Gerstner argues AWS, GCP and Azure enable software companies to scale faster and more capital efficiently than before.
“But the fact of the matter is because of AWS, GCP and Azure, software companies are scaling faster and in a more capital efficient way”
Gerstner says only 21 public software companies exceed $2B revenue, yet dog walking software got 100x multiples.
“There are only 21 that are worth more than $25,000,000,000 in all the public markets of all the millions of software companies that have been started.”
Gerstner found only 21 public software companies exceed $2B revenue and $25B value.
“Public software companies over 2,000,000,000 in revenue, we got to 21. Okay? There are only 21 that are worth more than $25,000,000,000”
Gerstner explains that rule of 40 and revenue multiples are shortcuts for determining free cash flow multiples.
“Whether your rule of 40 or a multiple of revenue, those are shorthands for getting at the multiple of free cash flow.”
Gerstner states 54% of software companies missed guidance expectations, worst quarter since 2022.
“54% of software companies disappointed in the quarter. And that's the worst quarter I think we've had since 2022 in terms of their view as to the future.”
Gerstner recounts Satya Nadella saying most applications are just interfaces on CRUD databases, which Benioff disputed.
“When Satya came on our pod and he said that, you know, that at the end of the day, most applications are just consumer interfaces sitting on top of a CRUD database and, you know, Mark Benioff calls me and he's like, you know, that's not true.”
Gerstner says now is the time to find the 10% of beaten-down software companies that will benefit from AI.
“90% of the companies that are down deserve to be down. Find the 10 that got thrown out with the bathwater. Find the 10%, right, that are going to benefit from AI.”
Gerstner states software trading at 4.2 times forward revenue, a generational low versus 17x peak in 2021.
“Today, we're at at about 4.2 times. So we're at a generational low in terms of the the multiple for software.”
Gerstner argues the market wrongly treats all software equally and expects meaningfully accelerating revenues from AI beneficiaries.
“And so we'll see. These guys have to deliver. And so I expect we're gonna see meaningfully accelerating revenues out of those companies,”
Gerstner says software multiples fell from 17x forward revenue in 2021 to 4.2x today, a generational low.
“We're almost 17 times forward revenue. Today, we're at at about 4.2 times. So we're at a generational low in terms of the the multiple for software.”
Gerstner explains belief that Claude Code or OpenAI Codex can build CRM systems in an hour.
“There's a belief in the world today that I can just go to Claude Code or I can go to Codex at OpenAI.”
Gerstner says now is the time to find the 10% of beaten-down software companies that will benefit from AI.
“90% of the companies that are down deserve to be down. Find the 10% that got thrown out with the bathwater. Find the 10%, right, that are going to benefit from AI.”
Gerstner says software multiples fell from 17x forward revenue in 2021 to 4.2x today, a generational low.
“Look at that peak in 2021. Right? We're almost 17 times forward revenue. Today, we're at at about 4.2 times. So we're at a generational low in terms of the the multiple for software.”
Gerstner says software valuations only recover when companies prove they are AI beneficiaries through revenue acceleration.
“So the only way that reverses, Scott, is those companies have to accelerate their core revenues and show that they are beneficiaries of AI.”
Gerstner explains investors aren't penalizing software companies for missing current numbers but reducing terminal value due to AI uncertainty.
“I'm gonna pay less for those future free cash flows. I'm not penalizing them because they're missing their numbers today.”
Gerstner explains software stocks previously traded at 35x free cash flow due to bond-like predictability.
“Give them 35 times free cash flow because I had that level of predictability. It was like a government bond.”
Gerstner says AI uncertainty has rationally caused investors to discount future cash flows and terminal values.
“I can't see as far into the future, so I'm gonna pay less for the terminal value. I'm gonna pay less for those future free cash flows.”
Gerstner explains software stocks fall before earnings miss due to higher discount rates and lower terminal values.
“We can't forecast as well. Therefore, the terminal value must be lower. The discount rate is higher and the multiple comes down. So the stocks come down well before they start missing.”
Gerstner says software stocks are down 30-40% not from missing numbers but from investors seeing cloudier futures.
“They're all hitting the numbers. But what has happened is their stocks are down 30 or 40% because investors are saying the future is cloudier than it was just a few years ago.”
Gerstner argues software stocks have reverted from premium valuations to market multiples when adjusted for stock-based compensation.
“Software stocks have reverted from a decade long superior multiple to the market to a market multiple.”