composition and Case Studies

First Eagle’s portfolio includes a range of software investments, categorized by their "mission-critical" nature:

• Workday & Salesforce: Cited as examples of companies maintaining steady growth while pivoting toward efficiency.
• Dassault Systèmes: A French company specializing in 3D CAD software. McLennan highlights this as "mission-critical" because high-stakes engineering (e.g., designing a jet engine) requires precision that cannot be replaced by "predictive tokens" (a reference to generative AI models).
• Microsoft & Oracle: Held as part of a diversified software strategy.

The Shift Toward Corporate Efficiency

The discussion touched on Microsoft’s recent move to offer voluntary buyouts, which McLennan views as a positive signal for the sector.

• The "P&L" Investment Era: Over the last decade, software companies invested heavily through their Profit and Loss (P&L) statements to expand their product footprints and client reach.
• New Mindset: The current environment demands maximizing the efficiency of existing employee bases. This includes:
  • Using AI to assist in coding to reduce development costs.
  • Being more judicious regarding sales force expansion.
  • Reducing the reliance on stock-based compensation (issuing fewer stock options).

Conclusion

The main takeaway is that the software sector has transitioned from a speculative growth phase to a mature, efficiency-focused phase. By leveraging their proprietary data and deep integration within Fortune 500 companies, established software firms are not only surviving the threat of AI but are using it to enhance their value proposition. For value-oriented investors, the current revenue multiples offer an attractive entry point, provided the companies continue to prioritize disciplined capital allocation and operational efficiency.