MS The Moat & The Journey – Assessing Software Durability + Growth in the Age of AI

Software North America Insight

Assessing Software Durability +

Equity Analyst Software is evolving to address the risks + opportunities from Josh Baer, CFA Equity Analyst AI, just as it has in prior cycles. To assess implications, we

introduce a Moat & Journey framework and come away with Chris Quintero Equity Analyst conviction on MSFT, PANW, CRWD, NET, DDOG, SNOW, and

SHOP and assume coverage of CRM/INTU at EW and ADBE/ Jonathan Eisenson Research Associate WDAY at UW.

Jamie Reynolds Research Associate Key Takeaways

Kathleen A Keyser The software industry is maturing, but we think the market has become too Research Associate negative on the group. We consider 5 key debates and introduce an industry

framework. Ryan Lountzis Research Associate

Moat and Journey - moats are important, but are not enough standalone. The

Lucas Cerisola journey is key to who has best positioned themselves for coming industry Research Associate changes.

Abhishek S Murli Software tends to follow a buy then build cycle. We are in the build phase today Research Associate

with infra & cyber already benefitting, while apps remain a later cycle play.

We establish a valuation framework based on maturity - for mature software we Software North America focus on GAAP P/E, while growth software we use EV/gross profit vs. Rule of 40. Industry View Attractive

Our key OWs best positioned across these themes are MSFT, PANW, CRWD, SHOP, NET, NOW, DDOG and SNOW.

With this report, Adam Wood assumes coverage of 9 large-cap software stocks (ADBE, CRM, INTU, IOT, MSFT, NOW, SHOP, TEAM, WDAY). See Exhibit 8 for more details.

Software Is Changing...Yet Again. Over the course of multiple decades, the software industry has undergone multiple evolutions, not just as a result of technological advancement (via more and more abstraction) but also in terms of distribution and business model changes. However, market Morgan Stanley does and seeks to do business with perception on this evolution of software has skewed companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm may have a conflict of more negative as questions of terminal value have interest that could affect the objectivity of Morgan Stanley become embedded in many valuations (e.g., S&P North American Technology Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment Software Index has underperformed the NASDAQ 100 by 40% and the S&P 500 by decision. 30% over the last 2 years). For the software space as a whole, we see 5 major For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this questions striking at the heart of the current investor debate: 1) Where does AI report.

value accrue?, 2) Can software companies effectively capture value outside of seats?, 3) Do gross margins move structurally lower?, 4) Is going headless inevitable or will closed ecosystems continue to exist? and 5) How will the end of token subsidization and the rise of "Tokenomics" impact growth in the industry? In this report, we tend to agree with the investor perception that the industry has become more mature, but think there are more opportunities than investors currently believe (we maintain an Attractive industry view on Software). To identify these risks and opportunities in this next era, we introduce an evaluation framework that assesses both business durability as well as the prospects for growth in the era of AI. We conclude that Microsoft, Palo Alto Networks, CrowdStrike, Cloudflare, Datadog, ServiceNow, Snowflake and Shopify represent our highest conviction Overweights offering the strongest combination of strong moat, businesses well setup for secular AI tailwinds and with nearer term growth inflection potential.

Please see attached Slide Deck for a deep dive into our framework and assumption of coverage.

Our Key Overweights: CRWD, DDOG, MSFT NET, NOW, PANW, SHOP, and SNOW. At the company level, we marry our Moat & Journey framework with our segmented valuation approach while also taking into account nearer term growth prospects to determine our High-Conviction Overweights (OW) and…