CITIC Securities: Corporate IT spending rebounds + AI productization accelerates, US stock software sector enters performance upcycle

According to the Zhitong Finance APP, CITIC Securities released a research report stating that based on the current point in time and looking ahead to the next 12 to 24 months, the firm judges that software will become the most attractive investment sector in the technology field. This is mainly because the core factors that previously suppressed the sector are expected to gradually ease and turn into positive catalysts, including corporate IT spending likely entering an upward cycle, AI productization and commercialization expected to accelerate in 2025, and the current valuation levels of most targets in the sector still being at relatively low historical levels. Although the firm believes that investors will continue to closely monitor the sustainability of performance improvements and the progress of AI commercialization, market sentiment towards investment in this sector has already shown a significant change. Looking ahead to 2025, the firm believes that targets with strong performance resilience, sustained upward momentum, and rapid AI progress will continue to benefit; companies that are expected to see a turning point in performance and are at relatively low historical valuation levels are also worth ongoing attention, with the potential for greater valuation elasticity.

The main points of CITIC Securities are as follows:

Overall Judgment: Software SaaS is the top pick for investment in the US technology sector in 2025.

Based on the current point in time and looking ahead to the next 12 to 24 months, the firm judges that software will become the most attractive investment sector in the technology field, mainly because the core factors that previously suppressed the sector are expected to gradually ease and turn into positive catalysts, including corporate IT spending likely entering an upward cycle, AI productization and commercialization expected to accelerate in 2025, and the current valuation levels of most targets in the sector still being at relatively low historical levels.

1. Software Spending: The firm has observed a broad recovery in software spending starting in the third quarter, involving a wide range of customer groups and scenarios. Previously, the SMB and digital-native customer groups, which were most affected by macro pressures and budget controls, have also shown signs of stabilizing and recovering spending. Considering that corporate spending trends often have sustainability once the direction is clear, the firm tends to believe that US corporate software spending has gradually entered a recovery cycle.

2. AI Acceleration: In terms of application software, the evolution of AI products from Assist forms to Agent forms is expected to cover more customer scenarios and generate higher ROI. Investors hope that the introduction of Agents can significantly contribute to the performance of related companies in 2025; in terms of infrastructure software, the growth of AI-related revenue mainly relies on the implementation of more AI applications in production environments. The firm believes that AI-related revenue in infrastructure software is expected to grow significantly in 2025 alongside the actual implementation of more AI applications.

3. Valuation Position: During the phase when software spending is generally under pressure, related spending often concentrates on areas with rigid spending and higher priority, as well as platform vendors that can integrate spending, while most software targets remain at relatively low historical levels. If corporate software spending enters a recovery cycle in 2025, the firm believes that related spending will gradually spread, and previously pressured sub-sectors are expected to show significant performance and valuation elasticity.

Priority Ranking: Prefer high performance elasticity and low valuation.

Based on the current situation, the firm judges that the US software sector will gradually enter an upward cycle, and factors that previously contributed to the performance resilience of software companies may become obstacles to their performance elasticity, while many targets that performed poorly during the downward cycle may achieve excess performance during the upward cycle 1) Software Subsector: Infrastructure Software > Application Software > Information Security. In the phase of economic recovery and warming IT spending by enterprises, the revenue growth elasticity under the consumption model will significantly outperform the subscription model. The bank believes that infrastructure software companies under the consumption model have the best elasticity, while the previously resilient information security sector may exhibit weaker elasticity.

2) Customer Structure: SMB Dominant > Medium and Large Enterprises. In the expectation of economic recession, compared to the relatively stable IT spending budgets and strong risk resistance of medium and large enterprise customers, the payment ability and willingness of SMB customers are clearly more susceptible to macroeconomic shocks. However, during the recovery cycle, SMB customers show significantly greater recovery elasticity.

3) Product Functionality: Front-end Applications > Back-end Applications. In a weakening economic environment, enterprises typically have a demand for cost reduction and efficiency improvement, thus showing strong investment willingness for software focused on cost optimization and efficiency enhancement in the middle and back-end. As the macro environment begins to warm up, enterprises will be more willing to boost investments related to sales and marketing, making front-end applications more performance elastic.

4) AI Attributes: Highly Related to AI > Weakly Related to AI. During the spending recovery cycle, the bank believes that the speed of AI productization and commercialization will effectively catalyze valuations. Although at the current time point, the market can see relatively few targets with disclosed related revenues or significant AI benefits, the bank has also observed positive progress from multiple companies in product testing or early adoption stages.

5) Financial Performance: High Growth Elasticity > High Profitability. At the current time point, the bank believes that the market will gradually give valuation premiums to those with higher growth potential and revenue growth elasticity. Companies still in the early stages, as well as infrastructure software companies that charge based on the consumption model and have greater revenue elasticity, are expected to benefit significantly in this environment.

2025 Outlook: Gradually Increase Allocation Weight in the Software Sector.

Based on the judgment that U.S. enterprise software spending has gradually entered a recovery cycle, the bank believes that targets with previously strong performance resilience, continuously improving prosperity, and rapid AI progress will continue to benefit in the future, including: 1) Targets in application software with superior patterns, strong execution, and rapid AI integration. 2) General ERP targets expected to accelerate performance alongside the acceleration of ERP cloudification. 3) The information security sector with continuously strong demand.

At the same time, the bank believes that companies expected to see a turning point in performance and whose valuations are at historically relatively low levels are also worth continuous attention, including: 1) Cloud infrastructure software-related targets. If demand recovery continues, combined with accelerated AI-related revenues, the bank believes that the performance growth rate of infrastructure software companies may exceed expectations and maintain high levels or even further expand, with a hope of achieving year-on-year growth recovery. 2) Targets that previously faced significant demand pressure from certain customer groups. These companies have a high proportion of SMBs, or there was excessive purchasing among certain customer groups during the pandemic, which significantly dragged down growth performance. Looking ahead, on one hand, the demand from SMB customers is beginning to stabilize and improve, and on the other hand, the impact of excessive purchasing during the pandemic will largely be digested by the end of this year. These companies are expected to regain growth momentum and realize significant elasticity Follow-up Focus: Macroeconomics and Inflation, Government Budget, GenAI Progress, etc.

Looking ahead to 2025, in addition to the analysis above, the bank believes there are several related factors worth close attention.

1. Risk of Economic Re-inflation: Although U.S. inflation has generally receded, considering that U.S. inflation remains sticky and the resilience of the labor market supports core PCE, the bank believes that U.S. inflation pressures are unlikely to dissipate quickly. The Federal Reserve may slow the pace of interest rate cuts or even adjust policies when inflation rises. If expectations for rate cuts are hindered, interest rates may remain at a high level, continuously suppressing the valuation and performance of the software sector.

2. Impact of U.S. Government Spending Cuts: The U.S. government is reducing non-core budgets by establishing the Department of Efficiency (DOGE), which may affect contract revenues and R&D funding for companies in cloud computing, cybersecurity, and other sectors. However, in the long term, global IT spending demand is expected to remain robust, and regulatory easing is favorable for market competition and technological innovation, especially in the rapid development of AI, cloud computing, and fintech.

3. Obstacles to AI Application Diffusion and Potential Risks: Despite the immense enthusiasm generated by GenAI in the market, the actual implementation process still faces issues such as computing resources, costs, security, and privacy risks. Additionally, the technological capabilities and business models of AI still need further improvement, and the performance and cost issues of AI Agents in handling complex tasks remain to be resolved, which may hinder the subsequent commercialization of AI.

Risk Factors:

Risks of core AI technology development falling short of expectations; risks of continued tightening of policy regulation in the technology sector; risks related to policy regulation of private data; risks of global macroeconomic recovery being weaker than expected; risks of macroeconomic fluctuations leading to lower-than-expected IT spending by European and American companies; potential ethical, moral, and user privacy infringement risks associated with AI; risks of corporate data breaches and information security; risks of intensified industry competition, etc