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In the April 2020-February 2021 period following the start of the COVID crisis, the
software sector experienced a once-in-a-lifetime valuation multiple re-rating as investors priced-in not only lower yields but also an outlook that the crisis would kick-start a “digital acceleration” spending wave with IT budgets increasing as a portion of total revenues. Yet here we are a full 14 months after the start of the COVID crisis in March 2020 and objectively, we’re really not seeing tangible evidence of this playing out as expected. We reached out to several F500 IT executives (CIOs/CTOs) to ask why, and conclude that the “digital acceleration” theme is exaggerated and is proving to be more modest and slower to layer-in to software company growth rates than we expected.

Not a single IT executive pushed back on our view that we’re just not seeing a “digital acceleration” trend show up in the numbers reported by public software companies. The consensus view of our checks was that: 1. The magnitude of the post-COVID “digital acceleration” theme was being exaggerated by technology firms and their partners. 2. While efforts to modernize and transform are indeed real, large enterprises move very slowly and we’re likely not sitting in front of a “big bang” spending pick-up in 2H21. The demand lift is being layered-in gradually, over several years. 3. We’re not seeing IT budgets ramp materially faster than overall corporate revenue growth largely because the dream of digital acceleration is meeting the reality of a still-prevalent focus on cost savings resulting from the massive economic hit that organizations absorbed in 2020. 4. The “digital acceleration” theme is not a blanket trend lifting everyone serving the technology sector. For many enterprises, “digital acceleration” has meant a faster move to the cloud and a rapid adoption in 2020 of work-from-home productivity tools.

Our base assumption is that what we’re seeing now is what we’re going to get – a still-positive demand backdrop for software spending but a gradual boost from “digital transformation” efforts that will help to keep the growth metrics of the well-positioned software firms stable (or help growth rates decelerate more gradually) in 2H21/2022. Of course, there will likely be pockets of spending where growth will be stronger than others, but this is always the case. With the software sector down 20% since mid-February and the 1Q21 results across the software sector solid but not above investor expectations, post-COVID “digital acceleration” enthusiasm has already started to wane. If we’re right – that we might see IT spending continue to improve in 2H21 as hard-hit sectors recover but that there probably won’t be an added “big bang” boost as a wave of new digital transformation projects kick-in – then we might see some continued pressure on multiples in the high-growth segment of the software space.