Investor reaction to the risk posed by artificial intelligence (AI) to software investments has been “excessive” and “overextended”, according to a report by Adams Street Partners.
The report, written this week by Bill Sacher, head of private credit, Fred Chung, head of credit underwriting, private credit, and James Charalambides, head of European private credit, said that advances in AI have “prompted a reassessment of valuation levels and competitive positioning, leading to a broad repricing across both public and private markets”.
In liquid markets, this has resulted in “declining prices for software-related debt and meaningful outflows from vehicles with concentrated exposure”.
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However, they said the reaction has been “overextended” and that the risk lies “less in the sector itself and more in how some firms have managed their exposure and PIK interest levels”.
“We believe this reaction has been excessive and insufficiently differentiated. Some software companies that lack clear moats are undoubtedly at risk of AI disruption,” the report said.
“But many incumbent software providers possess material competitive barriers and are benefiting from incorporating AI into their platforms. This places a premium on disciplined underwriting at the sector and sub-sector level.
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“In addition, major technological shifts have historically expanded IT spending overall rather than diminished it. We expect AI to follow a similar pattern given its potential for step-change productivity improvements that can reduce future headcount needs. This creates tangible ROI that justifies incremental technology spending.”
However, they said that the market’s reaction does highlight a legitimate concern: concentration risk. “Software has been a favored sector in recent years, and some managers may have overindulged, including in loans reliant on annual recurring revenue (“ARR”) rather than cash flow”.
“From our perspective, software is not a systemic issue for private credit, but a manager-specific issue. The risk lies less in the sector itself and more in how some firms have managed their exposure and PIK interest levels.”
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